Question

On January 1, 2011 Reese Company granted Jack Buchanan, an employee, an option to buy 100 shares of Reese Co. stock for $40 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $1,200. Buchanan exercised his option on September 1, 2011, and sold his 100 shares on December 1, 2011. Quoted market prices of Reese Co. stock during 2011 were:

January 1 $40 per share
September 1 $48 per share
December 1 $54 per share
The service period is for two years beginning January 1, 2011. As a result of the option granted to Buchanan, using the fair value method, Reese should recognize compensation expense for 2011 on its books in the amount of
a. $0.
b. $600.
c. $1,200
d. $1,400

Answer 1

The compensation expense for 2011 on Reese's books should be $1,200.

Step-by-step explanation:

The fair value of an employee stock option is determined using a fair value option pricing model. In this case, the total compensation expense was determined to be $1,200. This expense needs to be recognized for the service period, which is two years beginning on January 1, 2011.

Jack Buchanan exercised his option on September 1, 2011, and sold his 100 shares on December 1, 2011. The fair value of the stock on September 1 was $48 per share, and on December 1 it was $54 per share.

To calculate the compensation expense for 2011, we need to consider the fair value of the option at the date of grant and the fair value of the stock at the date of exercise. In this case, since Buchanan exercised his option in 2011, we only need to consider the fair value of the stock on September 1, which is $48 per share.

The number of shares that Buchanan exercised is irrelevant for the calculation of compensation expense. Therefore, the compensation expense for 2011 on Reese's books should be $1,200.