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Long Shot

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Submitted By schmalz89
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The 1,000 employee stock options granted on January 1, 2006 have two vesting conditions; the first being a performance condition and the second being a service condition according to ASC 718-10-20. The performance condition requires the company to achieve cumulative revenue in excess of $10 million over a three year vesting period. The service condition, instead, requires that the eligible employees have to be still employed by Long Shot after the three-year reporting period. These conditions have both to be met to vest the options.
Based on ASC 718-10-30-27 Long Shot should use the $9 grant-date fair value to measure its compensation cost. The codification determines that performance and service conditions are not reflected in the estimate of the fair value of an award at the grant date because those conditions are restrictions that stem from the forfeitability of instruments to which employees have not yet earned the right. Since the $6 grant-date fair value has the revenue target factored into the fair value assessment it should not be used.
Plus to strengthen the previous stated paragraph, ASC 718-10-55-64 says “Performance or service conditions that only affect vesting are excluded from the estimate of grant-date fair value”. As mentioned above current conditions affect exclusively vesting and thus are not to be factored into the fair value at the grant date.
Compensation cost is generally recognized from the grant date through the vesting date. ASC 718-10-30 requires an estimate of the requisite service period based on an analysis of all vesting conditions, explicit, implicit, and derived service periods, and the probability that performance or service conditions will be satisfied. Long Shot should recognize compensation cost associated with the stock options over three years, because Management believes it probable that the company will achieve cumulative revenue in excess of $10 and an explicit period of three years is stated in the terms of the share-based award.

ASC 718-10-25-20 requires accruals of compensation cost when the outcome is probable. Since the management believes that the required revenue goal is probable, compensation expense should be accrued from when Long Shot granted the option (January 1st 2006 grant-date) until the performance condition is achieved not exceeding December 31st 2008, date in which the performance condition will expire. In our opinion, since no further details have been provided, as soon as Long Shot hits 10 million dollars and the employees granted the option are still employed, the award will automatically vest.
According to 718-10-35-3 compensation cost is recognized only for awards that are estimated to vest at the end of the requisite service period and will be adjusted to reflect those awards that do ultimately vest. It also states that the cumulative effect on current and prior periods of a change in the estimated number shall be recognized in compensation cost in the period of the change. At the grant date Long Shot’s management assumed a 10% turnover rate. Actual forfeitures in 2006 however are 4%. Management should change their estimate in turnover to 4% at the end of 2006 due to the incentive effects of the options. Therefore, in this example, the compensation cost to be recognized over the requisite service period is $8,640 (1,000 options x.96 = 960 x $9), and the compensation cost to be recognized during each year of the 3-year vesting period is $2,880 ($8,640 ÷ 3). At the end of 2008 when the award becomes vested, actual forfeitures have averaged 4 percent per year, and no further adjustment is necessary.
Long Shot should also reassess the probability of vesting at the end of each reporting period for awards with performance conditions and adjust compensation based on its probability assessment. Since management didn’t indicate concerns regarding the probability of achieving the revenue goal no changes in compensation cost need to be made.

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