Chapter 019 Share-Based Compensation and Earnings per Share
True/False Questions
1. GAAP requires using intrinsic value accounting for employee stock options.
2. 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.
3. 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.
4. Current year stock dividends and splits require retroactive restatement of EPS for all prior years
presented in comparative financial statements.
5. 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.
6. Dilutive convertible bonds affect both the numerator and the denominator in computing diluted EPS.
7. 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.
8. No time-weighting of contingently issuable shares is required when computing basic EPS.
9. 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.
Chapter 019 Share-Based Compensation and Earnings per Share
10. If a company reports discontinued operations, EPS must be disclosed for both income from
continuing operations and net income.
Multiple Choice Questions
11. Lance Chips granted restricted stock units (RSUs) representing 40 million of its $1 par common
shares to executives, subject to forfeiture if employment is terminated within four years. After
the recipients of the RSUs satisfy the vesting requirement, the company will distribute the
shares. The common shares had a market price of $5 per share on the grant date. The total
compensation cost pertaining to the restricted stock units is:
A. $ 5 million.
B. $ 40 million.
C. $ 50 million.
D. $200 million.
12. Taxon Corp. granted restricted stock units (RSUs) representing 30 million of its $1 par
common shares to executives, subject to forfeiture if employment is terminated within three
years. After the recipients of the RSUs satisfy the vesting requirement, the company will
distribute the shares. The common shares had 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. $30 million.
C. $80 million.
D. $240 million.
13. The compensation associated with restricted stock units (RSUs) under a stock award plan is:
A. The book value of an unrestricted share of the same stock times the number of shares
represented by the RSUs.
B. Allocated to expense over the service period which usually is the vesting period.
C. The estimated fair value of a share of similar stock times the number of shares represented
by the RSUs.
D. The book value of a share of similar stock times the number of shares represented by the
RSUs.
14. The compensation associated with restricted stock units (RSUs) under a stock award plan is the
number of shares represented by the RSUs multiplied by:
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.
15. Restricted stock units (RSUs):
A. are a grant valued in terms of a set number of shares of company stock.
B. are reported as a liability if payable in shares rather than cash.
C. are recorded based on a value estimated by a restricted stock valuation model.
D. represent shares issued at the date of grant that must be returned if the recipient fails to
satisfy the vesting requirement.
16. Restricted stock units (RSUs):
A. are reported as a liability if payable in shares rather than cash.
B. are reported as part of shareholders’ equity if payable in shares rather than cash.
C. are reported as part of shareholders’ equity if payable in cash rather than shares.
D. are reported as part of shareholders’ equity if the recipient will receive cash or can elect
to receive cash.
17. 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.
Chapter 019 Share-Based Compensation and Earnings per Share
18. 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.
19. 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.
Use the following to answer questions 20 and 21:
On January 1, 2016, M Company granted 90,000 stock options to certain executives. The options are
exercisable no sooner than December 31, 2018, and expire on January 1, 2022. Each option can be
exercised to acquire one share of $1 par common stock for $12. An option-pricing model estimates the
fair value of the options to be $5 on the date of grant.
20. What amount should M recognize as compensation expense for 2016?
a. $ 30,000.
b. $ 60,000.
c. $120,000.
d. $150,000.
21. If unexpected turnover in 2017 caused the company to estimate that 10% of the options would be
forfeited, what amount should M recognize as compensation expense for 2017?
a. $ 30,000.
b. $ 60,000.
c. $120,000.
d. $150,000.
22. Under its executive stock option plan, N Corporation granted options on January 1, 2016, 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, 2018 (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.
23. 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.
24. 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 answer choices is correct.
25. 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.
26. On January 1, 2016, 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
compensation expense for 2016?
a. $ 0.
b. $ 200,000.
c. $ 400,000.
d. $1,200,000.
27. On January 1, 2016, Oliver Foods issued stock options for 40,000 shares to a division manager. The
options have an estimated fair value of $5 each. To provide additional incentive for managerial
achievement, the options are not exercisable unless Oliver Foods’ stock price increases by 5% in four
years. Oliver Foods initially estimates that it is not probable the goal will be achieved. How much
compensation will be recorded in each of the next four years?
a. $10,000.
b. $45,000.
c. $50,000.
d. No effect.
28. On January 1, 2016, G Corp. granted stock options to key employees for the purchase of 80,000
shares of the company’s common stock at $25 per share. The options are intended to compensate
employees for the next two years. The options are exercisable within a four-year period beginning
January 1, 2018, by the grantees still in the employ of the company. No options were terminated during
2016, but the company does have an experience of 4% forfeitures over the life of the stock options. The
market price of the common stock was $31 per share at the date of the grant. G Corp. used the Binomial
pricing model and estimated the fair value of each of the options at $10. What amount should G charge
to compensation expense for the year ended December 31, 2016?
a. $307,200.
b. $320,000.
c. $384,000.
d. $400,000.
29. Under its executive stock option plan, W Corporation granted options on January 1, 2016, 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, 2018 (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. The options are exercised on
April 2, 2019, when the market price is $21 per share. By what amount will W’s shareholder’s equity be
increased when the options are exercised?
a. $ 60 million.
b. $270 million.
c. $315 million.
d. $330 million.
30. On January 1, 2016, D Corp. granted an employee an option to purchase 6,000 shares of D’s $5 par
common stock at $20 per share. The options became exercisable on December 31, 2017, after the
employee completed two years of service. The option was exercised on January 10, 2018. The market
prices of D’s stock were as follows: January 1, 2016, $30; December 31, 2017, $50; and January 10,
2018, $45. An option pricing model estimated the value of the options at $8 each on the grant date. For
2016, D should recognize compensation expense of:
a. $ 0.
b. $24,000.
c. $30,000.
d. $60,000.
31. Under its executive stock option plan, M Corporation granted options on January 1, 2016, 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, 2018 (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 2017 caused the forfeiture of 5% of the stock options. Ignoring taxes, what is the effect on
earnings in 2017?
a. $18.5 million.
b. $18 million.
c. $20 million.
d. $19 million.
32. Under its executive stock option plan, Z Corporation granted options on January 1, 2016, 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, 2018 (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. The options expired in 2022
without being exercised. By what amount will Z’s shareholder’s equity be increased?
a. $ 60 million
b. $270 million.
c. $315 million.
d. $330 million.
33. If restricted stock is forfeited because an employee leaves the company, the appropriate accounting
procedure is to:
a. Reverse related entries previously made.
b. Do nothing.
c. Prepare correcting entries.
d. Record an income item.
34. When recognizing compensation under a stock option plan, unanticipated forfeitures are treated as:
a. A change in accounting principle.
b. A loss.
c. An income item.
d. A change in estimate.
35. Under its executive stock option plan, Q Corporation granted options on January 1, 2016, 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, 2018 (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 2017 caused the forfeiture of 5% of the stock options. Ignoring taxes, what is the effect on
earnings in 2018?
a. $18.5 million.
b. $18 million.
c. $19 million.
d. $20 million.
36. On January 1, 2016, Black 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.
Black initially estimates that it is probable the goal will be achieved. In 2017, after one year, Black
estimates that it is not probable that divisional revenue will increase by 6% in three years. Ignoring
taxes, what is the effect on earnings in 2017?
a. $200,000 decrease.
b. $200,000 increase.
c. $400,000 increase.
d. No effect.
37. On January 1, 2016, Blue 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.
Blue initially estimates that it is not probable the goal will be achieved, but in 2017, after one year, Blue
estimates that it is probable that divisional revenue will increase by 6% by the end of 2018. Ignoring
taxes, what is the effect on earnings in 2017?
a. $200,000.
b. $400,000.
c. $600,000.
d. $800,000.
Chapter 019 Share-Based Compensation and Earnings per Share
Use the following to answer questions 38–40:
Wilson Inc. developed a business strategy that uses stock options as a major compensation incentive for
its top executives. On January 1, 2016, 20 million options were granted, each giving the executive
owning them the right to acquire five $1 par common shares. The exercise price is the market price on
the grant date—$10 per share. Options vest on January 1, 2020. They cannot be exercised before that
date and will expire on December 31, 2022. The fair value of the 20 million options, estimated by an
appropriate option pricing model, is $40 per option. Ignore income tax.
38. Wilson’s compensation expense in 2016 for these stock options was:
a. $0.
b. $200 million.
c. $400 million.
d. $800 million.
39. On March 1, 2020, when the market price of Wilson’s stock was $14 per share, 3 million of the
options were exercised. The journal entry to record this would include:
a. A debit to paid-in capital—stock options for $42 million
b. A credit to paid-in capital—excess of par for $255 million
c. A credit to common stock for $75 million
d. All of these answer choices are correct.
40. Assume that all compensation expense from the stock options granted by Wilson already has been
recorded. Further assume that 200,000 options expire in 2021 without being exercised. The journal
entry to record this would include:
a. Debit to paid-in capital—stock options for $8 million.
b. A debit to common stock for $5 million.
c. A debit to paid-in capital—expiration of stock options for $8 million.
d. None of these answer choices is correct.
41. What would be the total compensation indicated by these options?
a. $ 3 million.
b. $27 million.
c. $ 8 million.
d. $35 million.
42. If the options have a vesting period of five years, what would be the balance in “Paid-in Capital—
Stock Options” three years after the grant date?
a. A credit of $4.8 million.
b. A credit of $16.2 million.
c. A debit of $4.8 million.
d. A debit of $16.2 million.
Use the following to answer questions 43–46:
Wall Drugs offered an incentive stock option plan to its employees. On January 1, 2016, options were
granted for 60,000 $1 par common shares. The exercise price equals the $5 market price of the common
stock on the grant date. The options cannot be exercised before January 1, 2019, and expire December
31, 2020. Each option has a fair value of $1 based on an option pricing model.
43. What is the total compensation cost for this plan?
a. $0.
b. $60,000.
c. $240,000.
d. $300,000.
44. Which is the correct entry to record compensation expense for the year 2016?
a. Compensation expense 12,000
Paid-in capital—stock options 12,000
b. Compensation expense 20,000
Common stock 20,000
c. Compensation expense 20,000
Paid-in capital—stock options 20,000
d. Compensation expense 80,000
Chapter 019 Share-Based Compensation and Earnings per Share
Paid-in capital—stock options 80,000
45. Which is the correct entry to record the exercise of 90% the options on April 15, 2019, when the
market price of the stock was $8?
a. Cash 270,000
Paid-in capital—stock options 54,000
Common stock 60,000
Paid-in capital—excess of par 264,000
b. Cash 378,000
Paid-in capital—stock options 54,000
Common stock 54,000
Paid-in capital—excess of par 378,000
c. Cash 270,000
Paid-in capital—stock options 54,000
Compensation expense 108,000
Common stock 54,000
Paid-in capital—excess of par 378,000
d. Cash 270,000
Paid-in capital—stock options 54,000
Common stock 54,000
Paid-in capital—excess of par 270,000