Chapter 19 - Share-Based Compensation and Earnings Per Share

Maggie Company issued options valued at $1 million to one of its executives that are contingent on the company achieving a 10% increase in sales revenue within the next 12 months. The company believes that it is not possible that this target will be achieved. After 6 months, the company estimates that it is probable that the target will be achieved. Based on this new estimate, the company must

debit compensation expense for $1 million.

Contingent issuable shares may be included in the calculation of

diluted EPS.

Dividends per common share divided by earnings per share provides an indication of

dividend payout.

Which of the following accounting numbers is reported most frequently by the media?

earnings per share

If the employer can elect to settle SAR awards with company stock, SAR awards are classified as

equity.

The FASB's 1993 exposure draft on stock options proposed that the estimated value of stock options should be

expensed.

Under current GAAP, stock options must be reported in the income statement at

fair value.

Falcon Company grants stock options to its upper and middle management employees. The options vest over a 4-year period, with 25% exercisable after 1 year, 25% after 2 years, another 25% after 3 years, and the remaining 25% after 4 years. This is an example of

graded vesting.

The goal of diluted EPS is to report the _____ potential dilution that might result from the conversion or exercise of securities and equity contracts.

highest

Antidilutive securities are excluded from the calculation of EPS because they would

increase EPS.

When the tax benefit derived from nonqualified stock options is less than the amount recognized as a deferred tax asset, the company should recognize the difference by

increasing income tax expense.

When the tax benefit derived from nonqualifying stock options exceeds the amount recognized as a deferred tax asset, the company should recognize the difference by

increasing paid-in capital.

Selina Inc. sponsors a restricted stock units awards plan under which employees may elect to receive cash. When Selina debits "compensation expense," it should credit:

liability - restricted stock

On the date when stock options are granted, the sponsoring company should

measure the fair value of the options.

Consistent with the revised FASB standard on stock options, the value of stock options

must be recognized as an expense.

Compensation expense related to share-based awards is recognized regardless of whether the market-related conditions are met because

option-pricing models already implicitly reflect market conditions.

Frohe Inc. sponsors a restricted stock units award plan under which employees can choose to receive either company stock or cash. Frohe should recognize compensation expense:

over the service period

From an accounting perspective, the significance of the stock option vesting period is that it is the time period

over which compensation expense is allocated.

When stock options are allowed to lapse, paid-in capital from stock options should be reclassified as:

paid-in capital from expired stock options

Vested restricted stock awards are (Select all that apply.)

- included in the denominator of basic EPS. - already outstanding.

Securities that may become common shares in the future are considered

potential common shares.

Which of the following are subtracted when determining earnings available to common shareholders?

preferred stock dividends

The treasury stock method takes into account the dilutive effect of stock options and assumes that the proceeds from the exercise of options are used to

purchase treasury shares.

For the purpose of deriving EPS, securities are considered dilutive if they are capable of

reducing earnings per share.

When it becomes probable that a performance target will not be met, previously recognized compensation expense must be:

reversed

Typically stock options are exercisable

several years after the grant date.

Stock options are often used as employee incentives; therefore, stock options are typically exercisable

several years after they were granted.

Stock options are said to be "in the money" if

the current market price of the stock exceeds the option exercise price.

The time between the date that options are granted and the first date they can be exercised is referred to as the _____ period.

vesting

On January 2, 20X1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. On the date of grant, the estimated value of the options is $6 per option. During 20X4, when the market value of the stock is $30 per share, 9,000 stock options were exercised. Utta Corp. should recognize this event by debiting (Select all that apply.)

- paid-in capital—stock options for $54,000. - cash for $180,000.

Compensation plans that are tied to the achievement of certain targets and are used to motivate key employees are referred to as _____ compensation plans.

Blank 1: executive, management, manager, performance, share-based, shared, performance-based, or share based

Muller Company sponsors a performance-based stock option plan. When the options are granted, Muller should recognize related compensation expense if it is _____ that the performance target will be met.

Blank 1: probable or likely

Salt Company reports net income of $360 million for 2017; the company's tax rate is 40%. At the beginning of the year, 200 million common shares were outstanding. On July 1, Salt sold an additional 80 million shares and on October 1 distributed a 10% stock dividend. On December 1, the company reacquired 24 million of its outstanding shares. The company's weighted-average shares for the purpose of calculating basic EPS will be

262 million. Reason: [(200 + [80 x 6/12]) x 1.1] - 24/12

Nonqualified stock option plan

The employer granting the stock options can deduct the difference between the exercise and the market price at the exercise date for tax purposes.

Incentive stock option plan

The employer granting the stock options cannot deduct stock option-related values for tax purposes.

Which of the following stock options is considered "in the money" relating to options with an exercise price of $15 per share?

Current stock price per share is $20.

If convertible securities are dilutive to EPS, the effect of the assumed conversion will (Select all that apply.)

- increase the numerator by interest on bonds or preferred dividends that would have been avoided. - increase the denominator by the additional common shares that would have been issued upon conversion.

An actual conversion of dilutive convertible securities will (Select all that apply.)

- not affect the reported amount of diluted EPS. - decrease the reported amount of basic EPS.

On January 2, 20X1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $6 per option. During 20X4, 9,000 stock options were exercised. In 20X5, the remaining stock options expire. When the options expire, Utta should credit

paid-in capital—expired stock options for $6,000. Reason: 1,000 x $6 = $6,000

Accounting for stock option plans consistent with the FASB's recommendation provided two choices for valuing stock options. What were these choices?

- intrinsic value method - fair value method

The value of stock options has a time value component because (Select all that apply.)

- options do not have to be exercised immediately. - the value of the options may change between the date of grant and the time the options are exercised.

Horst Company has 50,000 stock options outstanding. The option exercise price is $13 per share, the average market price of the stock was $12 per share during the year, and the end-of-year stock price was $14. For the purpose of calculating EPS, these stock options are

antidilutive.

When restrictions are lifted on restricted stock units for par value stock, paid-in capital restricted stock is replaced by (Select all that apply.)

- paid-in capital - excess of par - common stock

Place the presentation of earnings per share in the correct order.

1. EPS - income from continuing operations 2. EPS - discontinued operations 3. EPS - net income

On January 2, 201X1, Muenster Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $4 per option. During 20X4, 8,800 stock options were exercised. In 20X5, the remaining stock options expire. How will the expiration of the stock options affect the company's compensation expense?

Compensation expense will not be affected.

Stock options, rights, and warrants must be considered when calculating _____ EPS.

diluted

The price-earnings ratio indicates a company's earnings quality by

indicating the multiple the market is willing to pay for earnings

The incremental effect of convertible bonds is the after-tax _____ saved divided by the additional common shares from the conversion. (Enter only one word.)

interest

The benefit the holder of an option would realize by exercising the option rather than buying the underlying stock directly is referred to as _____ value.

intrinsic

When stock options expire, compensation expense

is not affected.

On January 2, 20X1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $6 per option. During 20X4, 9,000 stock options were exercised. In 20X5, the remaining stock options expire. Utta should recognize the expiration by debiting

paid-in capital—stock options for $6,000.

The way we take into account the dilutive effect of stock options is referred to as the _____ stock method.

treasury

Assume that the stock price rises from $50 to $55. An employee with stock appreciation rights (SAR) would earn cash or shares equal to ___ per SAR.

$5

Which of the following are likely advantages of employee share purchase plans for employees? (Select all that apply.)

- A discount on the purchase price of the shares. - The absence of brokerage fees to purchase the shares.

Which of the following factors (each considered independently) will tend to increase the value of stock options? (Select all that apply.)

- a longer option term - volatility of the stock price - increases in the market price of the underlying stock

Which of the following may result in potential common shares? (Select all that apply.)

- convertible preferred stocks - convertible bonds

Which of the following are among the factors that must be considered in order to estimate the total compensation associated with stock options? (Select all that apply.)

- expected dividends on the underlying stock - expected risk-free rate of return during the option term - expected volatility of the stock price

At the beginning of the year, Solen Corp. had 100,000 shares of common stock outstanding. On April 1, the company issued an additional 60,000 shares. Weighted-average shares for the year will be

145,000 shares.

Vogel Corp.'s denominator for calculating diluted EPS is 57,300 weighted-average shares. Included in the denominator were 5,000 shares related to convertible preferred stocks assumed to have been converted. If the convertible preferred stock had actually been converted, the weighted-average shares for purposes of diluted EPS would have been

57,300 shares.

Bonnie Inc. has 500, 6%, $1,000 face amount bonds outstanding during the entire year. The bonds were issued at face. Each bond is convertible into 14 shares of common stock. The company's tax rate is 30%. What would be the effect of the assumed conversion on the denominator of diluted EPS?

7,000 shares would be added. Reason: 500 x 14 = 7,000

Mueller Company estimates that it is unlikely that a particular executive will achieve a specific performance target. Mueller already recognized compensation expense related to this performance plan. Mueller must _____ the related expense.

Blank 1: reverse or credit

Because options are not exercised immediately, their valuation includes a(n) _____ _____ component.

Blank 1: time Blank 2: value

Which of the following shares may be included in the calculation of basic EPS?

Outstanding common shares

Incentive stock option plan

The recipient pays taxes only when the shares acquired under the plan are sold.

Which of the following scenarios will increase total assets and equity?

The sale of new shares

Which of the following statements regarding stock appreciation rights (SARs) is correct?

They enable employees to benefit from increases in the company's stock without having to purchase shares.

True or false: Stock options have become an integral part of most medium and large companies.

True

In calculating EPS, preferred stock dividends are subtracted from the numerator because EPS represents earnings available to _____ shareholders. (Only one word per blank.)

common

Munster Company issued options to a key executive that are contingent on the company achieving a 10% increase in sales revenue within the next 12 months. The company believes that it is likely that this target will be achieved and accrues $5 million in related compensation expense. After 9 months, the company estimates that it is possible, but not likely that the target will be achieved. Based on this new estimate, the company must

credit compensation expense for $5 million.

When we include options, rights, and warrants in the calculation of diluted EPS, we pretend that the potential increase in shares

has already occurred.

Warrants, options, and rights are antidilutive if the exercise price is

higher than the stocks' average market price.

The method that assumes that a conversion into common stock occurred at the later of the beginning of the period or the time the convertible security is issued is referred to as the ____ method.

if converted

When estimates of options forfeitures change, the cumulative effect on compensation is recognized

in current earnings.

Restricted stock awards are

included in the calculation of EPS if unvested.

Total compensation associated with restricted stock awards typically is equal to the shares'

market price at grant date of the award.

When a company reacquires its own shares, and weighted-average shares are calculated for the purpose of determining EPS, the reacquired shares that are subtracted from the weighted-average calculation are weighted for the

period that they are not outstanding.

A low dividend payout ratio may indicate that the company is

planning to reinvest its earnings.

Initially, recognition of compensation expense for performance-based plans requires that the achievement of the target is

probable.

Under a ______ stock option incentive plan, the exercise price of stock options must be ______ the market price at the grant date.

qualified; equal to

The price-earnings ratio provides an indication of a company's

quality of earnings.

Compensation relating to stock option grants should be

recognized over the service period for which employees receive options.

If share-based awards are contingent on the achievement of specific market conditions, compensation expense is

recognized regardless of whether the conditions are met.

The fair value of stock options is measured when the

stock options are granted.

Donald Company grants stock options to certain employees. On the date of grant, Donald should measure total compensation based on

the fair value of the options.

Which of the following are facts or conditions that are specifically set forth in stock option plans? (Select all that apply.)

- The time period during which option holders may purchase shares - The price at which option holders may purchase shares - The maximum number of shares option holders may purchase

Falken Company awards 1,000 shares of common stock to Robert Small. The shares are restricted and require that Robert remains with the company for at least 2 more years. The current market price of the shares is $15 per share. Total compensation associated with this restricted stock award is

$15,000.

Bonnie Inc. has 500, 6%, $1,000 face amount bonds outstanding during the entire year. The bonds were issued at face. Each bond is convertible into 14 shares of common stock. The company's tax rate is 30%. What would be the effect of the assumed conversion on the numerator of diluted EPS?

$21,000

Under its restricted stock award plan, Katrin Corp. grants 100,000 of its $1 par value common shares to certain executives on January 2, 2018. The awards are contingent on continued employment for 4 years. Shares have a current market value of $10 per share. For the year ended December 31, 2021, Katrin should recognize compensation expense of

$250,000.

Fuller Corp. has 10,000 options outstanding that allow employees to purchase each share of stock for $10. The market price of the stock is $14. The intrinsic value of the related options is

$4 per share.

Which of the following potential common shares may be included in the calculation of diluted EPS, but not basic EPS?

- Contingent issuable shares - Restricted stock - Stock options - Convertible securities

Which of the following must be presented in a company's financial statements (which include the financial statement notes), assuming that the related financial statement items exist for that company? (Select all that apply.)

- EPS—net income - EPS—discontinued operations - EPS—income from continuing operations

Which of the following are common types of restricted stock plans? (Select all that apply.)

- Restricted stock units - Restricted stock awards

Which of the following can be used to satisfy SARs awards? (Select all that apply.)

- Shares - Cash

Which of the following plans frequently specify a performance condition or a market condition that must be satisfied before employees are allowed the benefits of the reward? (Select all that apply.)

- Stock option plans - Other share-based plans

What factors would affect the calculation of diluted EPS if convertible bonds are assumed to have been converted into common stock of the issuing company? (Select all that apply.)

- The numerator would reflect the after-tax savings of interest. - The denominator would reflect the additional common shares assumed issued.

Which of the following represent typical goals of executive compensation plans? (Select all that apply.)

- To create performance incentives for certain employees. - To provide compensation to certain employees.

Proceeds under the treasury stock method may include (Select all that apply.)

- amounts received under the hypothetical exercising of the options. - total compensation from nonvested awards.

On January 2, 20X1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. On the date of grant, the estimated value of the options is $6 per option. During 20X4, 9,000 stock options were exercised. Utta Corp. should recognize this event by crediting (Select all that apply.)

- common stock for $9,000. - paid-in capital in excess of par for $225,000. Reason: $1 x 9,000 shares = $9,000 $180,000 + $54,000 - $9,000 = $225,000

Marian Company granted restricted stock units for its par value stock to its top executives. When the restriction is lifted, Marian should (Select all that apply.)

- credit paid-in capital in excess of par. - credit common stock. - debit paid-in capital—restricted stock.

Which of the following are among the factors that must be considered in order to estimate the total compensation associated with stock options? (Select all that apply.)

- current market price of the stock - exercise price of the options - expected term of the option

The journal entry to record unexercised stock options that have been allowed to lapse includes (select all that apply)

- debit to paid-in-capital-stock options - credit to paid-in-capital-expiration of stock options

Which of the following factors (each considered independently) will tend to lower the value of stock options? (Select all that apply.)

- higher dividends - a higher exercise price

Which of the following are valid categories of stock option plans for tax purposes? (Select all that apply.)

- nonqualified stock option plans - incentive stock option plans

Share-based plans typically are grouped into two major categories based on the conditions that must be met by employees in order to receive the benefits of the award. These categories are

- performance-based plans. - market-based plans.

Which of the following are the essential components of option values? (Select all that apply.)

- time value - intrinsic value

Pfeffer Company reports net income of $360 million for 20X1; the company's tax rate is 40%. At the beginning of the year, 200,000 common shares were outstanding. On August 1, the company issued an additional 120,000 shares. Weighted-average shares will be

250,000. Reason: 250,000 = [200,000 + (120,000 x 5/12)]

_____ _____ plans give employees the choice to purchase a specified number of shares of the firm's stock at a specified price during a specified period of time.

Blank 1: Stock Blank 2: option

Stock appreciation rights may be payable in _____ or _____.

Blank 1: cash Blank 2: shares or stock

Option values include the following essential components: a(n) _____ value and a(n) _____ value.

Blank 1: intrinsic Blank 2: time

Which of the following strategies will simplify the determination of whether convertible securities are dilutive or antidilutive to EPS?

Comparing the incremental effect of the conversion.

True or false: In calculating diluted EPS,convertible preferred stock is assumed converted only if the stock was issued during an earlier period.

False

Which method for valuing stock options typically resulted in the recognition of no compensation expense?

Intrinsic value method

Which of the following statements regarding the prevalence of stock option awards is correct?

Many large and medium-size companies grant stock options.

Cliff vesting

Stock options vest all at once.

Graded vesting

Stock options vest over time.

Which of the following methods will affect both the numerator and the denominator of diluted earnings per share?

The "if converted" method

Gruen Inc. has 1,000, $100 par, 6% preferred stocks outstanding during the entire year. Each preferred stock can be converted into 2 shares of common stock. The company's tax rate is 30%. What would be the effect of the assumed conversion on the denominator of diluted EPS assuming the preferred stocks were dilutive?

The denominator would increase by 2,000 shares.

Gruen Inc. has 1,000, $100 par, 6% preferred stocks outstanding during the entire year. Each preferred stock can be converted into 2 shares of common stock.The company's tax rate is 30%. What would be the effect of the assumed conversion on the numerator of diluted EPS assuming the preferred stocks were dilutive?

The numerator would be $6,000 greater.

Nonqualified stock option plan

The recipient must pay taxes on the difference between the exercise price and the market price of the stock at the exercise date.

Which of the following scenarios will increase stockholders' equity?

The sale of new shares

Which of the following is correct regarding the nature of restricted stock?

The shares typically are contingent on the continued employment of the awardee.

Under its restricted stock award plan, Katrin Corp. grants 100,000 of its $1 par value common shares to certain executives on January 2, 2018. The awards are contingent on continued employment for 4 years. Shares have a current market value of $10 per share. On January 2, 2022, Katrin's journal entry should include

a credit to common stock for $100,000.

If an employee is entitled to receive cash under a restricted stock units award plan, the sponsoring company should recognize:

a liability

Restricted stock units that are payable in cash are classified as

a liability

Frohe Inc. sponsors a restricted stock units award plan under which employees can choose to receive cash. During the vesting period, the company should recognize the award as a credit to a:

a liability account

The incremental effect of convertible bonds is the _____ interest saved divided by the ____ common shares from the conversion.

after-tax; additional

Employee share purchase plans typically allow ______ to purchase company shares at favorable terms.

all employees

Securities that upon conversion or exercise of potential common shares would increase EPS are referred to as _____ securities.

antidilutive

For the purpose of calculating diluted EPS, convertible preferred stock is

assumed to have already been converted.

Restricted stock units are classified as a liability if they are payable in _____.

cash

In calculating diluted EPS under the treasury stock method, one component of the proceeds from the exercise of options include

cash received at exercise

Which of the following would prevent Norbert Company from having a simple capital structure for the purpose of reporting EPS?

convertible preferred stocks

Diluted EPS should be calculated using different combinations of potential common shares to find the combination that yields the:

lowest possible EPS.

The effect of changes in estimated option forfeitures must be recognized

cumulatively in the year the estimate changes.

A strategy that simplifies the determination of whether convertible securities are dilutive is to compare their _____ effect on earnings per share.

incremental

If employees can elect to receive cash, SAR awards are classified as

Liabilities.

Which of the following represents an important accounting issue with respect to stock option plans?

Measurement of the related compensation

What condition must be met to include contingent issuable shares in the calculation of diluted EPS?

Meeting the target performance level is already complete.

A single number that summarizes a company's performance and to which investors pay reasonable attention is the:

earnings per share.