Sample Problems Share-Based Compensation

SELF-CONSTRUCTED PROBLEMS IN FINANCIAL ACCOUNTING WITH SUGGESTED SOLUTIONS A Partial Requirement in XACRE1

Submitted by: John Kenneth M. Gonzales

Submitted to: Mr. Adriano M. Aguarin Jr.

October 3, 2016

Problem 1 (Share-based Compensation) On January 1, 2016, J Company grants its operations manager 3,000 share options. The grant is conditional upon the operations manager remaining in the company’s employ until the end of 2018. However, the share options cannot be exercised unless the share price has increased from P65 on January 1, 2016 to above P80 at the end of 2018. If the share price is above P80 at the end of 2018, the share options can be exercised any time during the next three years up to the end of 2021. The company takes into account the possibility that the share price will exceed P80 at the end of 2018 thus the share options become exercisable and the possibility that the share price will not exceed P80 at the end of 2018 thus the share options will be forfeited. The company estimates that the fair value of the share options at grant date is P28 per option. 1. What is the compensation expense in 2016? 2. What is the cumulative compensation expense in 2017? 3. What is the compensation expense in 2018?

Suggested Solution: Share options Multiply by: fair value of options Total compensation Multiply by: ratio of vesting period Cumulative compensation expense Less: prior years' compensation expense Current year’s compensation expense

2016 3,000 P28 P84,00 0 1/3 P28,000 0 P28,000

1. Compensation expense in 2016: P28,000 2. Cumulative compensation expense for 2017: P56,000 3. Compensation expense for 2018: P28,000

Problem 2 (Share-based Compensation)

2017 3,000 P28 P84,00 0 2/3 P56,000 P28,000 P28,000

2018 3,000 P28 P84,00 0 3/3 P84,000 P56,000 P28,000

K Company grants 250 share options each to its 400 employees at the beginning of 2016. The grant is conditional upon the employee working for the company over the next three years. The company estimates that the fair value of the share options at grant date is P18 per option. The company estimates based on a weighted average probability that 15% of the employees will resign during the three-year period. 33 employees resigned during 2016. The company adjusts its estimate of employee resignation from 15% to 12%. A further 22 employees resigned during 2017. The company adjusts its estimate of employee resignation from 12% to 10%. 11 employees resigned during 2018. 4. What is the compensation expense in 2016? 5. What is the compensation expense in 2017? 6. What is the compensation expense in 2018?

Suggested Solution: 4.) No. of employees Multiply by: % of employees who will not resign No. of employees entitled to share options Multiply by: share options per employee Total share options Multiply by: fair value of share option Total compensation Multiply by: ratio of vesting period Compensation expense in 2016:

400 88% 352 250 88,000 P18 P1,584,000 1/3 P528,000

5.) No. of employees Multiply by: % of employees who will not resign No. of employees entitled to share options Multiply by: share options per employee Total share options Multiply by: fair value of share option Total compensation Multiply by: ratio of vesting period Cumulative compensation expense in 2017 Less: compensation expense in 2016 Compensation expense in 2017

400 90% 360 250 90,000 P18 P1,620,000 2/3 P1,080,000 P528,000 P552,000

6.) No. of employees

400

Less: Number of employees that resigned No. of employees entitled to share options Multiply by: share options per employee Total share options Multiply by: fair value of share option Total compensation Multiply by: ratio of vesting period Cumulative compensation expense in 2018 Less: compensation expense in 2016 and 2017 Compensation expense in 2018

66 334 250 83,500 P18 P1,503,000 3/3 P1,503,000 P1,080,000 P423,000

Problem 3 (Share-based Compensation) At the beginning of 2015, M Company granted 150 share options each to its 700 employees. The grant is conditional upon the employees remaining in the company’s employ during a vesting period of three years. The company estimated the exercise price at grant date to be P75. However, the exercise price drops to P60 if the company’s earnings will increase by at least an average of 12% per year over the three-year period. The company estimates that the fair value of the share options on grant date is P20 per option if the exercise price is P60. And if the exercise price is P75, the company estimates that the fair value of the share options is P17 per option. During 2015, the company’s earnings increased by 14%. And 22 employees left during this year and the company expects on the basis of weighted average probability that a further 47 employees will leave the company during 2016 and 2017. During 2016, the company’s earnings increased by 16% and 15 employees have left and the company expects that a further 23 employees will leave during 2017. During 2017, the company’s earnings increase by only 8%. By the end of 2017, 28 employees have left the company. 7. What is the compensation expense for 2015? 8. What is the expected number of employees entitled to share options in 2016? 9. What is the cumulative compensation expense for 2016? 10. What is the compensation expense in 2017? 11. What is the cumulative compensation expense for 2017?

Suggested Solution:

No. of employees at grant date Less: Actual number of resignations Expected number of resignations Employees entitled to share options

2015 700

2016 700

2017 700

22 47 631

37 23 640

65

2015 No. of employees entitled to share options Multiply by: share options per employee Total share options Multiply by: fair value of option Total compensation Multiply by: ratio of vesting period Cumulative compensation expense Less: prior years' compensation expense Current year's compensation expense

2016 63 1 15 0 94,65 0 P20 P1,893,0 00 1/3 P631,0 00 0 P631,0 00

64 0 15 0 96,00 0 P20 P1,920,0 00 2/3 P1,280,0 00 P631,0 00 P649,0 00

635 2017 63 5 15 0 95,25 0 P17 P1,619,2 50 3/3 P1,619,2 50 P1,280,0 00 P339,2 50

7. Compensation expense for 2015: P631,000 8. Expected number of employees entitled to share options in 2016: 640 9. Cumulative compensation expense for 2016:P1,280,000 10. Compensation expense in 2017: P339,250 11. Cumulative compensation expense for 2017: P1,280,000 Problem 4 (Share-based Compensation) On January 1, 2016, G Company grants 500 share appreciation rights each to its 150 employees on the condition that the employees will stay in the company for the next three years. During 2016, 7 employees leave and the company estimates that a further 18 employees will leave during 2017 and 2018. During 2017, 5 employees and the company estimates that a further 8 employees will leave during 2018. 3 employees leave during 2018.

At the end of 2018, 50 employees exercise their share appreciation rights and 35 employees exercise theirs at the end of 2019. The remaining employees exercise their share appreciation rights at the end of 2020. The company estimates that the fair value of the share appreciation rights at the end of each year in which a liability exists as shown below. At the end of 2018, all share appreciation rights held by the employees vested. The intrinsic values of the share appreciation rights at the date of exercise at the end of 2018, 2019, and 2020 are also shown below: Year 2016 2017 2018 2019 2020

Fair Value P18 P20.5 P22.5 P24

Intrinsic Value

P18.5 P28 P30.5

12. What is the compensation expense in 2017? 13. What is the compensation expense in 2018? 14. What amount of accrued salaries should the company report at the end of year 2018? 15. What is the compensation expense in 2019? 16. What is the compensation expense in 2020?

Suggested Solution: 12.) No. of employees (150-7-18) Share appreciation rights per employee Total share appreciation rights Multiply by: fair value Total fair value Compensation expense in 2016

No. of employees (150-7-5-8) Share appreciation rights per employee Total share appreciation rights Multiply by: fair value Total fair value Accrued Liability - Dec.31, 2017

125 500 62,500 P18 P1,125,000 x 1/3 P375,000

130 500 65,000 20.5 P1,332,500 x 2/3 P888,333

Less: Compensation expense in 2016 Compensation expense in 2017

P375,000 P513,333

13.) and 14.) Share Appreciation rights not yet exercised (85x500) Multiply by fair value Accrued liability - Dec. 31, 2018 Less: Accrued liability - Dec. 31, 2017 Compensation expense related to right not yet exercised

42,500 P22.5 P956,250 P888,333 P67,917

Share appreciation rights exercised (50x500) Multiply by: intrinsic value Compensation paid for rights already exercised

25,000 P18.5 P462,500

Total compensation expense for 2018

P530,417

15.) Share Appreciation rights not yet exercised (50x500) Multiply by fair value Accrued liability - Dec. 31, 2019 Less: Accrued liability - Dec. 31, 2018 Decrease in accrued liability

25,000 P24 P600,000 P956,250 (P356,250)

Share appreciation rights exercised (35x500) Multiply by: intrinsic value Compensation paid for rights already exercised

17,500 P28 P490,000

Total compensation expense for 2018

P133,750

16.) Share appreciation rights exercised (50x500) Multiply by: intrinsic value Total payment in 2020 Less: Accrued liability - Dec. 31, 2019 Compensation expense in 2020

25,000 P30.5 P762,500 P600,000 P162,500

Problem 5 (Share-based Compensation) On January 1, 2015, JK Company grants to its executive the right to choose either cash payment equal to the value of 12,000 phantom shares, or 15,000 shares upon the condition that the executive will complete three years of service. If the executive chooses the share alternative, the share must be held for three years after the vesting period. The par value of the share is P20 and the share price at grant date is P32.The share price during the vesting period is P34, P39, and P42 on December 31, 2015, December 31, 2016, and December 31, 2017 respectively. After taking into consideration the effects of the post-vesting transfer restrictions, the entity estimates that the fair value of the share alternative is P38 per share at grant date. 17. What is the equity component on January 1, 2015 arising from the share-based payment with cash and share alternative? 18. What is the compensation expense in 2015? 19. What is the compensation expense in 2016? 20. What is the compensation expense in 2017?

Suggested Solution:

17.) Fair value of share alternative (15,000 x 38) Less: Fair value of liability on grant date (12,000 x 32) Equity component 18.) Share basis Multiply by: fair value Total Liability Compensation expense - liability component Compensation expense - equity component (186,000 / 3) Total compensation expense in 2015

P570,000 P384,000 P186,000

12,000 P34 P408,000 x 1/3 P136,000 P62,000 P198,000

19.) Share basis Multiply by: fair value Total Liability Accrued liability - Dec. 2016 Less: Accrued liability - Dec. 2015 Compensation expense - liability component in 2016 Compensation expense - equity component (186,000 / 3) Total compensation expense in 2016 20.) Share basis Multiply by: fair value Total Liability Accrued liability - Dec. 2017 Less: Accrued liability - Dec. 2016 Compensation expense - liability component in 2016 Compensation expense - equity component (186,000 / 3) Total compensation expense in 2017

12,000 P39 P468,000 x 2/3 P312,000 P136,000 176,000 62,000 374,000

12,000 P42 P504,000 x 3/3 P504,000 P312,000 P192,000 P62,000 P254,000