Question

In order to retain certain key executives, Smiley Corporation granted them incentive stock options on December 31, 2009. 80,000 options were granted at an option price of $35

per share. Market prices of the stock were as follows:
December 31, 2010 $46 per share
December 31, 2011 51 per share
The options were granted as compensation for executives' services to be rendered over a two-year period beginning January 1, 2010. The Black-Scholes option pricing model determines total compensation expense to be $800,000. What amount of compensation expense should Smiley recognize as a result of this plan for the year ended December 31, 2010 under the fair value method?
a. $1,400,000.
b. $880,000.
c. $800,000.
d. $400,000.

Answer 1

Smiley Corporation should recognize $400,000 as compensation expense for the year ended December 31, 2010. Therefore, the correct option is d. $400,000.

Step-by-step explanation:

The amount of compensation expense that Smiley should recognize as a result of this plan for the year ended December 31, 2010 is $400,000.

Under the fair value method, the compensation expense is recognized over the vesting period based on the fair value of the options granted. The fair value of the options granted is determined using the Black-Scholes option pricing model, which calculates the present value of the options considering factors such as the current stock price, exercise price, expected volatility, time to expiration, and risk-free interest rate.

In this case, the total compensation expense determined by the Black-Scholes model is $800,000, which is spread over the two-year period. Therefore, for the year ended December 31, 2010, Smiley should recognize half of the total compensation expense, which is $400,000.