Gryphon Gifts Inc. Compensation Incentive Plan

Gryphon Gifts Inc. (“Gryphon” or “the Company”) is a retailer of novelty gifts and souvenirs based in King of Prussia, PA, and is an SEC registrant. In order to incentivize its employees to work hard, Gryphon created a compensation incentive plan in which a total of 120,000 options were granted on January 1 of this year (Year 1). On that date (the grant date), Gryphon’s stock price was $16.00 per share.

The key terms of the compensation incentive plan are the following:

• The exercise or “strike” price of the options is $16.00 (the price the employee would pay to acquire a share of the Company’s stock if the options vest).
  
  
• In order for the options to vest, the following must take place:
  
  
  • The employee must continue to provide service to Gryphon throughout the entire five-year explicit service period.
    
    
  • Gryphon must attain annual sales of at least $18 million during the fifth year of the explicit service period.
    
    
  • Gryphon’s share price must increase by at least 20 percent over the course of the five-year explicit service period.
    
    
• Additionally, should Gryphon achieve sales of at least $24 million during the fifth year of the explicit vesting period, the exercise price of the options will decrease from $16 to $12.
  
  
• The options will expire after 10 years from the grant date.
  
  
• The options are designated as equity awards.

The following additional assumptions and facts also hold:

• Assume that at all times, it is probable that 100 percent of the employees eligible for the awards will continue to provide service to Gryphon as employees for the entire five-year explicit service period, which has been determined to be the requisite service period.
  
  
• As of the grant date, Gryphon’s management deemed it probable that the Company’s sales in the fifth year will be $28 million, and thus it is probable as of the grant date that sales are greater than or equal to at least $24 million.
  
  
• The grant-date fair value of the options assuming an exercise price of $16 is $9 per option. The grant-date fair value assuming a strike price of $12 per option is $14 per option.

Required:

1. What conditions (market, service, performance, and/or “other”) exist in the plan for the vesting of the stock options?
   
   
2. Which of the various conditions present in the stock option awards affect:
   
   
   1. The vesting of the award?
      
      
   2. Factors other than vesting of the award? What is the appropriate accounting treatment for these factors? (No journal entries needed.)
      
      
3. As noted above, on the grant date of January 1, Year 1, $28 million of sales were probable for Year 5. During Years 1-3, $28 million of sales for Year 5 remained probable. At the commencement of Year 4, management deemed it probable that only $21 million of sales will occur for Year 5. Determine the appropriate accounting treatment and journal entries for Years 1-5.
   
   
4. Gryphon’s share price remained at $16 through the end of Year 5 and thus the market condition was not met. What impact does this have on the accounting for the stock option award? (No journal entry needed.)