Murray Compensation

Re: Murray Compensation, Inc.

Facts

Murray Compensation, Inc. (Murray), an SEC registrant that provides payroll processing and benefit administration services to other companies, granted 100,000 “at-the-money” employee share options on January 1, 2006. The awards have a grant-date fair value of $6, vest at the end of the third year of service (cliff-vesting), and have an exercise price of $21.

Subsequent to the awards being granted, the stock price has fallen significantly. On January 1, 2008, Murray decreased the exercise price on the stock options to $12. This downward adjustment to the exercise price was made in order to ensure that the options continue to provide intended motivation benefit to employees. However, in addition to the reduction in the exercise price, Murray also changed the vesting terms, such that the employees must provide an additional two years of service (awards will no vest on January 1, 2011).

Immediately prior to the reduction in the exercise price of the awards, the fair value was $1 per award. After considering the impact of the January 1, 2008, re-pricing, the fair value was $4 per award.

Issue

What amount of compensation expense should Murray recognize in the years ended December 31, 2008, 2009, and 2010?

Answer

2008 Compensation expense $166,667

2009 Compensation expense $166,667

2010 Compensation expense $166,667

Discussion

FAS 123 was revised during 2004. For public entities that are not small business issuers, the effective date of FAS 123(R) is June 15, 2005. FAS 123(R) 74 states that all public entities that used the fair-value-based method for either recognition or disclosure shall adopt this Statement using a modified prospective application. Under the modified prospective application, FAS 123(R) applies to new awards, and awards modified, repurchased or canceled after June 15, 2005. The awards at issue in this case were issued after June 15, 2005 and therefore must be accounted for under the provisions of FAS 123(R).

FAS 123(R) 5 states that an entity should recognize services received in a share based payment transaction when those services are received. 10 states that an entity shall account for compensation cost from share-based payment transactions with employees in accordance with the fair-value-based method. Under the fair-value-based method, the cost of services received from employees in exchange for awards of share-based compensation shall be measured based on the grant-date fair value of the equity instruments issued. A10-A17 discuss the acceptable methods of calculating fair value at the grant date. The grant-date fair value of the Murray options is $6. Following the guidance in Illustration 4(a), Share Options with Cliff Vesting, of FAS 123(R), compensation expense for the years ended December 31, 2006 & 2007 is $200,000 per year (calculation attached hereto).

However, at issue is the calculation of compensation expense for the years subsequent to the change in exercise price and vesting period. FAS 123(R) 51 states that a modification of the terms