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```							Acct 414                                                               3/7/2011                                                   Prof. Teresa Gordon

Example 1 - Award Classified as Equity                             Public Company
On January 1, Year 1, an Alice receives 1,000 options for to buy the company’s \$3 par value
common stock for \$8 per share. On the date of the grant, the market price was also \$8. The
employee must work for the company for 4 years before she can exercise the options. The options
expire at the end of 5 years. An option pricing model determines that the fair value of the options is
\$6 each.                                                                                                         APIC-Stock Options    Balance
\$       3.00 = par value                                                     1,000 = number of options                                          0
\$       8.00 = Option (strike) price                                                                                                            0
\$       8.00 = Market price on                                    Jan 1, Year 1                                                                 0
\$       6.00 = Fair value on                                      Jan 1, Year 1                                                                 0
Grant date                                                                           Exercise Period
0
0
0
0
0
Service Period
0
#REF!
JOURNAL ENTRIES                                         Debit             Credit
Jan 1, Yr 1
Grant date

Dec 31 Yr 1

Dec 31 Yr 2

Dec 31 Yr 3

Dec 31 Yr 4

VERSION A:
Mar 31, Yr 5   Employee exercises all options when market price =                  \$              15 per share

Version B:
WHAT IF EMPLOYEE QUIT AFTER 2 YEARS?
Jan 15 Yr 3

Version C:
WHAT IF EMPLOYEE FAILS TO EXERCISE OPTIONS AFTER THEY ARE VESTED?
Dec 31 Yr 5

Acc4 414                                                              3/7/2011                                      Prof. Teresa Gordon

Example 2 - Award Classified as Liability                      NOT TESTED!
Mary works for a nonpublic company. On January 1, Year 1, Mary receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices (\$10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 3 years from the grant date.           SARS Liability        Balance
This is the "last vestige" of the intrinsic value method.                                                             0
\$       3.00 = par value                                               1,000 = number of options                                   0
\$10 = Option (strike) price                                                                                               0
\$10 = Market price on                                Jan 1, Year 1                                                        0
Grant date                                                            Expiration Date                                   0
0
0
0
0
Service Period                          Exercise Period                                                         0

JOURNAL ENTRIES                                       Debit            Credit
Jan 1, Yr 1    Market price = \$10

Dec 31, Yr 1 Market price = \$11

Dec 31, Yr 2 Market price = \$13

Dec 31, Yr 3 Market price = \$8

Mar 31, Yr 4   Market price rises to \$12 and she exercises all 1,000 SARS

ad6db501-147a-4a66-b3b0-4667defa293e.xls                                - 22 -                                              Example 2
Acc4 414                                                               3/7/2011                                     Prof. Teresa Gordon

Example 3 - Award Classified as Liability
Sally works for a public company. On January 1, Year 1, Sally receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices (\$10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 3 years from the grant date.           SARS Liability    Balance
For this award, the company must re-compute fair value at each balance sheet date                                 0
\$       3.00 = par value                                         1,000 = number of options                                     0
\$10 = Option (strike) price                                                                                           0
\$10 = Market price on                         Jan 1, Year 1                                                           0
Grant date                                                               Expiration Date                                   0
0
0
0
0
0
Service Period                         Exercise Period
JOURNAL ENTRIES                                      Debit             Credit
Jan 1, Yr 1     Market price = \$10, fair value = \$3

Dec 31, Yr 1 Market price = \$11, FAIR VALUE = \$1.50

Dec 31, Yr 2 Market price = \$13 Fair value = \$4

Dec 31, Yr 3 Market price = \$8, fair value = \$1

Mar 31, Yr 4    Market price rises to \$12 and she exercises all 1,000 SARS

ad6db501-147a-4a66-b3b0-4667defa293e.xls                                 - 33 -                                                Example 3
Acct 414                                                              3/7/2011                                                   Prof. Teresa Gordon

Example 1 - Award Classified as Equity
On January 1, Year 1, an executive receives 1,000 options for to buy the company’s \$3 par value               APIC-Stock Options    Bal
1500     -1500
\$         3.00   = par value                                              1,000 = number of options                           1500     -3000
\$         8.00   = Option (strike) price                                                                                      1500     -4500
\$         8.00   = Market price on                              Jan 1, Year 1                                                 1500     -6000
\$         6.00   = Fair value on                                Jan 1, Year 1                                    6000                      0
Grant date                                                                        Exercise Period
0
0
0
0
0
Service Period                                                                                           0
0
JOURNAL ENTRIES                                     Debit            Credit
Jan 1, Yr 1       Total value = \$6 FV * 1,000 options =
Grant date         \$6,000 * 0% earned
Memo entry only

Dec 31 Yr 1       Compensation expense                            \$     1,500.00
APIC-stock options outstanding                                   \$    1,500.00
Recognize comp expense 25% * 1,000 options *
\$6 FV

Dec 31 Yr 2       Compensation expense                            \$     1,500.00
APIC-stock options outstanding                                   \$    1,500.00
Recognize comp expense 25% * 1,000 options *
\$6 FV

Dec 31 Yr 3       Compensation expense                            \$     1,500.00
APIC-stock options outstanding                                   \$    1,500.00
Recognize comp expense 25% * 1,000 options *
\$6 FV

Dec 31 Yr 4       Compensation expense                            \$     1,500.00
APIC-stock options outstanding                                   \$    1,500.00
Recognize comp expense 25% * 1,000 options *
\$6 FV

VERSION A:
Mar 31, Yr 5      Employee exercises all options when market price =               \$        15.00 per share
Cash (1000 shares * \$8)                        \$   8,000.00
APIC - stock options outstanding               \$   6,000.00                             \$6 FV * 1,000 shares
Common stock (\$3 par * 1,000)                                    \$    3,000.00
APIC - common stock                                              \$   11,000.00
\$ 14,000.00       \$   14,000.00

Version B:
WHAT IF EMPLOYEE QUIT AFTER 2 YEARS?
Jan 15 Yr 3 APIC - stock options outstanding                      \$     3,000.00
Compensation expense                                                   \$    3,000.00
Reverse compensation related to options forfeit by
employee

Version C:
WHAT IF EMPLOYEE FAILS TO EXERCISE OPTIONS AFTER THEY ARE VESTED?
Dec 31 Yr 5 APIC -stock options outstanding                     \$ 6,000.00
APIC - expired stock options                                   \$            6,000.00
Move expired options out of APIC-stock options
outstanding
Note: This is most likely to occur when the options
are "underwater" during the exercise period (also
called "out of the money"). For example, the
market price might range from \$6.50 to \$7.25
during the exercise period.

Acc4 414                                                              3/7/2011                                        Prof. Teresa Gordon

Example 2 - Award Classified as Liability                      NONPUBLIC COMPANY

Mary works for a nonpublic company. On January 1, Year 1, Mary receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices (\$10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 5 years from the grant date.
SARS Liability          bal
This is the "last vestige" of the intrinsic value method.                                                 500          -500
\$       3.00 = par value                                               1,000 = number of options                      2500         -3000
\$10 = Option (strike) price                                                                  3000                             0
\$10 = Market price on                                Jan 1, Year 1                                           2000         -2000
Grant date                                                                   Expiration Date      2000                             0
0
0
0
0
0
Service Period                           Exercise Period
NOTE - I WILL NOT HAVE A NONPUBLIC COMPANY ON ANY EXAM!
JOURNAL ENTRIES                                       Debit              Credit
Jan 1, Yr 1    Market price = \$10
Nothing has benn earned yet
0% *(\$10-10) = 0
NO ENTRY NEEDED

Dec 31, Yr 1 Market price = \$11
Compensation expense                               \$       500.00
SARS Liability                                                         \$      500.00
50% * (\$11-10) * 1,000 = 500
Record liability at estimated amount

Dec 31, Yr 2 Market price = \$13
Compensation expense                               \$     2,500.00
SARS Liability                                                         \$     2,500.00
100% earned * 1,000 * (\$13-10) = \$3,000
(desired ending balance in liability account)
Therefore, we make journal entry to go from
\$500 to \$3,000:

Dec 31, Yr 3 Market price = \$8
SARS liability                                  \$        3,000.00
Compensation expense                                                   \$     3,000.00
100% * 1,000 * (worthless) so liability balance
should be ZERO - the intrinsic value can never
be negative.

Mar 31, Yr 4   Market price rises to \$12 and she exercises all 1,000 SARS
100% * 1,000 * (\$12-10) = 2,000 owed
Compensation expense                           \$    2,000.00
SARS liability                                                       \$     2,000.00
Up-date balance in SARS liability account from
the previous estimate to the actual amount
owed to employee

SARS liability                                   \$     2,000.00
Cash                                                                 \$     2,000.00
Pay employee amount owed

ad6db501-147a-4a66-b3b0-4667defa293e.xls                                - 55 -                                               Example 2 (sol)
Acc4 414                                                               3/7/2011                                         Prof. Teresa Gordon

Example 3 - Award Classified as Liability                        PUBLIC COMPANY

Sally works for a public company. On January 1, Year 1, Sally receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices (\$10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 5 years from the grant date.
SARS Liability          bal
For this award, the company must re-compute fair value at each balance sheet date                        750           -750
\$       3.00 = par value                                         1,000 = number of options                           3250          -4000
\$10 = Option (strike) price                                                                 3000                          -1000
\$10 = Market price on                         Jan 1, Year 1                                                 1000          -2000
Grant date                                                                Expiration Date                                      -2000
-2000
-2000
-2000
-2000
-2000
Service Period                            Exercise Period

JOURNAL ENTRIES                                      Debit              Credit
Jan 1, Yr 1     Market price = \$10, fair value = \$3
Nothing has been earned yet
0% * 1,000 * \$3 FV
NO ENTRY NEEDED

Dec 31, Yr 1 Market price = \$11, FAIR VALUE = \$1.50
50% * \$1.50 FV * 1,000 options=\$750
Compensation expense                                \$      750.00
SARS Liability                                                         \$      750.00
Record liability at estimated amount

Dec 31, Yr 2 Market price = \$13 Fair value = \$4
Compensation expense                                \$    3,250.00
SARS Liability                                                         \$    3,250.00

100% earned * 1,000 * \$4 FV = \$4,000
(desired balance in liability account.) Adjust
from previously estimated balance of \$750.

Dec 31, Yr 3 Market price = \$8, fair value = \$1
SARS liability                                      \$    3,000.00
Compensation expense                                                   \$    3,000.00
100% * 1,000 * \$1 FV = \$1,000 correct liability
balance. Adjust balance in liability account to
new estimate

Mar 31, Yr 4    Market price rises to \$12 and she exercises all 1,000 SARS
This is the MEASUREMENT DATE.
Computation: 100% * 1,000 * (\$12-10) =
\$2,000 amount owed
Compensation expense                             \$     1,000.00
SARS liability                                                      \$    1,000.00
Up-date balance in SARS liability account
from \$1,000 estimated balance to \$2,000
actual.

SARS liability                                   \$    2,000.00
Cash                                                                \$    2,000.00
Pay employee amount owed

Note that the fair value at exercise = intrinsic value. Compare total
compensation expense to Example 2.
However different amounts could be recognized in particular time periods.

ad6db501-147a-4a66-b3b0-4667defa293e.xls                                   - 66 -                                                 Example 3 (sol)

```
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