Chapter 19, Problem 19.27E

(1)

To determine

Stock appreciation rights (SARs): Stock appreciation rights are the compensation plans provided in the form of rights to receive cash or shares for the appreciated value (difference between the market price of shares on the exercise date and the market price of shares on the grant date). The choice between the cash or shares would be chosen either by employers or employees.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To journalize: The entry to record the grant of SARs on January 1, 2016, and mention whether SARs would be reported as debt or equity

Explanation of Solution

The SARs would be reported as equity by Company IE because the SARs are entitled to be settled as stock on the exercise date. Since the compensation expense would be recognized only after the completion of one year, do not record any entry for this transaction on the grant date.

(2)

To determine

To journalize: The entries related to SARs from December 31, 2016 to December 31, 2019

Explanation of Solution

Prepare journal entry for compensation expense on December 31, 2016.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2016
December	31	Compensation Expense		18,000,000
		Paid-In Capital–SAR Plan			18,000,000
		(To record compensation expense)

Table (1)

• Compensation Expense is an expense account. Since expenses decrease stockholders’ equity, and a decrease in stockholders’ equity is debited.
• Paid-in Capital–SAR Plan is a stockholders’ equity account. Since shares are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

Working Notes:

Compute the total compensation cost of SARs.

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of SARs}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Estimated fair market value × }\\ \text{Number of SARs granted}\end{array}\right\}\\ \text{= \$3 × 24,000,000 shares}\\ \text{=\$72,000,000}\end{array}$ (1)

Compute the compensation expense allocated each year.

$\begin{array}{c}\text{Expense allocated each year =}\frac{\text{ Total compensation cost of SARs}}{\text{Vesting period}}\\ \text{=}\frac{\text{\$72,000,000}}{\text{4 years}}\\ \text{= \$18,000,000}\end{array}$ (2)

Note: Refer to Equation (1) for the value and computation of compensation cost.

Prepare journal entry for compensation expense on December 31, 2017.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2017
December	31	Compensation Expense		18,000,000
		Paid-In Capital–SAR Plan			18,000,000
		(To record compensation expense)

Table (2)

• Compensation Expense is an expense account. Since expenses decrease stockholders’ equity, and a decrease in stockholders’ equity is debited.
• Paid-in Capital–SAR Plan is a stockholders’ equity account. Since shares are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

Note: Refer to Equation (2) for value and computation of compensation expense.

Prepare journal entry for compensation expense on December 31, 2018.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
December	31	Compensation Expense		18,000,000
		Paid-In Capital–SAR Plan			18,000,000
		(To record compensation expense)

Table (3)

• Compensation Expense is an expense account. Since expenses decrease stockholders’ equity, and a decrease in stockholders’ equity is debited.
• Paid-in Capital–SAR Plan is a stockholders’ equity account. Since shares are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

Note: Refer to Equation (2) for value and computation of compensation expense.

Prepare journal entry for compensation expense on December 31, 2019.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2019
December	31	Compensation Expense		18,000,000
		Paid-In Capital–SAR Plan			18,000,000
		(To record compensation expense)

Table (4)

• Compensation Expense is an expense account. Since expenses decrease stockholders’ equity, and a decrease in stockholders’ equity is debited.
• Paid-in Capital–SAR Plan is a stockholders’ equity account. Since shares are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

Note: Refer to Equation (2) for value and computation of compensation expense.

(3)

To determine

To prepare: Journal entry for the unexercised SARs as on December 31, 2020

Explanation of Solution

The compensation cost is expensed till December 31, 2019, and would be measured only once. The expense would not be re-measured on December 31, 2020. So do not record any entry for this transaction on December 31, 2020.

(4)

To determine

To journalize: The entry for SARs exercised on June 6, 2021

Explanation of Solution

Journalize the entry for options exercised.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2021
June	6	Paid-in Capital – SAR Plan		72,000,000
		Common Stock			1,920,000
		Paid-in Capital–Excess of Par			70,080,000
		(To record SARs exercised by employees)

Table (5)

• Paid-in Capital–SAR Plan is a stockholders’ equity account. Since stock options are exercised and shares are issued, stock options value is decreased, and a decrease in equity is debited.
• Common Stock is a stockholders’ equity account. Since stock options are exercised and shares are issued, common stock value increased, and an increase in equity is credited.
• Paid-in Capital–Excess of Par is a stockholders’ equity account. Since stock options are exercised and shares are issued, excess of par value increased, and an increase in equity is credited.

Working Notes:

Compute the paid-in capital amount.

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Estimated fair market value × }\\ \text{Number of SARs granted}\end{array}\right\}\\ \text{= \$3 × 24,000,000 shares}\\ \text{= \$72,000,000}\end{array}$ (3)

Compute number of shares for SARs granted.

$\begin{array}{c}\begin{array}{l}\text{Number of shares }\\ \text{for SARs}\end{array}\}\text{ = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Market price on exercise date – }\\ \text{Market price on grant date}\end{array}\right)\text{ × }\\ \text{Number of SARs granted}\end{array}\right\}\\ \text{= }\left(\text{\$50–\$46}\right)\text{×24,000,000 SARs}\\ \text{= 96,000,000 shares}\end{array}$ (4)

Compute number of shares to be received by employees for the market price on exercise date.

$\begin{array}{c}\begin{array}{l}\text{Number of shares }\\ \text{to be received}\end{array}\}\text{ =}\frac{\text{ Number of shares for SARs}}{\text{Market price on exercise date}}\\ \text{= }\frac{\text{96,000,000 shares}}{\text{\$50}}\\ \text{= 1,920,000 shares}\end{array}$ (5)

Note: Refer to Equation (4) for the value and computation of number of shares for SARs.

Compute the common stock amount.

$\begin{array}{c}\begin{array}{l}\text{Common stock }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Par value per share × }\\ \text{Number of shares received by employees}\end{array}\right\}\\ \text{= \$1 × 1,920,000 shares}\\ \text{= \$1,920,000}\end{array}$ (6)

Note: Refer to Equation (5) for the value and computation of number of shares received by employees.

Compute the paid-in capital–excess of par amount.

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital–}\\ \text{excess of par value}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Paid-in capital value – }\\ \text{Common stock value}\end{array}\right\}\\ \text{= \$72,000,000 – \$1,920,000}\\ \text{= \$70,080,000}\end{array}$

Note: Refer to Equations (3) and (6) for both the values.