Question

Part 3: GAAP for Stock Options VU Enterprises Corp, grants its CEO 10,000 stock options on January 1, 2018. Each option has an exercise price of $50 per share, which is also the market price of the stock on January 1, 2018. The options vest in four years from the date of the grant and may be exercised within the six years that follow vesting. VU's stock has a par value of $1. 1. Assume that VU uses the Black-Scholes option pricing model and estimates the fair value of the options to be $240,000 at the time of the grant. VU has a 12/31 fiscal year end. Using the fair value method, prepare any necessary journal entries for VU for: a) January 1, 2018 b) December 31, 2018 c) December 31, 2019 d) December 31, 2020 e) December 31, 2021 How would your answers in part 1 be different if VU instead used the intrinsic value method? 2. Suppose that the CEO exercised 5,000 of the options on May 28, 2023, when the stock was trading at $110 per share. Prepare the journal entry to record the exercise. 3. Suppose that soon after the CEO exercised the 5,000 options in 2023 a bear market caused VU's stock price to plummet well below $50. As of January 1, 2028, the stock had still not fully recovered and remained below $50. The CEO never exercised his remaining options and thus they expired on January 1, 2028. Prepare the journal entry to record the expiration. 4. Now ignore parts 2 and 3. Assume instead that the CEO decided to leave the firm on January 1, 2021, thus failing to satisfy the vesting period and forfeiting his options. Prepare the journal entry to record the forfeiture.

Answer 1

1.

Options expected to vest = 10,000

Stock option compensation cost = Fair value of option at grant

Stock option compensation cost = $240,000

Vesting period = 4 years

Service period completed = 1 year

Cumulative expense at end of year 1 = Total cost x Service period / Vesting period

Cumulative expense at end of year 1 = 240,000 x 1/4 = $60,000

Previously recognized expense = 0

Stock option compensation expense for year 1 =$60,000

SINCE THERE IS NO CHANGE IN ESTIMATES, EACH YEAR $60,000 WOULD BE RECORDED.

Jan-01	NO ENTRY
31-12-18	Stock option expense journal entry – Year 1
	PARTICULARS	Debit	Credit
	Stock option compensation expense	$60,000
	Stock options		$60,000
31-12-19	Stock option expense journal entry – Year 2
	PARTICULARS	Debit	Credit
	Stock option compensation expense	$60,000
	Stock options		$60,000
31-12-20	Stock option expense journal entry – Year 3
	PARTICULARS	Debit	Credit
	Stock option compensation expense	$60,000
	Stock options		$60,000
31-12-21	Stock option expense journal entry – Year 4
	PARTICULARS	Debit	Credit
	Stock option compensation expense	$60,000
	Stock options		$60,000
	SINCE THE MARKET VALUE IS EQUAL TO THE EXERCISE PRICE OF THE SHARE, NO COMPENSATION EXPENSE WOULD BE RECORDED.

2.

Number of options exercised = 5000
Exercise price / share = $50.00
Amount paid for shares = 5000 * 50 = $250,000
PARTICULARS	Debit	Credit
Cash	$ 250,000
Common stock		$      5,000
Stock options		$ 240,000
Reserve Account		$       5,000

3.

PARTICULARS	Debit	Credit
Stock options	$ 240,000
Income account		$      240,000

4.

Cumulative expense at end of year 4 = Total cost x Service period / Vesting period

Cumulative expense at end of year 1 = 0 x 4/4 = 0

Previously recognized expense = $180,000

Stock option compensation reverse for year 4 =$180,000

31-12-21	Stock option expense journal entry – Year 4
	PARTICULARS	Debit	Credit
	Stock options	$180,000
	Stock option compensation expense		$180,000