Concept explainers
Stock options; forfeiture; exercise
• LO19–2
On October 15, 2017, the board of directors of Ensor Materials Corporation approved a stock option plan for key executives. On January 1, 2018, 20 million stock options were granted, exercisable for 20 million shares of Ensor’s $1 par common stock. The options are exercisable between January 1, 2021, and December 31, 2023, at 80% of the quoted market price on January 1, 2018, which was $15. The fair value of the 20 million options, estimated by an appropriate option pricing model, is $6 per option. Ensor chooses the option to recognize forfeitures only when they occur.
Ten percent (2 million) of the options were forfeited when an executive resigned in 2019. All other options were exercised on July 12, 2022, when the stock’s price jumped unexpectedly to $19 per share.
Required:
- 1. When is Ensor’s stock option measurement date?
- 2. Determine the compensation expense for the stock option plan in 2018. (Ignore taxes.)
- 3. What is the effect of forfeiture of the stock options on Ensor’s financial statements for 2019 and 2020?
- 4. Is this effect consistent with the general approach for accounting for changes in estimates? Explain.
- 5. How should Ensor account for the exercise of the options in 2022?
(1)
Stock options: Stock options are the stock-based compensation plans provided in the form of an option to buy certain number of shares for a certain price during certain period.
To mention: The stock options measurement date
Explanation of Solution
The compensation cost of stock options would be measured on the grant date, January 1, 2018.
(2)
Explanation of Solution
Determine the amount of compensation expense to be recorded by Corporation E in 2018.
Step 1: Compute the total compensation cost of stock options.
Step 2: Compute the compensation expense of stock options allocated to each of the three vesting periods.
Note: Refer to Equation (1) for value and computation of total compensation cost.
Thus, compensation expense to be recorded in 2018 is $40,000,000.
(3)
Explanation of Solution
Effect of forfeiture of stock options in 2019:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
2019 | |||||
Compensation Expense | 32,000,000 | ||||
Paid-In Capital – Stock Options | 32,000,000 | ||||
(To record changes in compensation expense due to forfeiture) |
Table (1)
Working Notes:
Compute the new estimated expense allocated in 2019, after the 10% forfeiture.
Note: Refer to Equation (1) for value and computation of total compensation cost, and Equation (2) for value of compensation expense in 2018.
Thus the forfeiture of 10% of stock options reduces the compensation expense of $40,000,000 to $32,000,000 in 2019.
Effect of forfeiture of stock options in 2020:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
2020 | |||||
Compensation Expense | 36,000,000 | ||||
Paid-In Capital – Stock Options | 36,000,000 | ||||
(To record changes in compensation expense due to forfeiture) |
Table (2)
Working Notes:
Compute the new estimated expense allocated in 2020, after the 10% forfeiture.
Note: Refer to Equation (1) for value and computation of total compensation cost, Equations (2), and (3) for values of compensation expense in 2018 and 2019.
Thus the forfeiture of 10% of stock options reduces the compensation expense of $40,000,000 to $36,000,000 in 2020.
(4)
To explain: If the accounting method followed for forfeiture is in consistent with the usual method applied for changes in estimates
Explanation of Solution
No, the method is inconsistent.
Generally, the revised expense for changes in estimates which would be allocated to each year would be deducted by 10%, the original expense recorded in 2018 ($40,000,000) would be reduced from the revised total cost, 90% of total compensation cost
(5)
To journalize: The options exercised on July 22, 2022
Explanation of Solution
Journalize the entry for options exercised in the books of Corporation E.
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
2022 | |||||
July | 22 | Cash | 216,000,000 | ||
Paid-in Capital – Stock Options | 108,000,000 | ||||
Common Stock | 18,000,000 | ||||
Paid-in Capital–Excess of Par | 306,000,000 | ||||
(To record purchase option exercised by stock option holders) |
Table (3)
- Cash is an asset account. Since cash is received, asset value increased, and an increase in asset is debited.
- Paid-in Capital–Stock Options is a stockholders’ equity account. Since stock options are exercised and shares are issued, stock options value is decreased, and a decrease in equity is debited.
- Common Stock is a stockholders’ equity account. Since stock options are exercised and shares are issued, common stock value increased, and an increase in equity is credited.
- Paid-in Capital–Excess of Par is a stockholders’ equity account. Since stock options are exercised and shares are issued, excess of par value increased, and an increase in equity is credited.
Working Notes:
Compute cash received by Corporation E.
Compute the paid-in capital of stock options amount.
Compute the common stock amount.
Compute the paid-in capital–excess of par amount.
Note: Refer to Equations (4), (5), and (6) for all the values.
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Chapter 19 Solutions
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