Chapter 15, Problem 7E

1.

To determine

Prepare a schedule of Corporation P’s compensation computation for its compensatory share option plan for 2019.

Explanation of Solution

Share option plan: This is an option given to an employee to buy a certain number of shares of stock of the company at a pre-determined price during certain period of time.

Prepare a schedule of Corporation P’s compensation computation for its compensatory share option plan for 2019:

Particulars	2019	2020	2021
Total compensated cost $\left(\$14\times 200\times 50\times 0.85\right)$	$119,000	$119,000	$120,400 (1)
Fraction of service period expired	1/3	1/3	1/3
Compensation expense	$39,667	$79,333	$120,400
Previously recognized compensation expense	(0)	(39,667)	($79,333)
Current compensation expense	$39,667	$39,666	$41,067

Table (1)

Working note 1: Compute the total compensation cost for the year 2021:

$\begin{array}{c}\text{Total compensation expense}\text{for}\text{2021}\text{=}\left[\$14\times 200\times \left(50-7\right)\right]\\ =\$14\times 200\times 43\\ =\$120,400\end{array}$

2.

To determine

Prepare a memorandum entry on the grant date and journal entries for 2019 to 2022 related to the given plan.

Explanation of Solution

Prepare a memorandum entry on the grant date:

Memorandum entry: On January 1, 2019, the company granted compensatory share options to 50 executives. The plan allows each executive to exercise 200options to acquire the same number of shares of company’s common stock at an exercise price of $30 per share and vest at the end of service period of 3 years. The estimated fair value of the options expected to be exercised is $119,000.

Working note 2: Compute the total compensation cost of options for the year 2019.

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options expected to vest}\end{array}\right\}\\ \text{= }\left\{\begin{array}{l}\text{\$14 × 200 shares}\times 50\text{ executives}\times \\ \left(100\%–15\%\right)\text{retention rate}\end{array}\right\}\\ \text{= \$14 × 200 shares}\times 50\text{ executives}\times 85\%\\ \text{= \$119,000}\end{array}$

Journalize compensation expense for share options for the year 2019 in the books of Company P:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
2019	Compensation expense		$39,667
	Paid-in capital from share options			$39,667
	(To record share options)

Table (2)

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $39,667.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $39,667.

Journalize compensation expense for share options for the year 2020 in the books of Company P:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
2020	Compensation expense		$39,667
	Paid-in capital from share options			$39,667
	(To record share options)

Table (3)

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $39,667.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $39,667.

Journalize compensation expense for share options for the year 2021 in the books of Company P:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
2021	Compensation expense		$39,667
	Paid-in capital from share options			$39,667
	(To record share options)

Table (4)

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $39,667.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $39,667.

Journalize compensation expense for share options for the year 2022 in the books of Company P:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
2022	Cash		$48,000
	Paid-in capital from share options		$22,400
	Common stock, $5 par			$3,200
	Additional paid-in capital			$67,200
	(To record share options)

Table (5)

• Cash is an asset account. Since share options are exercised and shares are purchased for cash, cash is received. Therefore, debit Cash account with $48,000.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options which are granted are exercised, the entry is reversed and cancelled for options exercised. Therefore, debit Paid-in Capital from Share Options account with $22,400.
• Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold, common stock amount increased. Therefore, credit Common Stock account with $3,200.
• Additional Paid-in Capital on Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold for more than par value, additional capital amount increased. Therefore, credit Additional Paid-in Capital on Common Stock account with $67,200.

Working Note 3: Compute cash received by Company P.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\text{Number of options exercised × }\\ \text{Exercise price}\end{array}\right\}\\ \text{= 8 executives}\times 2\text{00 shares× \$30}\\ \text{= \$48,000}\end{array}$

Working Note 4: Compute the paid-in capital of stock options amount.

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options exercised}\end{array}\right\}\\ \text{= \$14 × 200 shares}\times 8\text{ executives}\\ \text{= \$22,400}\end{array}$

Working Note 5: Compute the common stock amount.

$\begin{array}{c}\begin{array}{l}\text{Common stock }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Par value per share × }\\ \text{Number of options exercised}\end{array}\right\}\\ \text{= \$2 × 200 shares}\times 8\text{ executives}\\ \text{= \$3,200}\end{array}$

Working Note 6: Compute the additional paid-in capital amount.

$\begin{array}{c}\begin{array}{l}\text{Additional paid-in }\\ \text{capital amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received + }\\ \text{Paid-in capital of stock options value – }\\ \text{Common stock value}\end{array}\right\}\\ \text{= \$48,000 + \$22,400 – \$3,200}\\ \text{= \$67,200}\end{array}$