Walters Audio Visual Inc. offers an incentive stock option plan to its regional

Question

Walters Audio Visual Inc. offers an incentive stock option plan to its regional managers. On January 1, 2016, options were granted for 60 million $1 par common shares. The exercise price is the market price on the grant date—$10 per share. Options cannot be exercised prior to January 1, 2018, and expire December 31, 2022. The fair value of the 60 million options, estimated by an appropriate option pricing model, is $1 per option. Required:

1. Determine the total compensation cost pertaining to the incentive stock option plan. (Enter your answer in millions (i.e., 10,000,000 should be entered as 10).)

2. Prepare the appropriate journal entries to record compensation expense on December 31, 2016 and 2017. Prepare the appropriate journal entry to record the exercise of 75% of the options on March 12, 2018, when the market price is $11 per share and the entry on December 31, 2022, when the remaining options that have vested expire. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)

Explanation / Answer

Solution:

1) Calculation of Total Compensation Expenses

Total Compensation Expenses = No. of Options granted x Estimated Fair Value per option = 60 Million options x $1 estimated fair value per option = $60 Million

Total Compensation Expenses = $60 Million

2) Total Compensation Expenses is allocated to expense over the 3 years service (vesting) period 2016 - 2018

$60 Million / 3 = $20 Million

Journal Entry to Record Compensation Expenses on

Dec 31, 2016

Compensation Expenses A/c Dr.     $20 million

      To Stock Options – Paid in Capital A/c        $20 Million

Dec 31, 2017

Compensation Expenses A/c Dr.     $20 million

      To Stock Options – Paid in Capital A/c        $20 Million

Journal entry to record the exercise of 75% of the options on March 12, 2018

Market price = $11 per share

75% Options are exercised on March 12, 2018

Journal Entry

Debit

($ in millions)

Credit

($ in millions)

Cash ($10 exercise price x 60 million option x 75%) Dr.

$450

Stock Options – Paid in Capital A/c Dr. ($60 million x 75%)

$45

    To Common Stock (60 Million Shares at $1 per share)

$60

   To Paid in Capital – excess of par

$435

Entry on December 31, 2022, when the remaining options that have vested expire

Debit

($ in millions)

Credit

($ in millions)

Stock Options – Paid in Capital A/c Dr. ($60 million x 25%)

$15

   To Paid in Capital – Expiration of Stock Options

$15

Debit

($ in millions)

Credit

($ in millions)

Cash ($10 exercise price x 60 million option x 75%) Dr.

$450

Stock Options – Paid in Capital A/c Dr. ($60 million x 75%)

$45

    To Common Stock (60 Million Shares at $1 per share)

$60

   To Paid in Capital – excess of par

$435

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