Non-Compensatory & Compensatory Share Option Plans Flashcards
(17 cards)
True or False:
As per the FASB, the compensation cost for stock options is recognized using the fair value method.
True
True or False:
Under the fair value method, the fair value of the options expected to vest, prevailing at the grant date, is used to determine the total compensation expense.
True
True or False:
When using the fair value method, the difference between the market price of the stock and the option price on the measurement date equals the total compensation cost.
False
When using the fair value method, the total compensation cost is equal to the fair value of the options expected to vest, as prevailing on the grant date. It is worth noting that the grant date is the date on which the options are granted to the employees.
True or False:
The date on which the number of shares an employee is entitled to receive and the fair market value of the stock are known is considered to be the measurement date.
False
The date on which the number of shares an employee is entitiled to receive and the purchase/option price of the stock are known is considered to be the measurement date.
True or False:
When using the fair value method to account for compensation cost, the compensation expense is reported on the income statement on the measurement date.
False
When using the fair value method, the compensation expense is allocated over the vesting period or the period over which employees perform the services they are supposed to.
True or False:
A restricted stock plan is considered advantageous because it never becomes worthless.
True
True or False:
The fair value of a restricted stock granted to the employees is determined on the grant date and allocated over the whole vesting/service period.
True
True or False:
The unearned compensation associated with restricted stock plans is not an asset for the corporation. It represents the cost of services that are not been performed yet and is reported as a contra-equity account.
True
On January 2, 20×3, XYZ company granted one of its executives an option to purchase 500 shares of its common stock, at a price of $40 per share. This option may be exercised within 1 year from the end of the service period. To determine the executive’s total compensation expense, XYZ company used a fair value option pricing model and estimated the fair value of the option granted at $1,500, on January 2, 20×3.
The option was exercised on July 1, 20×6, when the quoted market price of XYZ stock was $45 per share. Three months later, the executive sold the 500 shares acquired at a market price of $50 per share.
Given that the service period for the executive is three years, starting from January 2, 20×3, determine the compensation expense that XYZ company should recognize in its 20×3 income statement:
a. $500
b. $1,500
c. $417
d. $0
a. $500
The executive’s compensation expense is computed based on the fair value of the option granted as it was prevailing on the grant date. Therefore, the total compensation expense is $1,500. This total has to be allocated over the service period, which is the period when the executive performs the services for which he is compensated. Given that the service period starts from Jan 2, 20×3 and lasts for 3 years (20×3, 20×4, and 20×5), the compensation expense that should be recognized for 20×3 equals $1,500/3 = $500.
On January 1, year 2, Palma Co granted its employee John an option to purchase 200 shares of Palma Co. stock for $27 per share. The option has to be exercised before the end of year 6, or else it will expire. The total compensation expense of John was determined to be $820 using a fair value option pricing model.
On June 1, year 4 John exercised his option. He held the shares for 2 months before selling them on August 1, year 4. The quoted market prices of the stock of Palma Co during year 4 were as follows:
January 1 – $30 per share
June 1 – $40 per share
August 1 – $45 per share
The service period of John begins on January 1, year 2 and ends on January 1, year 4. Using the fair value method, determine the compensation expense that Palma Co should report on its year 2 income statement:
a. $820
b. $410
c. $0
d. $240
b. $410
John’s compensation expense is computed based on the fair value of the option granted as prevailing at the grant date. Therefore, the total compensation expense is $820. This total has to be allocated over the service period, which is the period over which John should be providing his services. Given that the service period starts from Jan 1, year 2, and ends on January 1, year 4, the compensation expense that should be recognized for year 2 equals $820/2 = $410.
By the end of year 1, Farhat Company granted its executives options to buy 50,000 shares of its common stock, which has a par value of $10, at an option price of $60 per share. The total compensation expense was determined to be $250,000 using the Black-Scholes option pricing model. The employees may exercise their options starting from January 1, year 2. The service period starts on January 1, year 2, and runs until December 31, year 3. Under the fair value method, what would be the impact of the stock option on Farhat company’s net income for year 2, given that none of the employees had exercised their options during that year?
a. Net income would decrease by $250,000
b. Net income would decrease by $125,000
c. There is no impact on the net income because none of the options were exercised
d. Net income would increase by $250,000
b. Net income would decrease by $125,000
The total compensation expense should be allocated over the service period regardless of whether the employees have exercised their options or not. Therefore, Farhat company has to report a compensation expense of $125,000 in each of the years 2 and 3. As a result, the net income reported in year 2 will decrease by $125,000, and the journal entry that the company would prepare at year-end to account for these stock options is:
DR Compensation expense $125,000
CR Additional Paid-in capital – Stock Options $125,000
Thus, the correct answer choice is (B Net income would decrease by $125,000.
All of the following statements represent characteristics of noncompensatory stock option plans except for:
a. All the employees working full time should be eligible to participate to the plan on an equitable basis
b. No substantive option feature should be offered by the plan
c. The holder of the option has an unlimited period to exercise its option
d. the discount offered through an exercise period that would normally be lower than the market price should be reasonable
c. The holder of the option has an unlimited period to exercise its option
By definition, an option gives its holder the right to purchase a stock at a predetermined price, within a specified period of time. Therefore, the time period over which the holder may exercise its option can not be unlimited.
On March 31, year 3, Prime Company distributed compensatory stock options to 5 of its key employees allowing them to purchase 7,000 shares of its $20 par value common stock. At that date, the fair market value of Prime Co’s stock was $40, while the option price was determined at $35. The options are exercisable beginning year 5 provided the employees are still employed by the company at the time they exercise their options. If not exercised by the end of year 7, all the options granted expire. The total compensation expense was determined to be $45,000 using a fair value option pricing model. On April, year 5, all the options were exercised, and Prime Co issued 7,000 shares when the market price of its common stock was $41 per share. Using the fair value method, determine the compensation expense associated with these options that should be reported on Prime Co’s income statement for year 3. The service period is for 3 years starting from the grant date.
a. $15,000
b. $45,000
c. $0
d. $11,250
d. $11,250
The total compensation expense, determined using the fair value option pricing model should be allocated over the service period of 3 years. Therefore, the annual compensation expense that should be reported on the income statement is equal to $45,000/3 = $15,000.
Given that the service period started on March 31, year 3, the compensation expense that should be reported on the income statement for year 3 is equal to $15,000 x 9/12 = $11,250
Among the statements listed below, determine the one that does not represent an advantage of restricted stock plans.
a. Restricted stock supports the alignment of the employees’ incentives with the company’s incentives.
b. Restricted stock received by the employees may be sold or transferred anytime, even before the vesting occurs
c. Restricted stock does not become worthless
d. Restricted stock reduces the dilution of the existing stockholders’ earnings per shares
b. Restricted stock received by the employees may be sold or transferred anytime, even before the vesting occurs
Restricted-stock plans consist of transferring shares of common stock to the employees that they are not allowed to sell or transfer before the vesting occurs.
True or False:
When a corporation grants executive stock appreciation rights as a compensation for their services, the difference between the market price of the stock at the grant date and its book value represents the value of compensation.
False
When a corporation compensates its executives with stock appreciation rights, the difference between the market price of the stock at the exercise date and a pre-established price represents the value of the compensation.
When a company grants its employees stock appreciation rights, the compensation expense of these employees is measured:
a. on the date when the rights are granted
b. on the date when the rights are exercised
c. on the date at which the stock price rises above the predetermined price
d. on the date the employees sign their employment contracts
b. on the date when the rights are exercised
When a company grants its employees stock appreciation rights, it has to pay them the difference between a predetermined stock price and the market value of the stock prevailing at the exercise date.
On January 1, year 2, Justin Corporation granted its executives 4,000 stock appreciation rights exercisable within the next 4 years. The exercise price associated with these rights is determined to be $10. At the time the executives exercise their rights, they receive the difference between the market value of the stock and the predetermined stock price in cash.
The service period for the executives goes from Jan 1, year 2 till Dec 31, year 3. The fair value of the stock on Dec 31, year 2 and Dec 31, year 3, was $15, and $12, respectively.
What is the journal entry that Justin Corporation would record on Dec 31, year 3 to account for the stock appreciation rights?
a. DR Liability for Stock Appreciation Plan $2,000 CR Compensation Expense $2,000
b. DR Liability for Stock Appreciation Plan $8,000 CR Compensation Expense $8,000
c. DR Compensation Expense $10,000 CR Liability for Stock Appreciation Plan $10,000
d. DR Compensation Expense $2,000 CR Liability for Stock Appreciation Plan $2,000
a. DR Liability for Stock Appreciation Plan $2,000 CR Compensation Expense $2,000
Justin Corporation has to pay its executives who decide to exercise their rights, the difference between the predetermined price of $10, and the fair market value of the stock at the exercise date. The amounts to be paid by the corporation represent the executive’s compensation for their service period of 2 years.
At the end of year 2, the corporation has to accrue for the liability associated with the 4,000 rights. It amounts to 4,000 x $5 = $20,000, computed based on the difference between the $10 and the fair market value of $15, prevailing on Dec 31, year 2. This amount should be allocated over the 2 years of service.
Thus, the journal entry recorded on December 31, year 2 is:
DR Compensation expense $10,000
CR Liability for the stock appreciation rights $10,000
At the end of year 3, given that the fair value of the stock went down to $12, the liability that should be reflected on the year 3 balance sheet is equal to: 4,000 x $2 = $8,000 which is less than the liability recorded by the end of year 2.
Therefore, the journal entry to be recorded on Dec 31, year 3 would be:
DR Liability for the stock appreciation rights $2,000
CR Compensation expense $2,000
