Under its executive stock option plan, Q 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 $4 per option. No forfeitures were anticipated, however unexpected turnover during 2010 caused the forfeiture of 5% of the stock options. Ignoring taxes, what is the effect on earnings in 2011?
A)$ 0
B)$18 million
C)$19 million
D)$20 million The $60 million total compensation is expensed equally over the three-year vesting period, reducing earnings by $20 million in 2009.The company should adjust the cumulative amount of compensation expense recorded to date in the year the estimate changes.

Question

Quizplus · Accepted Answer

The unexpected turnover results in the forfeiture of 750,000 (15 million x 5%) options. Therefore, only 14,250,000 options (15 million - 750,000) will vest on December 31, 2011. The total compensation cost is $60 million (15 million options x $4 per option). To calculate the compensation cost to be expensed in 2011, we need to first adjust the cumulative expense recorded to date by subtracting the amount associated with the forfeited options: 14,250,000 options x $4 per option = $57 million. The cumulative expense recorded to date is $40 million ($60 million ÷ 3). Therefore, the expense to be recorded in 2011 is $17 million ($57 million - $40 million). This will reduce earnings by $17 million in 2011.

Under Its Executive Stock Option Plan, Q Corporation Granted Options