Question

5. On December 1, 2018, Folks Wagon Company adopted a stock-option plan that granted options

to key executives to purchase 50,000 shares of the company’s $10 par value common stock. The

options were granted on January 1, 2019, and were exercisable 3 years after the date of grant if the

grantee was still an employee of the company. The options expired 5 years from the date of grant.

The option price was set at $35, and the fair value option-pricing model determines the total

compensation expense to be $450,000.

All of the options were exercised during the year 2022: 20,000 on February 23 when the market

price was $46, and 30,000 on August 8 when the market price was $85 a share.

a. Prepare the journal entries relating to the stock option plan for the years 2019, 2020, and 2021.

Assume that the employee performs services equally in 2019, 2020, and 2021.

b. Prepare the journal entries that record the two events of exercising the options in 2022.

Answer 1

In stock option plan , employees have a option to purchase a company's share at a pre determined price.

The difference between fair value on that date and the pre determined price will be the expense of company and shown as compensation expense during vesting period.

Vesting period refers to period between the date on which options were granted ( January 1 2019 ) and the date after which employees can exercise (Purchase) their shares ( January 1 , 2022) i. e. 3 years in this case.

Employees compensation expense is distributed over the vesting period.

Employee compensation (Given) = 450000 $

Vesting period = 3 years

Employee compensation expense per year = 450000 / 3 = 150000 per year.

a) Journal entries relating to stock option plan for the years 2019, 2020, 2021.

Date	Particulars	Debit	Credit
Year 2019
31/12/2019	stock option compensation a/c	150000
	Employee stock option a/c		150000
	(Compensation expense recorded)
31/12/2019	Income statement a/c	150000
	Stock option compensation a/c		150000
	(Compensation expense transferred to income statement)
Year 2020
31/12/2020	stock option compensation a/c	150000
	Employee stock option a/c		150000
	(Compensation expense recorded)
31/12/2020	Income statement a/c	150000
	Stock option compensation a/c		150000
	(Compensation expense transferred to income statement)
Year 2021
31/12/2021	stock option compensation a/c	150000
	Employee stock option a/c		150000
	(Compensation expense recorded)
31/12/2021	Income statement a/c	150000
	Stock option compensation a/c		150000
	(Compensation expense transferred to income statement)

b)  journal entries that record the two events of exercising the options in 2022.

1. February 23

Market price = 46$

Option price = 35$

Share exercised = 20000 shares

Compensation expense (Charged from employee stock option a/c)

= no of share * ( Market price - Option price)

= 20000 * (46-35) = 220000$

Cash received = no of shares * option price = 20000 * 35 = 700000

Share face value = 10$ so share capital = 20000 share * 10 = 200000

Premium on share = (Market price - face value) * no of share

= (46 - 10 ) * 20000 = 720000

  Journal entry

Date	Particular	Debit	Credit
Feb 23 2022	Bank a/c	700000
	Employee stock option a/c	220000
	Share capital a/c		200000
	Share premium

2. august 8

Market price = 85$

Option price = 35$

Share exercised = 30000 shares

Compensation expense = no of share * ( Market price - Option price)

= 30000 * (85-35) = 1500000$

Balance of employee stock option = 450000 - 220000 = 230000

So out of total expense of 150000 , 230000 will be charged from employee stock option plan and remaining will be the expense of current year.

Current year expense = 1500000 - 230000 = 1270000$

Cash received = no of shares * option price = 30000 * 35 = 1050000

Share face value = 10$ so share capital = 30000 share * 10 = 300000

Premium on share = (Market price - face value) * no of share

= (85 - 10 ) * 30000 = 2250000

  Journal entry

Date	Particular	Debit	Credit
Feb 23 2022	Bank a/c	1050000
	Employee stock option a/c	230000
	compensation expense account	1270000
	Share capital a/c		300000
	Share premium		2250000