Question

On December 31, 2010, Gonzalez Company granted some of its executives options to purchase 100,000 shares of the company's $10 par common stock at an option price of $50 per share. The Black-Scholes option pricing model determines total compensation expense to be $750,000. The options become exercisable on January 1, 2011, and represent compensation for executives' services over a three-year period beginning January 1, 2011. At December 31, 2011 none of the executives had exercised their options. What is the impact on Gonzalez's net income for the year ended December 31, 2011 as a result of this transaction under the fair value method?

a. $250,000 increase.
b. $750,000 decrease.
c. $250,000 decrease.
d. $0.

Answer 1

The impact on Gonzalez's net income for the year ended December 31, 2011 as a result of this transaction under the fair value method would be a $250,000 decrease.

Step-by-step explanation:

The impact on Gonzalez's net income for the year ended December 31, 2011 as a result of this transaction under the fair value method would be a $250,000 decrease.

The Black-Scholes option pricing model determines that the total compensation expense for granting the options is $750,000. However, as of December 31, 2011, none of the executives had exercised their options. According to the fair value method, the compensation expense is recognized over the period during which the executives provide their services, which is three years beginning on January 1, 2011.

Since none of the executives exercised their options in 2011, there is no actual cash outflow or reduction in the company's assets. However, the fair value method requires the company to recognize the compensation expense over the service period. Therefore, the company would recognize $250,000 as compensation expense on its income statement for the year ended December 31, 2011, resulting in a decrease in net income.