Question 1

Executive stock options should be reported as compensation expense:
A)Using the intrinsic value method.
B)Using the fair value method.
C)Using either the fair value method or the intrinsic value method.
D)Only on rare occasions.

Accepted Answer

According to Generally Accepted Accounting Principles (GAAP), executive stock options should be reported as compensation expense using the fair value method. This method reflects the value of the option at the time it was granted, taking into account factors such as the stock price, exercise price, expected volatility, and expected term of the option. The fair value method provides a more accurate valuation of the compensation expense related to the options and is therefore the preferred method of reporting for executive stock options.

Question 2

What amount should M recognize as compensation expense for 2009?
A)$ 30,000
B)$ 60,000
C)$120,000
D)$150,000 (90,000 5 = $450,000; $450,000 / 3 yrs = $150,000)

Accepted Answer

The compensation expense should be recognized over the vesting period, which is 3 years. The total compensation to be recognized is $450,000 ($90,000 x 5 years). Therefore, the annual compensation expense to be recognized is $150,000 ($450,000 / 3 years). Therefore, Choice D is the correct answer.

Question 3

Dilutive convertible bonds affect both the numerator and the denominator in computing diluted EPS.

Accepted Answer

Dilutive convertible bonds can be converted into shares of common stock, which increases the number of shares outstanding in the denominator of the diluted EPS calculation. In addition, interest expense on the convertible bonds reduces net income in the numerator of the diluted EPS calculation. Therefore, both the numerator and denominator are affected.

Question 4

No time-weighting of contingently issuable shares is required when computing basic EPS.

Accepted Answer

No time-weighting of contingently issuable shares is necessary in the computation of basic EPS. Time-weighting is only necessary for dilutive securities when calculating diluted EPS.

Question 5

Compensation expense must be adjusted during the service period to reflect changes in the fair value of options caused by changes in the market price of the underlying shares.

Accepted Answer

The answer of Compensation expense must be adjusted during the...

Question 6

Stock options will be dilutive and included in the calculation of dilutive EPS if the exercise price is greater than the average market value of the stock.

Accepted Answer

Stock options will only be dilutive and included in the calculation of dilutive EPS if the exercise price is less than or equal to the average market value of the stock. If the exercise price is greater, the options are considered anti-dilutive and are not included in the calculation.

Question 7

If unexpected turnover in 2010 caused the company to estimate that 10% of the options would be forfeited, what amount should M recognize as compensation expense for 2010?
A)$ 30,000
B)$ 60,000
C)$120,000
D)$150,000 (90,000 5 = $450,000; $450,000 90% = $405,000 2/3 = $270,000; $270,000 150,000 = $120,000)

Accepted Answer

To determine the amount of compensation expense, we need to calculate the total number of options granted and adjust it for the estimated forfeiture rate (10%). The total number of options granted is 450,000, and the adjusted number is 405,000 (450,000 x 90%). The total compensation expense is then calculated by multiplying the adjusted number of options by the fair value per option (which is $2/3). Therefore, the total compensation expense for 2010 is $120,000 (405,000 x $2/3). Option C is the correct answer.

Question 8

The current FASB standard requires using intrinsic value accounting for employee stock options.

Accepted Answer

The current FASB standard requires using fair value accounting for employee stock options. Intrinsic value accounting is no longer allowed.

Question 9

The most important accounting objective for executive stock options is:
A)Measuring and reporting the amount of compensation expense during the service period.
B)Measuring their fair value for balance sheet purposes.
C)To disclose increases or decreases in the stock options held at the end of each accounting period.
D)None of these is correct.

Accepted Answer

The most important accounting objective for executive stock options is to measure and report the amount of compensation expense during the service period. This is because executive stock options represent one of the most significant forms of compensation for executives, and appropriate measurement and reporting is essential in order to accurately reflect the financial position and performance of a company. Measuring the fair value of the stock options and disclosing changes in the options held are also important objectives, but they are secondary to the primary objective of measuring and reporting the compensation expense.

Question 10

If previous experience indicates that a material number of stock options will be forfeited before they vest, the fair value estimate of the options on the grant date should be adjusted to reflect that expectation.

Accepted Answer

If there is a history of forfeitures, it is likely that a portion of the options granted will not end up being exercised, and this should be factored into the fair value estimate of the options at the grant date.

Question 11

FX Services granted 15 million of its $1 par common shares to executives, subject to forfeiture if employment is terminated within three years. The common shares have a market price of $8 per share on the grant date. Ignoring taxes, what is the effect on earnings in the year after the shares are granted to executives?
A)$ 0
B)$ 15 million
C)$ 40 million
D)$120 million The $120 million total compensation is expensed equally over the three-year vesting period, reducing earnings by $40 million each year.

Accepted Answer

The total compensation cost of $120 million ($8 market price x 15 million shares) is expensed over the three-year vesting period, resulting in a $40 million reduction in earnings each year.

Question 12

Under its executive stock option plan, N Corporation granted options on January 1, 2009, that permit executives to purchase 15 million of the company's $1 par common shares within the next eight years, but not before December 31, 2011 (the vesting date). The exercise price is the market price of the shares on the date of grant, $18 per share. The fair value of the options, estimated by an appropriate option pricing model, is $4 per option. No forfeitures are anticipated. Ignoring taxes, what is the effect on earnings in the year after the options are granted to executives?
A)$ 0
B)$20 million
C)$60 million
D)$90 million The $60 million total compensation is expensed equally over the three-year vesting period, reducing earnings by $20 million each year.

Accepted Answer

The total compensation cost of $60 million ($4 per option * 15 million options) is recognized over the three-year vesting period, resulting in an expense of $20 million per year.

Question 13

On January 1, 2009, Red Inc. issued stock options for 200,000 shares to a division manager. The options have an estimated fair value of $6 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 6% in three years. Red initially estimates that it is probable the goal will be achieved. Ignoring taxes, what is reduction in earnings in 2009?
A)$ 0
B)$ 200,000
C)$ 400,000
D)$1,200,000 The estimate of the total compensation would be:
200,000 $6 = $1,200,000
One-third of that amount, or $400,000, will be recorded in each of the three years.

Accepted Answer

Since the options are not exercisable unless divisional revenue increases by 6% in three years, there is a performance condition attached to it. As Red initially estimates that it is probable the goal will be achieved, they can recognize the compensation expense over the service period of three years. Therefore, the reduction in earnings in 2009 would be $400,000 (one-third of the total compensation expense).

Question 14

Current year stock dividends and splits require retroactive restatement of EPS for all prior years presented in comparative financial statements.

Accepted Answer

Stock dividends and splits affect the number of outstanding shares and therefore impact earnings per share (EPS) for all prior years presented in comparative financial statements. As a result, companies are required to retroactively restate EPS for all prior years to reflect the impact of current year stock dividends and splits.

Question 15

If a company reports an extraordinary gain, EPS must be disclosed for both income from ordinary continuing operations and net income.

Accepted Answer

When a company reports an extraordinary gain, EPS (earnings per share) must be disclosed for both income from ordinary continuing operations and net income. This is because the gain is considered an unusual and infrequent item that can distort the company's normal operating results, and investors need to see how it affects overall profitability. By providing EPS for both income figures, investors can more accurately assess the company's performance and make informed investment decisions.

Question 16

The compensation associated with restricted stock under a stock award plan is:
A)the book value of an unrestricted share of the same stock times the number of shares.
B)the estimated fair value of a share of similar stock times the number of shares.
C)allocated to expense over the service period which usually is the vesting period.
D)the book value of a share of similar stock times the number of shares.

Accepted Answer

The compensation cost for restricted stock is recognized over the service period, which is typically the vesting period, as the employee earns the right to the stock.

Question 17

The compensation associated with a share of restricted stock under a stock award plan is:
A)The market price of a share of similar fixed income securities.
B)The market price of an unrestricted share of the same stock.
C)The book value of an unrestricted share of the same stock.
D)The book value of a share of similar stock.

Accepted Answer

The compensation associated with a share of restricted stock under a stock award plan is typically based on the market price of an unrestricted share of the same stock. This is because the restricted stock may have limitations on when it can be sold or transferred, which reduces its value compared to an unrestricted share. The market price of an unrestricted share reflects this difference in value.

Question 18

The compensation associated with executive stock option plans is
A)the book value of a share of the company's shares times the number of options
B)the estimated fair value of the options
C)allocated to expense over the number of years until expiration
D)recorded as compensation expense on the date of grant

Accepted Answer

The compensation associated with executive stock option plans is the estimated fair value of the options. The fair value of the options is determined using complex models that take into account various factors like the stock price, exercise price, expected volatility, and expected life of the option. This fair value is then expensed over the vesting period of the options.

Question 19

Except for tax considerations the potentially dilutive effect of convertible preferred stock is handled in EPS calculations in much the same way as convertible debt.

Accepted Answer

Convertible preferred stock and convertible debt are both accounted for in EPS calculations using the if-converted method, which assumes that the securities have been converted into common stock. The difference in tax treatment between the two types of securities is not relevant to EPS calculations.

Question 20

If a company's capital structure includes convertible bonds, diluted EPS might be reduced even if the bonds are not actually converted during the year.

Accepted Answer

Convertible bonds have the potential to be converted into common shares, which would increase the number of outstanding shares and reduce diluted EPS. Even if the bonds are not actually converted during the year, their potential conversion may still have an impact on diluted EPS.

Quiz 19: Share-Based Compensation and Earnings Per Share

Executive stock options should be reported as compensation expense:

What amount should M recognize as compensation expense for 2009?

Dilutive convertible bonds affect both the numerator and the denominator in computing diluted EPS.

No time-weighting of contingently issuable shares is required when computing basic EPS.

Compensation expense must be adjusted during the service period to reflect changes in the fair value of options caused by changes in the market price of the underlying shares.

Stock options will be dilutive and included in the calculation of dilutive EPS if the exercise price is greater than the average market value of the stock.

If unexpected turnover in 2010 caused the company to estimate that 10% of the options would be forfeited, what amount should M recognize as compensation expense for 2010?

The current FASB standard requires using intrinsic value accounting for employee stock options.

The most important accounting objective for executive stock options is:

If previous experience indicates that a material number of stock options will be forfeited before they vest, the fair value estimate of the options on the grant date should be adjusted to reflect that expectation.

Current year stock dividends and splits require retroactive restatement of EPS for all prior years presented in comparative financial statements.

If a company reports an extraordinary gain, EPS must be disclosed for both income from ordinary continuing operations and net income.

The compensation associated with restricted stock under a stock award plan is:

The compensation associated with a share of restricted stock under a stock award plan is:

The compensation associated with executive stock option plans is

Except for tax considerations the potentially dilutive effect of convertible preferred stock is handled in EPS calculations in much the same way as convertible debt.

If a company's capital structure includes convertible bonds, diluted EPS might be reduced even if the bonds are not actually converted during the year.