Chapter 19, Problem 19.7E

(1)

To determine

Stock options: Stock options are the stock-based compensation plans provided in the form of an option to buy certain number of shares for a certain price during certain period.

To determine: The compensation cost of stock options

Explanation of Solution

Compute the total compensation cost of stock options.

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of stock options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Estimated fair market value of the option × }\\ \text{Number of options granted}\end{array}\right\}\\ \text{= \$1 × 40,000,000 shares}\\ \text{= \$40,000,000}\end{array}$ (1)

(2)

To determine

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 for compensation expense on December 31, 2016, in the books of Corporation WAV

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		20,000,000
		Paid-In Capital–Stock Options			20,000,000
		(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–Stock Options is a stockholders’ equity account. Since stock options are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

Working Notes:

Compute the compensation cost allocated each year.

$\begin{array}{c}\text{Expense allocated each year =}\frac{\text{ Total compensation cost of stock options}}{\text{Vesting period}}\\ \text{=}\frac{\text{\$40,000,000}}{\text{2 years}}\\ \text{= \$20,000,000}\end{array}$ (2)

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

(3)

To determine

To journalize: The entry for compensation expense on December 31, 2017, in the books of Corporation WAV

Explanation of Solution

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

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2017
December	31	Compensation Expense		20,000,000
		Paid-In Capital–Stock Options			20,000,000
		(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–Stock Options is a stockholders’ equity account. Since stock options are considered as earned by the employee, stockholders’ equity increased, and an increase in equity is credited.

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

(4)

To determine

To journalize: The options exercised in the books of Corporation WAV

Explanation of Solution

Journalize the entry for options exercised in the books of Corporation WAV.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
March	12	Cash		240,000,000
		Paid-in Capital – Stock Options		30,000,000
		Common Stock			30,000,000
		Paid-in Capital–Excess of Par			240,000,000
		(To record purchase option exercised by stock option holders)

Table (3)

• Cash is an asset account. Since cash is received, asset value increased, and an increase in asset is debited.
• Paid-in Capital–Stock Options 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 cash received by Corporation WAV.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\text{Number of shares granted }\times \\ \text{Exercise percentage × }\\ \text{Exercise price}\end{array}\right\}\\ \text{= 40,000,000 shares × 75\% }\times \text{ \$8}\\ \text{= \$240,000,000}\end{array}$ (3)

Compute the paid-in capital of stock options amount.

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Estimated fair market value of the option × }\\ \text{Number of options granted×}\\ \text{Exercise percentage}\end{array}\right\}\\ \text{= \$1 × 40,000,000 shares × 75\%}\\ \text{= \$30,000,000}\end{array}$ (4)

Compute the common stock amount.

$\begin{array}{c}\begin{array}{l}\text{Common stock }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Par value per share × }\\ \text{Number of shares }\times \\ \text{Exercise percentage}\end{array}\right\}\\ \text{= \$1 × 40,000,000 shares}\times \text{75\%}\\ \text{= \$30,000,000}\end{array}$ (5)

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

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital–}\\ \text{excess of par value}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received + }\\ \text{Paid-in capital of stock options value – }\\ \text{Common stock value}\end{array}\right\}\\ \text{= \$240,000,000 + \$30,000,000 – \$30,000,000}\\ \text{= \$240,000,000}\end{array}$

Note: Refer to Equations (3), (4), and (5) for all the values.

(5)

To determine

To journalize: The expired options before being exercised in the books of Corporation WAV

Explanation of Solution

Journalize the entry for expired options in the books of Corporation WAV.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2022
December	31	Paid-in Capital–Stock Options		10,000,000
		Paid-in Capital–Expiration of     Stock Options			10,000,000
		(To record expiry of option unexercised)

Table (4)

• Paid-in Capital–Stock Options 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.
• Paid-in Capital–Expiration of Stock Options is a stockholders’ equity account. Since stock options are expired before being exercised, this account is credited to close the unexercised stock options.

Working Notes:

Compute the paid-in capital–expiration of stock options amount.

$\begin{array}{c}\begin{array}{l}\text{Paid-in capital–expiration }\\ \text{of stock options value}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Total compensation granted as shares – }\\ \text{Paid-in capital of exercised stock }\\ \text{options value}\end{array}\right\}\\ \text{= \$40,000,000 – \$30,000,000}\\ \text{= \$10,000,000}\end{array}$

Note: Refer to Equation (4) for value and computation of paid-in capital of exercised options.