On December 31, 2014, Kessler Company granted some of its executives options to purchase 45,000 shares of the company's $10 par common stock at an option price of $50 per share. The options become exercisable on January 1, 2015, and represent compensation for executives' services over a three-year period beginning January 1, 2015. The Black-Scholes option pricing model determines total compensation expense to be $270,000. At December 31, 2015, none of the executives had exercised their options. What is the impact on Kessler's net income for the year ended December 31, 2015 as a result of this transaction under the fair value method?

Question

Quizplus · Accepted Answer

Under the fair value method, compensation expense is recognized each year equal to the fair value of the options granted divided by the number of years over which the executives must provide service in exchange for the options. In this case, the total compensation expense is $270,000, and since the executives must provide service for three years, the annual compensation expense is $90,000 ($270,000 ÷ 3). In 2015, no options were exercised, so there is no impact on net income. However, $90,000 of compensation expense must be recognized, which will decrease net income. Therefore, the answer is C, $90,000 decrease.

On December 31, 2014, Kessler Company Granted Some of Its