Question

Walters Audio Visual, Inc. offers a stock option plan to its regional managers. On January 1, 2018, 45 million options were granted for 45 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, 2020, and expire December 31, 2024. The fair value of the options, estimated by an appropriate option pricing model, is $2 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. to 4. Assume all of the options are exercised on March 20, 2023, when the market price is $14 per share. Prepare the necessary journal entries.

5. & 6. Assume the option plan qualifies as an incentive plan if all of the options are exercised on March 20, 2023, when the market price is $13 per share. Prepare the necessary journal entries.

Answer 1

1. Total compensation cost = 45 million *$2 = 90 Million

2 to 4 Expense to be recorded each year = Compensation Expense / Vesting period = $90,000,000/ 2 = $45,000,000

Date	General Journal	Debit	Credit
December 31,2018	Compensation expense	45,000,000
	Paid in Capital Stock Options		45,000,000
December 31,2018	Deferred Tax Asset	18,000,000
	Tax Expense		18,000,000
	[45,000,000*40%]
December 31,2019	Compensation expense	45000000
	Paid in Capital Stock Options		45000000
December 31,2019	Deferred Tax Asset	18000000
	Tax Expense		18000000
	[45,000,000*40%]
March 20,2023	Cash [$10* 45million]	450000000
	Paid in Capital Stock options	90000000
	Common Stock [ $1*30million]		45000000
	Paid in Capital in excess of par		495000000
	[Exercise of options]
March 20,2023	Income Tax Payable	72000000
	[$14-$10 ] *45million *40%
	Deferred Tax Asset		36000000
	[18million *2]
	Paid in Capital -tax effect of stock options		36000000

5 to6:

Date	General Journal	Debit	Credit
December 31,2018	Compensation expense	45000000
	Paid in Capital Stock Options		45000000
December 31,2019	Compensation expense	45000000
	Paid in Capital Stock Options		45000000
March 20,2023	Cash [$10* 45million]	450000000
	Paid in Capital Stock options	90000000
	Common Stock [ $1*45million]		45000000
	Paid in Capital in excess of par		495000000
	[Exercise of options]

No tax effect if it is an incentive plan since it does not qualify for tax deduction.