Stock Options Compensation Expense and Impact on Net Income: A Case Study

Stock Options Compensation Expense: A Bramble Corp. Case Study

This case study explores how stock option compensation expense is calculated under the fair value method and its subsequent impact on a company's net income. We'll analyze a specific scenario involving Bramble Corp.

Scenario: On December 31, 2017, Bramble Corp. granted some of its executives options to purchase 58,000 shares of the company's $10 par common stock. The option's exercise price was set at $60 per share. These options become exercisable on January 1, 2018, and represent compensation for the executives' services over a three-year period starting on that date. The Black-Scholes option pricing model determined the total compensation expense to be $365,100. As of December 31, 2018, none of the executives had exercised their options.

Question: What is the impact on Bramble's net income for the year ended December 31, 2018, due to this transaction under the fair value method?

Answer: Under the fair value method, Bramble's net income for the year ended December 31, 2018, would decrease by $121,700.

Explanation:

1. Total Compensation Expense: The Black-Scholes model determined the total compensation expense to be $365,100.

2. Amortization over Service Period: This expense is recognized over the three-year service period during which the executives earn the compensation.

3. 2018 Expense Recognition: Since none of the options were exercised by December 31, 2018, the compensation expense is recognized evenly over the three-year period. Therefore, the 2018 portion is calculated as follows:

   • Compensation expense for 2018 = Total compensation expense / Number of years * Compensation expense for 2018 = $365,100 / 3 = $121,700

4. Impact on Net Income: This $121,700 expense reduces Bramble's net income for the year ended December 31, 2018.

Conclusion: The granting of stock options to executives results in a decrease in net income during the service period, even if the options are not exercised. This highlights the importance of understanding the financial reporting implications of stock-based compensation.