Question

Could someone help me why we recognize compensation expense $8,000 per year when ALL of the options vest at the END OF FIVE YEARS from grant date? I thought the entire $40,000 compensation expense was recognized at year 5 end (I think it was called Cliff Vesting from the book).On January 1, year 1, a company grants 5,000 nonqualified stock options to an employee with a strike price of $3 per option and fair value of $8 per option. All of the options vest at the end of five years from the grant date. At the end of year 1, the company's stock price was $10 per share. What amount of annual stock compensation cost should the company report for year 1?

A.$0 (15%)
B.$3,000 (19%)
C.$5,000 (24%)
D.$8,000 (41%)

Answer 1

The company does not recognize any compensation expense in year 1 as none of the options have vested at that point.

Step-by-step explanation:

According to the question, the company grants 5,000 nonqualified stock options to an employee with a strike price of $3 per option and a fair value of $8 per option. These options vest at the end of five years from the grant date. The company needs to recognize the stock compensation cost annually over the vesting period, i.e., five years in this case.

To calculate the annual stock compensation cost for year 1, we need to determine the portion of options that have vested at the end of year 1. Since none of the options have vested at this point, the compensation expense for year 1 is $0.

Therefore, the correct answer is A. $0.