Question

In order to retain certain key executives, Smiley Corporation granted them incentive stock options on December 31, 2013. 120,000 options were granted at an option price of $35 per share. Market prices of the stock were as follows:

December 31, 2014 $46 per share December 31, 2015 51 per share. The options were granted as compensation for executives' services to be rendered over a two-year period beginning January 1, 2014. The Black-Scholes option pricing model determines total compensation expense to be $1,200,000. What amount of compensation expense should Smiley recognize as a result of this plan for the year ended December 31, 2014 under the fair value method?
a. $2,100,000.
b. $1,320,000.
c. $1,200,000.
d. $ 600,000.

Answer 1

For the year ended December 31, 2014, Smiley Corporation should recognize $600,000 as compensation expense under the fair value method, which is half of the total determined compensation expense of $1,200,000 for the two-year service period.

Step-by-step explanation:

The student is inquiring about the amount of compensation expense Smiley Corporation should recognize for the year ended December 31, 2014, given that incentive stock options were granted to executives as part of a compensation plan over a two-year period and the total compensation expense has been determined to be $1,200,000 using the Black-Scholes option pricing model.

Under the fair value method, the compensation expense recognized each year is based on the portion of the service period completed. Smiley Corporation's service period for these options is two years, meaning that the expense should be spread evenly over that time. Thus, for the year ended December 31, 2014, Smiley Corporation should recognize half of the total compensation expense, which would be:

Total Compensation Expense / Service Period = $1,200,000 / 2 = $600,000.

Therefore, the correct answer is d. $600,000.