Walters Audio Visual, Inc., offers a stock option plan to its regional managers.
ID: 2571440 • Letter: W
Question
Walters Audio Visual, Inc., offers a stock option plan to its regional managers. On January 1, 2016, options were granted for 40 million $1 par common shares. The exercise price is the market price on the grant date, $9 per share. Options cannot be exercised prior to January 1, 2018, and expire December 31, 2022. The fair value of the options, estimated by an appropriate option pricing model, is $3 per option. Because the plan does not qualify as an incentive plan, Walters will receive a tax deduction upon exercise of the options equal to the excess of the market price at exercise over the exercise price. The income tax rate is 40%.
Required:
1.
Determine the total compensation cost pertaining to the stock option plan.
2.
Prepare the necessary journal entries.
-Record compensation expense on December 31, 2016.
-Record any tax effect related to compensation expense recorded in 2016.
-Record compensation expense on December 31, 2017.
-Record any tax effect related to compensation expense recorded in 2017.
-Record the exercise of the options on March 20, 2021 when the market price is $13 per share.
-Record any tax effect related to the exercise of the options.
3.
Assume the option plan qualifies as an incentive plan if all of the options are exercised on March 20, 2021, when the market price is $12 per share. Prepare the necessary journal entries
-Dec 31, 2016 Record compensation expense on December 31, 2016.
-Dec 31 ,2016 Record any tax effect related to compensation expense recorded in 2016.
- Dec 31, 2021 Record the exercise of the options on March 20, 2021 when the market price is $12 per share.
-March 31, 2021 Record any tax effect related to the exercise of the options.
Explanation / Answer
Employee Stock Option
1) Total compensation cost pertaining to the stock option plan
Total options granted at the grant date is 40000000 options(40000000 at $1 par common stock)
Fair value of options expected to vest = 40000000 options * $3 = $120,000,000
Options expense per year = $120,000,000
2 Years
= $60,000,000
2) Journal Entries
a) Compensation expense on December 31, 2016
Employee Compensation Expense - Debit $60,000,000
To Employee Stock option outstanding - Credit $60,000,000
(record of 1st year employee stock option expense )
b) Tax effect related to compensation expense recorded in 2016
Assuming company has offered a qualified stock option and there is no deductions on qualified stock options, Since the plan does not qualify as incentive plan, companies will receive tax deduction to the extent amount in excess of market price at exercise price over market price , Hence no tax effect until vesting period.
c) compensation expense on December 31, 2017
Employee Compensation Expense - Debit $60,000,000
To Employee Stock option outstanding - Credit $60,000,000
(record of 2nd year employee stock option expense )
d) Tax effect related to compensation expense recorded in 2017
Assuming company has offered a qualified stock option and there is no deductions on qualified stock options, Since the plan does not qualify as incentive plan, companies will receive tax deduction to the extent amount in excess of market price at exercise price over market price , Hence no tax effect until vesting period.
e) Employee Stock Option
Value of options scheme = Number of options *(Market price - exercised price)
= (40000000*($13-$9))
= $160,000,000
Options expense per year = $160,000,000
2 Years
= $80,000,000
Please Note: 1) In case one question with multiple subparts, only first 4 subparts needs be answered as a mandatory requirement and
2) In case of multiple questions only first question (full) with minimum 4 sub parts (in case of more sub parts) needs to be answered as a mandatory requirement.
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