Employee Stock Options: Understanding and Calculating the Expense Implications

On 1 January 2016, Tucan granted 250 share options to each of 500 employees, which may be exercised by them only if they remain in service for three years following the date of grant. The fair value of each option is assessed as being 15. The company estimated at the time of granting the option that 50 of the 500 employees will leave before 31 December 2018, and will therefore not become entitled to exercise the options. During 2017, a further 10 employees left the company, in addition to the 15 that left in 2016. Tucan now revises its estimate to say that only a total of 40 will have left by 31 December 2018. Calculate the cumulative expense to 31 December 2017. A. 900,000 B. 1,150,000 C. 725,000

To calculate the cumulative expense to 31 December 2017, we can use the expected value of the share options granted to the remaining employees. At the time of grant, Tucan expected 50 out of 500 employees to leave before the end of the vesting period, which means 450 employees were expected to vest (500 - 50 = 450).

In 2016, 15 employees left, reducing the expected number of employees who will vest to 435 (450 - 15 = 435).

In 2017, an additional 10 employees left, so the new estimate is that 425 out of the original 500 will vest (435 - 10 = 425).

The fair value of each option is $15, and there are 250 options granted to each employee. So, the total fair value of the options that will vest by 31 December 2018 is 425 * 250 * $15 = 153,750.

However, by 31 December 2017, only 425 employees are expected to vest, so the cumulative expense recognized in 2017 would be based on these 425 employees. The calculation for 2017 would be 425 * 250 * $15 = 1,537,500.

Therefore, the cumulative expense to 31 December 2017 is $1,537,500.

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