Stock Compensation Expense
Hard Practice Test
Intermediate Accounting 2
Hard Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
b. the amount an employee earns from a stock option is equal to the fair market value of the common stock at the time of exercise less the exercise price when sold on the exercise date
c. stock option expense can decrease paid in capital
d. the assets of the company decrease when an employee exercises a stock option
Answer
D. When an employee exercises a stock option, cash is paid to the company and assets increase. All other accounts used are owners’ equity and total owner’s equity increases also. Whether or not a stock appreciation right or a stock option is more profitable to the employee depends on the exercise price and the terms of the SAR (a.). (b.) is always true. Stock option expense increases paid in capital unless the entry is to reduce the expense due to forfeitures (c.)
b. the total value granted to employees
c. the fair market value of common stock on the exercise date less the exercise price
d. none of the above
Answer
D. Intrinsic value is the difference in the fair market value of the common stock and the exercise price of the stock option on the grant date. Stock option expense and total value granted is based on time value + intrinsic value at the time of the grant.
3. A company typically issues a stock appreciation right that pays the employee in cash when
a. the company does not want to dilute earnings per share
b. the company wants to give more compensation to employees than would be given if the employee was paid in stock
c. the exercise price is higher than the value of the common stock at the end of the plan
d. employees do not believe the company’s common stock will increase in value
Answer
A. When the company pays the employee in cash there are no additional shares issued and weighted average shares is not increased. Increasing weighted average shares dilutes earning per share. The company’s goal is to give the employee incentive to increase the value of the company (share price), and not dilute earnings per share.
b. time value
c. intrinsic value
d. value of the common stock on the grant date
Answer
A. Stock option expense and total value granted is based on time value + intrinsic value at the time of the grant.
b. stock options are exercised by employees
c. the annual stock option expense is recorded
d. none of the above
Answer
D. Granting stock options has no impact on stockholder’s equity; no journal entry is made. When stock options are exercised, shares are issued which increases total stockholder’s equity. Recording stock option expense increases PIC-stock options, an owner’s equity account.
6. At the beginning of year 1, the company granted 100,000 stock appreciation rights that give employees the right to purchase for $30 shares of $.01 par value common stock for each $1 the fair market value of the company’s stock is greater than $30 at the end of 3 years. A three-year call option to purchase the stock at $30 is currently valued at $6 per share. 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 $28
End of year 3 $34
A. Record the journal entries required at the end of each year to record the expense.
B. What will be reported on the financial statements at the end of the 2nd year?
C. Record the award of the shares at the end of the 3rd year.
Answer
An SAR awarded in stock is treated and accounted for like a stock option granted.
Fair market value at the end of each year is not relevant and is ignored.
1st – Compute total value granted and calculate annual expense
| FMV of the SAR | $6 |
| x # shares granted | x 100,000 |
| Total Compensation value | 600,000 |
| / Vesting period | 3 years |
| Value each period | 200,000 |
End of the 1st and 2nd and 3rd year
| Stock Appreciation Right Expense 200,000 C.S. – Restricted Shares 200,000 |
B. Financial Statements at the end of the 2nd year will report:
Income Statement:
Stock Appreciation Right expense 200,000
Balance Sheet:
Common Stock – Restricted Shares 400,000
C. End of 3rd year – Award of shares:
| Cash 3,000,000 Common Stock – Restricted Shares 600,000 Common Stock 1,000 Paid in Capital – C.S. 3,599,000 |
A. Calculate the total value of the options granted and the amount to be expensed at the end of each annual period.
B. Prepare the required journal entries for the grant date and the end of the 2nd year
C. Record the exercise of one half of the stock options (100,000).
D. What will be reported on the financial statements at the end of the year three years after the grant date?
Answer
A.
| FMV of the stock awarded | $6 |
| x # stock granted | x 200,000 |
| Total Compensation value | 1,200,000 |
| / Vesting period | 5 years |
| Value each period | 240,000 |
| Expected Vested % | 88% |
| Expense each period | 211,200 |
B. Grant Date: no entry made
End of the 2nd year:
| Stock Option Expense 211,200 Paid In Capital – Stock Options 211,200 |
C. Exercise of ½ of the stock options:
| Cash 2,800,000 Paid In Capital – Stock Options 528,000 Common Stock 200,000 Paid In Capital – Common Stock 3,128,000 |
Cash: 200,000 x ½ =100,000 shares x $28 exercise price
PIC – Stock Options: 1,200,000 x 88% x ½
Common Stock: par value of $2 x 200,000 x ½
PIC – CS: always a plug to balance the journal entry
D. Financial Statements at the end of the 3rd year following the grant:
Income Statement:
Stock Compensation expense 211,200
Balance Sheet:
Common Stock – Restricted Shares 633,600
A. Calculate the total value of the options and the expense for each year.
B. Prepare all required journal entries for the current year through the exercise in the 5th year
C. What will be reported on the financial statements at the end of the 2nd year after the grant date?
Answer
A.
| FMV of the stock awarded | $6.25 |
| x # stock granted | x 400,000 |
| Total value 2,500,000 x 94% = 2,350,000 | |
| / Vesting period | 4 years |
| Value each period | 625,000 |
| Expected Exercise % | 94% |
| Expense each period | 587,500 |
B. Grant Date: no entry made
End of all 4 years:
| Stock Option Expense 587,500 Paid in Capital – Stock Options 587,500 |
C. Exercise of one third of the stock options:
| Cash 4,266,667 Paid In Capital – Stock Options 783,333 Common Stock 333,333 Paid In Capital – Common Stock 4,716,667 |
Cash: 400,000 x 1/3 x $32 exercise price
PIC – Stock Options: 587,500 x 4 x 1/3
Common Stock: par value of $2.50 x 400,000 x 1/3
PIC – CS: always a plug to balance the journal entry
D. Financial Statements at the end of the 2nd year following the grant:
Income Statement:
Stock Compensation expense 587,500
Balance Sheet:
Common Stock – Restricted Shares 1,175,000