Question

American Optical Corporation provides a variety of share-based compensation plans to its employees. Under its executive stock option plan, the company granted options on January 1, 2018, that permit executives to acquire 5 million of the company’s $1 par common shares within the next five years, but not before December 31, 2019 (the vesting date). The exercise price is the market price of the shares on the date of grant, $73.00 per share. The fair value of the 5 million options, estimated by an appropriate option pricing model, is $18 per option. No forfeitures are anticipated. Ignore taxes.
Required:

1. Determine the total compensation cost pertaining to the options.

2. to 4. Prepare the appropriate journal entries.

Answer 1

Answer:

1.

Total compensation cost pertaining to the options: $90 million

2.

31st Dec 2018

Dr Compensation expenses               $ 45,000,000

  Cr Paid-in capital - Stock options    $45,000,000

(to record compensation expenses allocating to the year 2018)

31st Dec 2019

Dr Compensation expenses               $ 45,000,000

  Cr Paid-in capital - Stock options    $45,000,000

(to record compensation expenses allocating to the year 2019)

Explanation:

1. The compensation cost pertaining to the option equals: Fair value of each option x Number of granted options = $18 x 5,000,000 = $90,000,000.

2. The compensation expenses will be for 02 years (2018 and 2019), thus this expense should be recorded half in the year of 2018 and the other half in the year of 2019, ie $90,000,000/2 = $45,000,000 each year.