Question

Stock Option

- On 1/1/2020, the stockholders of Firm ABC approve a plan that grants the company’s CEO options to purchase 5,000 shares each of the company’s zero par value common stock.

- The company grants the options on January 1, 2020. The executives may exercise the options after 1/1/2022. The exercise price per share is $10, and the market price of the stock at the date of grant is $10 per share.

- The company computes total compensation expense by applying an acceptable fair value option-pricing model (such as the Black-Scholes option-pricing model). To keep this illustration simple, we assume that the fair value option-pricing model determines the executive’s total compensation expense to be $10,000.

- Corporate tax rate is 20%. Income Tax Expense for 2020 and 2021 is $50,000, and Income Taxes Payble for 2020 and 2021 is $51,000.

Questions:

Prepare journal entries on 12/31/2020 and 12/31/2021. (15 pt)

Suppose that the CEO exercises options on 1/1/2022 to purchase 5,000 shares and the market price of the stock is $20 per share. Prepare the journal entries (10 pt):

What is the realized value loss to the current shareholders? (5 pt)

Prepare the journal entries related to tax return (10 pt)

Answer 1

Answer: Point No. A:

Date	Particulars	Amount (Dr.)	Amount (Cr.)
31/12/2020	Employees compensation expense account Dr. To Employee Stock Option Outstanding amount    (Being compensation expenses recongnized in respect of the employee stock option i.e. 10000$ apportioned in two years)	5000.00	5000.00
31/12/2020	Profit and Loss Account Dr. To Employees compensation expense account (Being expenses transferred to profit and loss account at year end)	5000.00	5000.00
31/12/2021	Employees compensation expense account Dr. To Employee Stock Option Outstanding amount    (Being compensation expenses recongnized in respect of the employee stock option i.e. 10000$ apportioned in two years)	5000.00	5000.00
31/12/2021	Profit and Loss Account Dr. To Employees compensation expense account (Being expenses transferred to profit and loss account at year end)	5000.00	5000.00

Answer: Point B:

01/01/2022	Bank Account ($5000*$10) Dr. Employee compensation expense account Dr. ($5000*$10) To Equity Share Capital A/C (Being shares issued to the CEO against the options vested to them and being the compnay's share at zero par value, hence whole amount transferred to equity share capital)	50000 50000	100000
01/01/2022	Profit and Loss Account    Dr. To Employees compensation expense account (Being transfer of employee compensation expenses to Profit and Loss Account)	50000	50000

Answer: Point C:

Realized value loss to shareholders is $10 per share.