PROBLEM 2 At the beginning of the Year 1, the entity grants 200 shares each to 500 employees, conditional upon the employees’ remaining in the entity’s employ during the vesting period. The shares...

At the beginning of the Year 1, the entity grants 200 shares each to 500 employees, conditional upon the employees’ remaining in the entity’s employ during the vesting period. The shares will vest at the end of the Year 1 if the entity’s earnings increase by more than 18%; at the end of Year 2 if the entity’s earnings increase by more than an average of 13% per year over the two-year period; and at the end of Year 3 if the entity’s earnings increase by more than an average of 10% per year over the three-year period. The shares have a fair value of P30 per share at the start of Year 1, which equals the share price at grant date. No dividends are expected to be paid over the three-year period.


By the end of Year 1, the entity’s earnings have increased by 14%, and 30 employees have left. The entity expects that earnings will continue to increase at a similar rate in Year 2, and therefore expects that the shares will vest at the end of Year 2. The entity expects, on the basis of a weighted average probability, that a further 30 employees will leave during leave during Year 2, and therefore expects that 440 employees will vest in 100 shares each at the end of Year 2.


By the end of Year 2, the entity’s earnings have increased by only 10% and therefore the shares do not vest at the end of Year 2. 28 employees have left during the year. The entity expects that a further 25 employees will leave during Year 3, and that the entity’s earnings will increase by at least 6%, thereby achieving the average of 10% per year.


By the end of Year 3, 23 employees have left and the entity’s earnings had increased by 8%, resulting in an average increase of 10.67 % per year. Therefore, 419 employees received 100 shares at the end of year 3.