Unit 6 (Lesson 30-31)

straight cash-compensation plans (salary and perhaps a bonus)

-oriented to the short run -many companies recognize that they need a longer-term compensation plan in addition to the cash component

112. A company compensates its CEO with 1,000 stock options. The stock options have a value of $3 each and enable the CEO to purchase shares of $2 par value common stock at $30 each. The following year, the CEO exercises 500 of the options. What is the journal entry to record the exercise of these 500 options?

D- Cash (500 x $30)-15,000 D-Paid-in capital-stock options (500 x $3)- 1,500 C-Common Stock (500 x $2)-1,000 C-Paid-in capital in excess of par-common stock-15,500

What is an advantage of a restricted-stock plan?

It never becomes completely worthless. Major advantages of a restricted-stock plan include: (1) the stock never becomes completely worthless, (2) the stock generally results in less dilution to existing shareholders, and (3) the stock better aligns the employee incentives with the company's incentives.

stock option

a warrant that gives selected employees the option to purchase common stock at a given price over an extended period of time -provide the employee with the opportunity to receive stock if the performance of the company (by whatever measure) is satisfactory

Determining Expense (recognition-stock compensation)

-Under the fair value method, companies compute total compensation expense based on the fair value of the options expected to vest on the date they grant the options to the employee(s) (i.e., the grant date) -companies estimate fair value by using an option-pricing model, with some adjustments for the unique factors of employee stock options

119. The accounting for restricted stock is a. similar to the accounting for stock options. b. dissimilar to the accounting for stock option.

a. similar to the accounting for stock options

107. Employee stock options should be reported as compensation expense using the? a. intrinsic-value. b. fair value. c. time value. d. book value.

b. fair value

123. The compensation associated with restricted stock under a stock award plan is a. the book value of an unrestricted share of the same stock times the number of shares. b. the estimated fair value of a share of similar stock times the number of shares. c. allocated to compensation expense over the service period which usually is the vesting period. d. the book value of a share of similar stock times the number of shares.

c. allocated to compensation expense over the service period which usually is the vesting period

108. What values are available to measure stock options? a. only the intrinsic value method. b. only the fair value method. c. either the fair value method or the intrinsic value method. d. none of these values.

c. either the fair value method or the intrinsic value method

124. A company allows all full-time employees--but no part-time employees--to participate in its employee stock purchase plan. The employees have the option to purchase common stock discounted by 25%, and the plan offers no substantive option feature. What is one of the three required features that causes the plan to be considered compensatory? a. the company only includes common stock as part of the plan. b. there is no substantive option feature. c. the stock is discounted by 25%. d. part-time employees are excluded from the stock option plan.

c. the stock is discounted by 25%

Stock Compensation Example: Assume that on November 1, 2019, the stockholders of Chen Company approve a plan that grants the company's five executives options to purchase 2,000 shares each of the company's $1 par value common stock. The company grants the options on January 1, 2020. The executives may exercise the options at any time within the next 10 years. The option price per share is $60, and the market price of the stock at the date of grant is $70 per share. We assume that the fair value option-pricing model determines Chen's total compensation expense to be $220,000. Assume that the expected period of benefit is two years, starting with the grant date.

*At date of grant Jan. 1, 2020* No entry *To record compensation expense for 2020* D-Compensation Expense-110,000 C-Paid-in capital-stock options-110,000 (220,000/2) = 110,000 *To record compensation expense for 2021* D-Compensation Expense-110,000 C-Paid-in capital-stock options-110,000 *Exercise* D-Cash D-Paid-in capital- stock options C-Common stock C-Paid-in capital in excess of par-common stock *Expiration* D-Paid-in capital-stock options C-Paid-in capital-expired stock options *Adjustment* -a company does NOT adjust compensation expense upon expiration of the options -if an employee forfeits a stock option because the employee fails to satisfy a service requirement (e.g., leaves employment), the company should adjust the estimate of compensation expense recorded in the current period (as a change in estimate)

stock-based compensation plans

long-term compensation plans that give employees an equity interest -the largest single component for executive officers' pay for companies that comprise the S&P 500 (the largest companies in the US) -companies continue to use these plans as the primary component to compensate key personnel

Allocating Compensation Expense (recognition-stock compensation)

-a company recognizes compensation expense in the periods in which its employees perform the service—the service period -Unless otherwise specified, the service period is the vesting period—the time between the grant date and the vesting date -the company determines total compensation cost at the grant date and allocates it to the periods benefited by its employees' services

Employee Stock-Purchase Plans (ESPPs)

Employee stock-purchase plans (ESPPs) generally permit all employees to purchase stock at a discounted price for a short period of time. The company often uses such plans to secure equity capital or to induce widespread ownership of its common stock among employees. These plans are considered compensatory unless they satisfy all three conditions presented below in which case it would be noncompensatory. 1. All full-time employees may participate on an equitable basis. 2. The discount from market is small. That is, the discount does not exceed the per share amount of costs avoided by not having to raise cash in a public offering. If the amount of the discount is 5 percent or less, no compensation needs to be recorded. 3. The plan offers no substantive option feature. Companies that offer their employees a compensatory ESPP should record the compensation expense over the service life of the employees.

When is the compensation expense resulting from a compensatory stock option plan generally reported?

When it is allocated to the periods benefited by the employee's required service In general, a company recognizes compensation expense in the periods in which its employees perform the service—the service period. Unless otherwise specified, the service period is the vesting period—the time between the grant date and the vesting date. Thus, the company determines total compensation cost at the grant date and allocates it to the periods benefited by its employees' services.

121. When is compensation expense recorded to date reversed if an employee does not fulfill the vesting requirements? a. only for stock options. b. only for restricted stock. c. for stock options and restricted stock. d. neither for stock options nor restricted stock.

c. for stock options and restricted stock Accounting Rule: stock options and restricted stock both require that compensation expense recorded to date be reversed when an employee does not fulfill vesting requirements.

Restricted Stock Example: Assume that on January 1, 2020, Ogden Company issues 1,000 shares of restricted stock to its CEO, Christie DeGeorge. Ogden's stock has a fair value of $20 per share on January 1, 2020. Additional information is as follows. 1. The service period related to the restricted stock is five years. 2. Vesting occurs if DeGeorge stays with the company for a five-year period. 3. The par value of the stock is $1 per share.

*Entry on the grant date* D-Unearned Compensation (fair value of stock) C-Common Stock (par value) C-Paid-in capital in excess of par- common stock Unearned Compensation represents the cost of services yet to be performed, which is not an asset. *Recording compensation expense* D-Compensation Expense C-Unearned Compensation *Recording forfeiture* D-Common Stock D-Paid-in capital in excess of par-common stock C-Compensation Expense C- Unearned Compensation

Measurement-Stock Compensation

grant date: the date someone receives stock options How to report granting of options: 1) *Intrinsic-value method*-measures what the holder would receive today if the option was immediately exercised -measures stock compensation by the excess of the market price of the stock over its exercise price at the grant date -no recognition of any compensation expense related to options because at the grant date the market price equaled the exercise price 2) *fair value method*-uses acceptable option-pricing models to value the options at the date of grant -bases the cost of employee stock options on the fair value of the stock options granted -GAAP requires that companies recognize compensation cost using the fair value method -results in greater compensation costs relative to the intrinsic-value model -the company computes total compensation expense by applying an acceptable fair value option-pricing model

116. A company granted options for 1 million shares of its $1 par common stock at the beginning of the current year. The exercise price is $35 per share, which was also the market value of the stock on the grant date. The fair value of the options was estimated at $8 per option. The options have a vesting period of five years. What is the balance in the additional paid-in capital - stock options account three years after grant date?

1 million shares x $8 (fair value) = 8,000,000 $8,000,000/5= 1,600,000 1,600,000 x 3 = 4,800,000 Accounting Rule: the journal entry is debit compensation expense for $4,800,000 and credit additional paid-in capital - stock options for $4,800,000.

117. A company offered an incentive stock option plan to its employees. On January 1, 2020, options were granted for 60,000 $1 par common shares. The exercise price equals the $5 market price of the common stock on the grant date. The options cannot be exercised before January 1, 2023, and expire December 31, 2024. Each option has a fair value of $1 based on an option pricing model. What is the total compensation cost of the plan and the journal entry to record compensation expense for the year 2020?

60,000 x $1=60,000 total compensation cost 60,000/3=20,000 compensation expense D-Compensation Expense- 20,000 C-Paid-in capital-stock options -20,000 Accounting Rule: total compensation cost is calculated by multiply the stock options by the fair value of the options at the grant date.

Restricted-Stock Plans

Stock plans that transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred or pledged until vesting occurs -used to compensate employees Major advantages of restricted-stock plans are: 1. Restricted stock never becomes completely worthless 2.Restricted stock generally results in less dilution to existing stockholders: Restricted-stock awards are usually one-half to one-third the size of stock options and have value at the end of the vesting period 3.Restricted stock better aligns the employee incentives with the companies' incentives The accounting for restricted stock follows the same general principles as accounting for stock options at the date of grant. That is, the company determines the fair value of the restricted stock at the date of grant (usually the fair value of a share of stock) and then expenses that amount over the service period -Total compensation cost is determined by multiplying the number of shares awarded by the market price of the stock at grant date (the fair value at that date). The amount is amortized over the service period using straight-line. Subsequent changes in the market price (fair value) of the stock are ignored. -If an employee leaves before vesting, the employee forfeits his/her rights to the stock (companies reverse the compensation expense)

120. On January 1, year 1, a company issues 2,000 shares of restricted stock to a manager. The stock has a par value of $1 and a fair value of $25 per share on the grant date. The service period is five years, and vesting will occur if the manager stays for five years. a. What is the journal entry on January 1, year 1? b. What is the journal entry at December 31, year 1? c. What is the journal entry if the manager leaves the on January 1, year 3?

a. D-Unearned Compensation(2,000 x $25)-50,000 C-Common Stock (2,000 x $1)-2,000 C-Paid-in capital in excess of par- common stock-48,000 b. D-Compensation Expense-10,000 C-Unearned Compensation-10,000 (2,000 x $25)/5=10,000 Accounting Rule: the company records compensation expense of $10,000 for each of the 5 years. c. D-Common stock-2,000 D-Paid-in capital in excess of par-common stock-48,000 C-Compensation Expense (10,000 x 2) -20,000 C-Unearned compensation- 30,000 Accounting Rule: the compensation expense recorded for years 1 and 2 are reversed. In addition, the unearned compensation account, common stock account, and additional paid-in capital - common stock account are reversed.

111. On December 31, year 1, a company grants an executive 120,000 stock options with an option price of $35. These options are granted as part of the executive's compensation package for years 2 and 3. The company uses an accepted option pricing model to determine that the value of the options is $1.2m. The market price of the company's stock is $46 per share on December 31 of year 2 and $51 per share on December 31 of year 3. The fair value method is used to determine the compensation expense. a. How much compensation expense should the company recognize in years 2 and 3? b. What is the journal entry to record the granting of the stock options for both years (2 & 3)? c. What is the journal entry to record the exercise of all 120,000 stock options?

a. 1,200,000/2= $600,000 for both years Accounting Rule: the company values the stock options to be $1.2m. This amount is allocated evenly over the service period of two years. b. D-Compensation Expense-600,000 C-Paid-in capital-stock options-600,000 Accounting Rule: at the end of the two-year service period, the balance in the additional paid-in capital from stock options account is $1.2 million that is equal to the grant date value of the options. c. D-Cash (120,000 x $35) -4,200,000 D-Paid-in capital- stock options-1,200,000 C-Common stock (no par)-5,400,000 Accounting Rule: since the common stock is no par, the full amount of the stock options is credited to common stock. On other hand, if the common stock has a par value, the amount of the stock options would be allocated between common stock and additional paid-in capital in excess of par - common stock.

115. A company grants 10,000 stock options to an executive on January 1 of year 1 when the market price of the option is $30 and the exercise price is $20 for $1 par stock. The service period for this award is two years and the compensation is valued at $220,000. The options are exercisable within a 3-year period beginning January 1 of year 3 if the executive remains in the employment of the company. The executive however leaves the company on March 1 of year 3 without exercising any of the options. Which journal entry should the company record on March 1, year 3? a. debit paid-in capital - stock options for $220,000; credit compensation expense for $220,000. b. debit paid-in capital - expired stock options for $220,000; credit common stock for $100,000; credit paid-in capital in excess of par - common stock for $120,000. c. debit paid-in capital - stock options for $220,000; credit paid-in capital - expired stock options for $220,000. d. debit paid-in capital - expired stock options for $220,000; credit common stock for $10,000; credit paid-in capital in excess of par - common stock for $210,000.

a. debit paid-in capital - stock options for $220,000; credit compensation expense for $220,000. D-Paid-in capital- stock options- 220,000 C-Compensation Expense- 220,000 Accounting Rule: if an employee forfeits a stock option because the employee fails to satisfy a service requirement (e.g., leaves employment), the company adjusts the estimate of compensation expense recorded in the current period as a change in estimate. The company records the change in estimate by debiting paid-in capital -stock options and crediting compensation expense for the amount of cumulative compensation expense recorded to date. In other words, reversing all previous journal entries.

118. On January 1, a company uses the fair value method of reporting stock options. It grants its employees 1,000 shares of $1 par value common stock options, which can be exercised anytime within the next five years. Under an acceptable option-pricing model, the total compensation expense is $30,000. The employees exercise all 1,000 options for $15,000. Which part of the journal entry should be recorded for the exercise of the options? a. debit paid-in capital - stock options for $30,000. b. credit paid-in capital - stock options for $30,000. c. debit paid-in capital in excess of par - common stock for $30,000. d. credit paid-in capital in excess of par - common stock for $30,000

a. debit paid-in capital - stock options for $30,000. D- Cash- 15,000 C-Paid-in capital-stock options-30,000 C-Common Stock-1,000 C-Paid-in capital in excess of par-common stock-44,000

110. The compensation cost associated with employee stock option plans is a. expensed on the exercise date. b. allocated to expense over the service period. c. allocated to expense until exercised. d. expensed on the date of grant.

b. allocated to expense over the service period Accounting Rule: The straight-line method is used to allocate the compensation expense of stock options over the service period which is the vesting period. The fair value of stock options granted is accrued as compensation expense over the service period using the straight-line method. The time between the date options are granted and the first date they can be exercised is the vesting period and is considered to be the service period over which the compensation expense is reported.

114. A company grants 10,000 stock options to an executive on January 1 of year 1 when the market price of the option is $30 and the exercise price is $20 for $1 par stock. The company believes the stock option will be exercised in two years and that the compensation is valued at $220,000. The options are valid for five years, and the executive continues to work for the company, but the options expire on December 31 of year 5 without exercise. Which journal entry should the company record on December 31 of year 5? a. debit paid-in capital - stock options for $220,000; credit compensation expense for $220,000. b. debit paid-in capital - expired stock options for $220,000; credit common stock for $100,000; credit paid-in capital in excess of par - common stock for $120,000. c. debit paid-in capital - stock options for $220,000; credit paid-in capital - expired stock options for $220,000. d. debit paid-in capital - expired stock options for $220,000; credit common stock for $10,000; credit paid-in capital in excess of par - common stock for $210,000.

c. debit paid-in capital - stock options for $220,000; credit paid-in capital - expired stock options for $220,000. D-Paid-in capital- stock options- 220,000 C-Paid-in capital- expired stock options-220,000 Accounting Rule: an unexercised stock option does not nullify the recorded compensation expense. Instead, the company transfers the balance in the paid-in capital stock options account to a paid-in capital -expired stock options account.

125. Which one of the following features causes an employee stock-purchase plan to be noncompensatory? a. full-time employees may participate. b. there is no substantive option feature. c. the stock is discounted by 5%. d. all of the above.

d. all of the above Accounting Rule: employee stock purchase plans (ESPPs) generally permit all employees to purchase stock at a discounted price for a short period at time. Compensation expense is not reported if a. Substantially all full-time employees may participate on an equitable basis; b. The discount from market is small; and c. The plan offers no substantive option feature.

Disclosure of Compensation Plans

Companies must fully disclose the status of their compensation plans at the end of the periods presented. To meet these objectives, companies must make extensive disclosures.

Recognition- Stock Compensation

Stock-option plans involve two main accounting issues: 1. How to determine compensation expense. 2. Over what periods to allocate compensation expense.

109. What date is used to determine the compensation cost for stock options? a. service date. b. exercise date. c. grant date. d. none of these dates.

c. grant date Accounting Rule: companies estimate the fair value of stock options on the grant date using an option-pricing model. Compensation expense should not be adjusted during the service period to reflect changes in the fair value of options caused by changes in the market price of the stock.

126. A company allows all full-time employees--but no part-time employees--to participate in its employee stock purchase plan. The employees have the option to purchase common stock discounted by 5%, and the plan offers no substantive option feature. Which one of the above features causes the plan to be considered compensatory? a. full-time and part-time employees may participate. b. there is no substantive option feature. c. the stock is discounted by 5%. d. all of the above.

a. full-time and part-time employees may participate

122. If restricted stock is forfeited because an employee leaves the company, the appropriate accounting procedure is to a. reverse related entries previously made. b. do nothing. c. prepare correcting entries. d. record an income item.

a. reverse related entries previously made