Under its executive stock option plan, M Corporation granted options on January 1, 2009, that permit executives to purchase 15 million of the company's $1 par common shares within the next eight years, but not before December 31, 2011 (the vesting date). The exercise price is the market price of the shares on the date of grant, $18 per share. The fair value of the options, estimated by an appropriate option pricing model, is $4 per option. No forfeitures were anticipated, however unexpected turnover during 2010 caused the forfeiture of 5% of the stock options. Ignoring taxes, what is the effect on earnings in 2010?
A)$ 0
B)$18 million
C)$19 million
D)$20 million The $60 million total compensation is expensed equally over the three-year vesting period, reducing earnings by $20 million in 2009.The company should adjust the cumulative amount of compensation expense recorded to date in the year the estimate changes.

Question

Quizplus · Accepted Answer

The unexpected turnover caused the forfeiture of 5% of the stock options, which means 5% of the 15 million options, or 750,000 options. The total value of the forfeited options is 750,000 x $4 = $3 million.

This $3 million represents a reduction in compensation expense that was previously recorded. As the compensation expense was expensed equally over the three-year vesting period, the amount of reduction in 2010 is $3 million / 3 = $1 million.

Since the reduction in compensation expense is recognized in 2010, it will increase earnings by the same amount, $1 million.

Therefore, the effect on earnings in 2010 is B) $18 million + $1 million = $19 million

Under Its Executive Stock Option Plan, M Corporation Granted Options