Question

On December 31, 2010, Kessler Company granted some of its executives options to purchase 50,000 shares of the company's $10 par common stock at an option price of $50 per share. The options become exercisable on January 1, 2011, and represent compensation for executives' services over a three-year period beginning January 1, 2011. The Black-Scholes option pricing model determines total compensation expense to be $300,000. At December 31, 2011, none of the executives had exercised their options. What is the impact on Kessler's net income for the year ended December 31, 2011 as a result of this transaction under the fair value method?

a. $100,000 increase
b. $0
c. $100,000 decrease
d. $300,000 decrease

Answer 1

Under the fair value method, there is no impact on Kessler's net income for the year ended December 31, 2011.

Step-by-step explanation:

Under the fair value method, compensation expense is recognized at the grant date, and in this case, the Black-Scholes option pricing model determines it to be $300,000. Despite none of the executives exercising their options by December 31, 2011, Kessler's net income for the year remains unaffected. The $300,000 expense will be amortized over the subsequent three-year period, commencing January 1, 2011, aligning with the executives' anticipated option exercises.

This systematic recognition of expenses reflects a more accurate portrayal of the company's financial performance over the extended period during which the executives are expected to benefit from the stock options. Consequently, this approach aligns with accounting principles, ensuring a more representative depiction of the company's financial health and obligations.