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Chapter19: Share-Based Compensation and Earnings Per Share

Problems

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An alternate exercise and problem set is available on the text website: www.mhhe.com/spiceland6e

P 19-1

 

Stock options; forfeiture; exercise

 

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On October 15, 2010, the board of directors of Ensor Materials Corporation approved a stock option plan for key executives. On January 1, 2011, 20 million stock options were granted, exercisable for 20 million shares of Ensor's $1 par common stock. The options are exercisable between January 1, 2014, and December 31, 2016, at 80% of the quoted market price on January 1, 2011, which was $15. The fair value of the 20 million options, estimated by an appropriate option pricing model, is $6 per option.

   Two million options were forfeited when an executive resigned in 2012. All other options were exercised on July 12, 2015, when the stock's price jumped unexpectedly to $19 per share.

Required:

1.

 

When is Ensor's stock option measurement date?

2.

 

Determine the compensation expense for the stock option plan in 2011. (Ignore taxes.)

3.

 

What is the effect of forfeiture of the stock options on Ensor's financial statements for 2012 and 2013?

4.

 

Is this effect consistent with the general approach for accounting for changes in estimates? Explain.

5.

 

How should Ensor account for the exercise of the options in 2015?

P 19-2

 

Stock options; graded vesting

 

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Pastner Brands is a calendar-year firm with operations in several countries. As part of its executive compensation plan, at January 1, 2011, the company issued 400,000 executive stock options permitting executives to buy 400,000 shares of Pastner stock for $34 per share. One-fourth of the options vest in each of the next four years beginning at December 31, 2011 (graded vesting). Pastner elects to separate the total award into four groups (or tranches) according to the year in which they vest and measures the compensation cost for each vesting date as a separate award. The fair value of each tranche is estimated at January 1, 2011, as follows:

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Required:

1.

 

Determine the compensation expense related to the options to be recorded each year 2011–2014, assuming Pastner allocates the compensation cost for each of the four groups (tranches) separately.

2.

 

Determine the compensation expense related to the options to be recorded each year 2011–2014, assuming Pastner uses the straight-line method to allocate the total compensation cost.

p. 1122

P 19-3

 

Stock options; graded vesting; measurement using a single fair value per option

 

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Refer to the situation described in Problem 19-2. Assume Pastner measures the fair value of all options on January 1, 2011, to be $4.50 per option using a single weighted-average expected life of the options assumption.

Required:

1.

 

Determine the compensation expense related to the options to be recorded each year 2011–2014, assuming Pastner allocates the compensation cost for each of the four groups (tranches) separately.

2.

 

Determine the compensation expense related to the options to be recorded each year 2011–2014, assuming Pastner uses the straight-line method to allocate the total compensation cost.

P 19-4

 

Stock options; graded vesting; IFRS

 

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Refer to the situation described in Problem 19-2. Assume Pastner prepares its financial statements using International Financial Reporting Standards.

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Required:

How might your responses to requirement 1 and requirement 2 differ using IFRS? Explain.

P 19-5

 

Steve Jobs' restricted stock; tax effects

 

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Apple Inc. provides its executives compensation under a variety of share-based compensation plans including restricted stock awards. The following disclosure note from Apple's 2007 annual report describes the plan created for the company's chief executive officer, Steve Jobs:

CEO Restricted Stock Award

On March 19, 2003, the Company's Board of Directors granted 10 million shares of restricted stock to the Company's CEO that vested on March 19, 2006. The amount of the restricted stock award expensed by the Company was based on the closing market price of the Company's common stock on the date of grant and was amortized ratably on a straight-line basis over the three-year requisite service period. Upon vesting during 2006, the 10 million shares of restricted stock had a fair value of $646.6 million and had grant-date fair value of $7.48 per share. The restricted stock award was net-share settled such that the Company withheld shares with value equivalent to the CEO's minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of 4.6 million were based on the value of the restricted stock award on the vesting date as determined by the Company's closing stock price of $64.66. The remaining shares net of those withheld were delivered to the Company's CEO. Total payments for the CEO's tax obligations to the taxing authorities were $296 million in 2006 and are reflected as a financing activity within the Consolidated Statements of Cash Flows. The net-share settlement had the effect of share repurchases by the Company as it reduced and retired the number of shares outstanding and did not represent an expense to the Company. The Company's CEO has no remaining shares of restricted stock.

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Real World Financials

Required:

1.

 

How much compensation did Apple record for its CEO related to the restricted stock in its fiscal year ended September 24, 2005?

2.

 

What was the CEO's combined income tax and employment tax rate that Apple used to determine the shares to be withheld at vesting?

3.

 

From the information provided in the disclosure note, recreate the journal entries Apple used to record compensation expense and its related tax effects on September 24, 2005, the end of the 2005 fiscal year.

4.

 

From the information provided in the disclosure note, recreate the journal entries Apple used to record the vesting of the restricted stock and its related tax effects on March 16, 2006, assuming the remaining compensation expense already has been recorded.

P 19-6

 

Stock option plan; deferred tax effect recognized

 

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Walters Audio Visual, Inc., offers a stock option plan to its regional managers. On January 1, 2011, options were granted for 40 million $1 par common shares. The exercise price is the market price on the grant date, $8 per share. Options cannot be exercised prior to January 1, 2013, and expire December 31, 2017. The fair value of the options, estimated by an appropriate option pricing model, is $2 per option. Because the plan does not qualify as an incentive plan, Walters will receive a tax deduction upon exercise of the options equal to the excess of the market price at exercise over the exercise price. The income tax rate is 40%.

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Required:

1.

 

Determine the total compensation cost pertaining to the stock option plan.

2.

 

Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2011.

3.

 

Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2012.

p. 1123

4.

 

Record the exercise of the options and their tax effect if all of the options are exercised on March 20, 2016, when the market price is $12 per share.

5.

 

Assume the option plan qualifies as an incentive plan. Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2011.

6.

 

Assuming the option plan qualifies as an incentive plan, record the exercise of the options and their tax effect if all of the options are exercised on March 20, 2016, when the market price is $11 per share.

P 19-7

 

Stock option plan; deferred tax effect of a nonqualifying plan

 

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JBL Aircraft manufactures and distributes aircraft parts and supplies. Employees are offered a variety of share-based compensation plans. Under its nonqualified stock option plan, JBL granted options to key officers on January 1, 2011. The options permit holders to acquire six million of the company's $1 par common shares for $22 within the next six years, but not before January 1, 2014 (the vesting date). The market price of the shares on the date of grant is $26 per share. The fair value of the 6 million options, estimated by an appropriate option pricing model, is $6 per option. Because the plan does not qualify as an incentive plan, JBL will receive a tax deduction upon exercise of the options equal to the excess of the market price at exercise over the exercise price. The tax rate is 40%.

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Required:

1.

 

Determine the total compensation cost pertaining to the incentive stock option plan.

2.

 

Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2011, 2012, and 2013.

3.

 

Record the exercise of the options and their tax effect if all of the options are exercised on August 21, 2015, when the market price is $27 per share.

P 19-8

 

Performance option plan

 

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LCI Cable Company grants 1 million performance stock options to key executives at January 1, 2011. The options entitle executives to receive 1 million of LCI $1 par common shares, subject to the achievement of specific financial goals over the next four years. Attainment of these goals is considered probable initially and throughout the service period. The options have a current fair value of $12 per option.

Required:

1.

 

Prepare the appropriate entry when the options are awarded on January 1, 2011.

2.

 

Prepare the appropriate entries on December 31 of each year 2011–2014.

3.

 

Suppose at the beginning of 2013, LCI decided it is not probable that the performance objectives will be met. Prepare the appropriate entries on December 31 of 2013 and 2014.

P 19-9

 

Net loss; stock dividend; nonconvertible preferred stock; treasury shares; shares sold; extraordinary loss

 

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On December 31, 2010, Ainsworth, Inc., had 600 million shares of common stock outstanding. Twenty million shares of 8%, $100 par value cumulative, nonconvertible preferred stock were sold on January 2, 2011. On April 30, 2011, Ainsworth purchased 30 million shares of its common stock as treasury stock. Twelve million treasury shares were sold on August 31. Ainsworth issued a 5% common stock dividend on June 12, 2011. No cash dividends were declared in 2011. For the year ended December 31, 2011, Ainsworth reported a net loss of $140 million, including an after-tax extraordinary loss of $400 million from a litigation settlement.

Required:

1.

 

Determine Ainsworth's net loss per share for the year ended December 31, 2011.

2.

 

Determine the per share amount of income or loss from continuing operations for the year ended December 31, 2011.

3.

 

Prepare an EPS presentation that would be appropriate to appear on Ainsworth's 2011 and 2010 comparative income statements. Assume EPS was reported in 2010 as $.75, based on net income (no extraordinary items) of $450 million and a weighted-average number of common shares of 600 million.

P 19-10

 

EPS from statement of retained earnings

 

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(Note: Problem 19-10 is based on the same situation described in Problem 18-4 in Chapter 18, modified to focus on EPS rather than recording the events that affected retained earnings.)

   Comparative Statements of Retained Earnings for Renn-Dever Corporation were reported as follows for the fiscal years ending December 31, 2009, 2010, and 2011.

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p. 1124

   At December 31, 2008, paid-in capital consisted of the following:

       Common stock, 1,855,000 shares at $1 par,

$1,855,000

       Paid in capital—excess of par

7,420,000

   No preferred stock or potential common shares were outstanding during any of the periods shown.

Required:

Compute Renn-Dever's earnings per share as it would have appeared in income statements for the years ended December 3l, 2009, 2010, and 2011.

P 19-11

 

EPS from statement of shareholders' equity

 

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Comparative Statements of Shareholders' Equity for Locke Intertechnology Corporation were reported as follows for the fiscal years ending December 31, 2009, 2010, and 2011.

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Required:

Infer from the statements the events and transactions that affected Locke Intertechnology Corporation's shareholders' equity and compute earnings per share as it would have appeared on the income statements for the years ended December 31, 2009, 2010, and 2011. No potential common shares were outstanding during any of the periods shown.

P 19-12

 

EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend

 

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On December 31, 2010, Dow Steel Corporation had 600,000 shares of common stock and 300,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $400,000 and $75,000 to common and preferred shareholders, respectively, on December 15, 2011.

   On February 28, 2011, Dow sold 60,000 common shares. In keeping with its long-term share repurchase plan, 2,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2011, was $2,100,000. The income tax rate is 40%.

Required:

Compute Dow's earnings per share for the year ended December 31, 2011.

p. 1125

P 19-13

 

EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend; options

 

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(Note: This is a variation of the previous problem, modified to include stock options.)

   On December 31, 2010, Dow Steel Corporation had 600,000 shares of common stock and 300,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $400,000 and $75,000 to common and preferred shareholders, respectively, on December 15, 2011.

   On February 28, 2011, Dow sold 60,000 common shares. In keeping with its long-term share repurchase plan, 2,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2011, was $2,100,000. The income tax rate is 40%.

   As part of an incentive compensation plan, Dow granted incentive stock options to division managers at December 31 of the current and each of the previous two years. Each option permits its holder to buy one share of common stock at an exercise price equal to market value at the date of grant and can be exercised one year from that date. Information concerning the number of options granted and common share prices follows:

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The market price of the common stock averaged $32 per share during 2011.

Required:

Compute Dow's earnings per share for the year ended December 31, 2011.

P 19-14

 

EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend; options; convertible bonds; contingently issuable shares

 

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(Note: This is a variation of the previous problem, modified to include convertible bonds and contingently issuable shares.)

   On December 31, 2010, Dow Steel Corporation had 600,000 shares of common stock and 300,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $400,000 and $75,000 to common and preferred shareholders, respectively, on December 15, 2011.

   On February 28, 2011, Dow sold 60,000 common shares. Also, as a part of a 2010 agreement for the acquisition of Merrill Cable Company, another 23,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2012, if Merrill's 2012 net income is at least $500,000. In 2011, Merrill's net income was $630,000.

   In keeping with its long-term share repurchase plan, 2,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2011, was $2,100,000. The income tax rate is 40%.

   As part of an incentive compensation plan, Dow granted incentive stock options to division managers at December 31 of the current and each of the previous two years. Each option permits its holder to buy one share of common stock at an exercise price equal to market value at the date of grant and can be exercised one year from that date. Information concerning the number of options granted and common share prices follows:

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The market price of the common stock averaged $32 per share during 2011.

   On July 12, 2009, Dow issued $800,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 30 common shares (adjusted for the stock dividend).

Required:

Compute Dow's basic and diluted earnings per share for the year ended December 31, 2011.

P 19-15

 

EPS; convertible preferred stock; convertible bonds; order of entry

 

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Information from the financial statements of Henderson-Niles Industries included the following at December 31, 2011:

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   Henderson-Niles' net income for the year ended December 31, 2011, is $520 million. The income tax rate is 40%. Henderson-Niles paid dividends of $2 per share on its preferred stock during 2011.

p. 1126

Required:

Compute basic and diluted earnings per share for the year ended December 31, 2011.

P 19-16

 

EPS; antidilution

 

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Alciatore Company earned a net income of $150,000 in 2011. The weighted-average number of common shares outstanding for 2011 was 40,000. The average stock price for 2011 was $33. Assume an income tax rate of 40%.

Required:

For each of the following independent situations, indicate whether the effect of the security is antidilutive for diluted EPS.

1.

 

10,000 shares of 7.7% of $100 par convertible, cumulative preferred stock. Each share may be converted into two common shares.

2.

 

8% convertible 10-year, $500,000 of bonds, issued at face value. The bonds are convertible to 5,000 shares of common stock.

3.

 

Stock options exercisable at $30 per share after January 1, 2013.

4.

 

Warrants for 1,000 common shares with an exercise price of $35 per share.

5.

 

A contingent agreement to issue 5,000 shares of stock to the company president if net income is at least $125,000 in 2012.

P 19-17

 

EPS; convertible bonds; treasury shares

 

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At December 31, 2011, the financial statements of Hollingsworth Industries included the following:

       Net income for 2011

$560 million

       Bonds payable, 10%, convertible into 36 million shares of common stock

$300 million

       Common stock:

     Shares outstanding on January 1

400 million

     Treasury shares purchased for cash on September 1

30 million

       Additional data:

       The bonds payable were issued at par in 2009. The tax rate for 2011 was 40%.

Required:

Compute basic and diluted EPS for the year ended December 31, 2011.

P 19-18

 

EPS; options; convertible preferred; additional shares

 

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On January 1, 2011, Tonge Industries had outstanding 440,000 common shares (par $l) that originally sold for $20 per share, and 4,000 shares of 10% cumulative preferred stock (par $100), convertible into 40,000 common shares.

   On October 1, 2011, Tonge sold and issued an additional 16,000 shares of common stock at $33. At December 31, 2011, there were incentive stock options outstanding, issued in 2010, and exercisable after one year for 20,000 shares of common stock at an exercise price of $30. The market price of the common stock at year-end was $48. During the year the price of the common shares had averaged $40.

   Net income was $650,000. The tax rate for the year was 40%.

Required:

Compute basic and diluted EPS for the year ended December 31, 2011.

P 19-19

 

EPS; stock options; nonconvertible preferred; convertible bonds; shares sold

 

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At January 1, 2011, Canaday Corporation had outstanding the following securities:

       600 million common shares

       20 million 6% cumulative preferred shares, $50 par

       8% convertible bonds, $2,000 million face amount, convertible into 80 million common shares

The following additional information is available:

 

On September 1, 2011, Canaday sold 72 million additional shares of common stock.

 

Incentive stock options to purchase 60 million shares of common stock after July 1, 2010, at $12 per share were outstanding at the beginning and end of 2011. The average market price of Canaday's common stock was $18 per share during 2011.

 

Canaday's net income for the year ended December 31, 2011, was $1,476 million. The effective income tax rate was 40%.

Required:

1.

 

Calculate basic earnings per common share for the year ended December 31, 2011.

2.

 

Calculate the diluted earnings per common share for the year ended December 31, 2011.

p. 1127

P 19-20

 

EPS; options; restricted stock; additional components for “proceeds” in treasury stock method

 

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Witter House is a calendar-year firm with 300 million common shares outstanding throughout 2011 and 2012. As part of its executive compensation plan, at January 1, 2010, the company had issued 30 million executive stock options permitting executives to buy 30 million shares of stock for $10 within the next eight years, but not prior to January 1, 2013. The fair value of the options was estimated on the grant date to be $3 per option.

   In 2011, Witter House began granting employees stock awards rather than stock options as part of its equity compensation plans and granted 15 million restricted common shares to senior executives at January 1, 2011. The shares vest four years later. The fair value of the stock was $12 per share on the grant date. The average price of the common shares was $12 and $15 during 2011 and 2012, respectively.

   The stock options qualify for tax purposes as an incentive plan. The restricted stock does not. The company's net income was $150 million and $160 million in 2011 and 2012, respectively. Its income tax rate is 40%.

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Required:

1.

 

Determine basic and diluted earnings per share for Witter House in 2011.

2.

 

Determine basic and diluted earnings per share for Witter House in 2012.

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