Stock Compensation Expense

Easy Practice Test

Intermediate Accounting 2

Easy Practice Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. Intrinsic value is equal to
a. fair market value of the option less fair market value of the common stock
b. fair market value of the common stock less fair market value of the option
c. fair market value of the option less the exercise price
d. fair market value of the common stock less the exercise price
Answer

D. The definition of intrinsic value is the fair market value of common stock less the exercise price on the grant date.

2. An expense is reported on the income statement
a. on the grant date for total value granted
b. for the amount of the intrinsic value granted on the grant date
c. at the expiration date of the stock options
d. on the exercise date
Answer

B. Companies must record an expense on the grant date for intrinsic value of options granted. Intrinsic value is the fair value of the common stock less the exercise price. Most companies set the exercise price equal to the fair value of common stock on the grant date to avoid the expense of intrinsic value on the grant date. 

3. Most companies set the exercise price equal to
a. fair market value of the stock on the grant date
b. expected fair market value of the stock on the expected exercise date
c. fair market value of the option
d. fair market value of the option plus fair market value of the stock
Answer

A. The exercise price is typically set at the fair market value of the common stock on the grant date. This gives no intrinsic value and the employee is compensated based on the increase in the common stock price from the date of the grant.

4. Total value granted is equal to
a. total options granted times the fair market value of the common stock on the grant date
b. total options granted times the fair market value of the options on the exercise date
c. total options granted times the fair market value of the options on the grant date
d. total fair market value of stock plus total fair market value of the options granted on the grant date
Answer

C. Total value granted is equal to total stock options granted multiplied by the fair market value of the stock option on the grant date.

5. The annual stock option expense is equal to
a. total value granted divided by the exercise date
b. total value granted divided by the years the employee has to exercise
c. total value granted divided by the vesting period
d. none of the above
Answer

C. The annual expense for stock options is equal to the number of options granted times the fair market value of the stock option ( equals total value granted) divided by the vesting period. 

6. The exercise date is the
a. date the options are awarded to the employees
b. date the employee purchases stock from the company at the exercise price
c. date the employee sells stock purchased from the company
d. date the employee has vested the options
Answer

B. The exercise date is the date the employee purchases common stock from the company by paying cash per share equal to the exercise price.

7. The fair market value of an option is determined by
a. the bid ask quote on an exchange for similar options of the company
b. using the Black Scholes model
c. using a quantitative model that considers factors relative to the stock
d. all of the above can be used to determine fair market value of the option
Answer

D. All of the listed methods can be used to determine the fair market value of the stock option which is used to determine the annual expense.

8. To record stock option compensation expense
a. stock option expense is the credit
b. paid in capital – common stock is the credit
c. paid in capital -stock option is the credit
d. paid in capital – stock option is the debit
Answer

C. To record stock option compensation expense, the expense is debited and paid in capital – stock option is credited.

9. The amount reported on the income statement is
a. the total value of stock options granted divided by the vesting period
b. the total value of stock options granted
c. the intrinsic value times the number of options granted divided by the vesting period
d. the total fair market value of the stock on the exercise date
Answer

A. The amount reported on the income statement is the expense which is computed as total value of stock options granted divided by the vesting period.

10. A stock appreciation right rewards
a. employees in stock as the stock price decreases
b. employees in stock as the stock price increases
c. employees in cash as the stock price increases
d. either a. or b.
Answer

D. The employee is compensated based on the increase in the company’s common stock over and above the base price set in the stock appreciation right agreement. As the common stock increases, the employee earns compensation. The employee can be paid in either common stock or cash as stated in the agreement.

11. A company granted a restricted stock award of 1,000,000, $1 par, common shares, to executives at the beginning of the current year. The shares are earned over a period of 3 years. The fair market value of the shares was $15 on the grant date. The fair market value of the common shares at the end of the 3 subsequent years was $12, $16, and $14 respectively.

A. Record the required journal entries for the first year.
B. Record the required journal entries at the end of the third year.

Answer

Granting restricted stock is expensed over the vesting period. Subsequent changes in fair market value of the stock are ignored. It is accounted for much like a stock option.

1st – Compute total value granted and calculate annual expense

   FMV of the stock awarded $15
x # stock granted                     x 1,000,000
   Total Compensation value 15,000,000
/ Vesting period                3 years
  Expense for each period 5,000,000

A. Grant Date:   No entry is made

End of the 1st year

Stock Compensation Expense          5,000,000
           C.S. – Restricted Shares                        5,000,000

B  End of the 3rd year:

Stock Compensation Expense            5,000,000
            C.S. – Restricted Shares                         5,000,000

Common Stock – Restricted Shares       15,000,000
             Common Stock                                           1,000,000
             Paid in Capital – C.S.                                   14,000,000

When the shares are issued to employees, the C.S. restricted is removed from the books for the total amount previously recorded.

Common stock is always par value x # shares, PIC is a plug to balance

12. On January 1, of the current year, Layton Co. granted a total of 180,000 stock options to purchase $2.50 par value common stock at $48 per share. The options had a fair market value of $6 on the date of the grant. All options were exercised at the end of the year 5 years after the grant date when the stock price was $59 per share. The options vest over 4 years and are exercisable for 2 years after the vesting date.

A. Calculate the total value of the options and the expense for each year.
B. Prepare all required journal entries for 1) the grant date, 2) end of the 2nd year, and
3) the exercise of the stock options

Answer

A. Compute total value granted and calculate annual expense

   FMV of the stock awarded $6
x # stock granted                x   180,000
   Total Compensation value 1,080,000
/ Vesting period             4 years
  Expense for each period 270,000

B.
1) Grant Date:     No entry is made

2) End of the 2nd year:

Stock Option Expense                    270,000
           Paid In Capital – Stock Options      270,000

3) Exercise of stock options:

Paid In Capital – Stock Options          1,080,000
Cash                                                        8,640,000
            Common Stock                                          475,000
            Paid In Capital – Common Stock          9,245,000

PIC – Stock Options: remove the total value when all options are exercised

Cash: number of options exercised x exercise price (180,000 x $48)

Common Stock: options exercised x par value (180,000 x $2.50)

PIC – C.S.: always a plug to balance

13. At the beginning of year 1, the company granted 100,000 stock appreciation rights that give employees the right to receive cash of $1 per share for each $1 the fair market value of the company’s stock is greater than $30 at the end of 2 years. The fair market value of the company’s stock was as follows:

Beginning of year 1 $30
End of year 1 $33
End of year 2 $38

Record the journal entries required at the end of both years the stock appreciation plan is in place.

Answer
Year 1 Year 2
Fair Market Value of stock at the end of the period 33 38
– Base price in the agreement                                                    30            30     
Increase in value of stock since agreement 3 8
x number of SARs issued                                                      100,000 100,000
Total estimated amount to be paid at end of agreement 300,000 800,000
x years since plan started/vesting period                                 1/2           2/2   
Cumulative expense to date 150,000 800,000
– Expense recognized in prior years                                           0       150,000
Expense this year 150,000 650,000

Year 1 – no entry at the grant date

Year 1 – end of period

Stock Appreciation Right Expense                 150,000
            Stock Appreciation Right Liability                         150,000

Year 2 – end of period

Stock Appreciation Right Expense                650,000
           Stock Appreciation Right Liability                         650,000

Stock Appreciation Right Liability                800,000
            Cash                                                                          800,000

The stock appreciation right liability account should equal what is owed at the end of the plan. Payment reduces the liability to 0.