ACCT 3621 Intermediate Accounting II

Correct Answer

C. After all vesting conditions have been met, Michael will receive 200 shares of Gordon Co.

Explanation

RSUs are equity-settled, meaning Michael will receive shares of the company upon the vesting of the RSUs, provided all vesting conditions are met. Since the RSUs are equity settled, Michael will receive the shares rather than cash, and no payment is required from him for the shares.

Why other options are wrong

A. During the vesting period, Michael has the right to receive cash equal to $7.00 per RSU.

This is incorrect because RSUs are typically settled in shares, not cash. Since the RSUs are equity settled, Michael will not receive cash but shares of the company once the vesting period is completed.

B. One downside risk for Michael is that if the share price falls below $7.00, he will receive nothing on settlement of the RSU.

This is incorrect because the fair value of the RSUs is determined at the grant date, but the actual settlement is based on the market price at the time of vesting. If the share price falls below $7.00, Michael will still receive shares, but the value of those shares could be lower than the initial fair value.

D. After the vesting period, Michael will be required to pay $7.00 to receive a share of Gordon Co.

This is incorrect because RSUs are not options; they do not require a purchase price from the executive. Once the RSUs vest, Michael will receive the shares without having to pay for them.

Correct Answer

D. A or B, whichever is more readily available

Explanation

When stock is issued in exchange for non-cash assets, accounting standards require that the transaction be recorded at the fair value. If the fair value of the stock issued is readily determinable, that value is used. However, if the fair value of the stock is not clearly measurable, then the fair value of the property or service received is used. This ensures that the recorded value accurately reflects the economic substance of the transaction.

Why other options are wrong

A. Fair market value of the stock issued

While this is often the preferred basis for recording the transaction, it is not always the most reliable. If the stock is not actively traded or lacks a quoted market price, its fair market value may be difficult to determine, which makes this answer incomplete.

B. Fair market value of the property received

This is also a valid measurement, but only if the fair value of the stock cannot be determined. Relying solely on this option ignores the fact that the fair value of the stock might be available and preferable, which makes this answer partially correct but not the best choice.

C. Par value of the stock issued

Par value is a nominal amount that does not reflect the true market value of the stock or the asset received. Recording transactions at par value would significantly understate the transaction's financial impact, making this an incorrect accounting treatment.

Correct Answer

B. expensed over the vesting period

Explanation

Under IFRS 2, the fair value of share-based payments granted to employees is measured at the grant date and recognized as an expense over the vesting period. This approach aligns the cost of compensation with the period in which the employee renders service. It ensures proper matching of expenses with the periods in which benefits are received, which upholds the accrual basis of accounting.

Why other options are wrong

A. deferred over the vesting period

This option is incorrect because the cost is not deferred but rather recognized as an expense over the vesting period. Deferring implies postponing recognition, whereas IFRS 2 requires systematic expense recognition aligned with the service period. Therefore, “deferred” misrepresents the accounting treatment required.

C. accrued at the grant date

Accruing the full amount at the grant date is incorrect because employees still need to fulfill service conditions over the vesting period. Recognition at the grant date would violate the matching principle and overstate expenses in the first year.

D. expensed at the grant date

This is incorrect because the entire amount should not be expensed immediately. The correct approach is to allocate the expense over the entire vesting period, reflecting the period during which the employee earns the benefit.

E. none of the answers apply

This is incorrect because one of the options—specifically, "expensed over the vesting period"—is indeed the correct treatment under IFRS 2. Therefore, this answer choice is not applicable.

Correct Answer

A) They change the total number of shares issued and outstanding, affecting earnings per share calculations.

Explanation

Stock dividends and stock splits increase the number of shares outstanding, which directly affects the weighted-average shares outstanding used in the earnings per share (EPS) calculation. Since the total number of shares increases, the weighted average for the period must be adjusted to account for the higher number of shares, ensuring accurate EPS reporting. This recalculation reflects the changes in the number of shares and their impact on earnings, which is a crucial aspect of financial reporting.

Why other options are wrong

B) They only affect the market price of the shares, not the number of shares outstanding.

This is incorrect because stock dividends and stock splits actually change the total number of shares outstanding, which is essential for calculating weighted-average shares. They may also impact the market price per share, but that is secondary to the number of shares outstanding.

C) They are irrelevant to the calculation of weighted-average shares outstanding.

This is incorrect because stock dividends and stock splits are very relevant to the calculation of weighted-average shares outstanding. They directly impact the total number of shares, requiring adjustments in the EPS calculation.

D) They only impact the company's cash flow statements.

This is incorrect because stock dividends and stock splits do not directly affect cash flow. These actions only impact the number of shares outstanding and the calculation of EPS, which are reflected in the income statement and shareholders' equity section of the balance sheet.

Correct Answer

B) Allocated to expense over the service period.

Explanation

The compensation cost associated with employee stock options is recognized over the vesting period (the service period) as employees earn the right to exercise the options. This period is the time during which the employee must work before they have the right to exercise the options. The expense is typically spread out evenly across the vesting period.

Why other options are wrong

A) Expensed on the exercise date.

This is incorrect because the compensation expense is recognized during the vesting period, not on the exercise date. The expense is recognized when the employee earns the right to the options, not when they are exercised.

C) Allocated to expense until exercised.

This is incorrect because the expense is recognized over the vesting period, not until the options are exercised. Once vested, no further expense is recognized, even if the options are exercised later.

D) Expensed on the date of grant.

This is incorrect because the compensation expense is not recognized on the date the stock options are granted. Instead, it is allocated over the vesting period, which is typically several years after the grant date.

Correct Answer

B) They decrease total shareholders' equity by reducing the number of outstanding shares.

Explanation

Treasury stock transactions affect shareholders' equity because when a company buys back its own shares, those shares are removed from circulation and held in the company's treasury. This reduces the number of outstanding shares and lowers total shareholders' equity because the company records a reduction in the paid-in capital related to those shares. Although treasury stock is not classified as an asset, it represents a reduction in equity because it is effectively the company's own capital that is being repurchased and held.

Why other options are wrong

A) They increase total shareholders' equity by reducing liabilities.

This is incorrect because treasury stock transactions do not reduce liabilities directly. The reduction in shareholders' equity is due to the repurchase of stock, not changes to liabilities.

C) They have no effect on total shareholders' equity.

This is incorrect because treasury stock transactions do affect total shareholders' equity by reducing it. When shares are repurchased, the company’s paid-in capital is reduced, which in turn lowers the total equity.

D) They increase total shareholders' equity by increasing paid-in capital.

This is incorrect because treasury stock transactions decrease paid-in capital, not increase it. When a company repurchases its shares, the repurchase price is deducted from paid-in capital and total equity.

Correct Answer

B) 2,200,000 shares.

Explanation

The stock dividend increases the number of shares outstanding by 10%. Therefore, after the 10% stock dividend, the company will have 1,100,000 shares (1,000,000 * 1.10). Following the 2-for-1 stock split, the total number of shares will double, resulting in 2,200,000 shares. The weighted-average shares outstanding for the next reporting period would reflect this increase.

Why other options are wrong

A) 1,100,000 shares.

This is incorrect because, while the stock dividend increases the shares to 1,100,000, the subsequent 2-for-1 stock split will double the number of shares to 2,200,000.

C) 1,000,000 shares.

This is incorrect because the stock dividend and stock split both increase the number of shares outstanding, so the weighted-average shares outstanding should reflect these changes.

D) 1,200,000 shares.

This is incorrect because after the stock dividend, the number of shares is 1,100,000. The stock split then doubles that number to 2,200,000 shares, not 1,200,000.

Correct Answer

C. Basic earnings per share may increase or decrease depending on the number of shares issued versus repurchased

Explanation

The effect on basic earnings per share (EPS) depends on the net change in the number of shares outstanding after both issuing new shares and repurchasing treasury stock. If more shares are issued than repurchased, the total number of shares outstanding increases, likely causing a decrease in EPS. If more treasury stock is repurchased than shares issued, the number of shares outstanding decreases, which could increase EPS.

Why other options are wrong

A. Basic earnings per share will definitely increase

This is incorrect because repurchasing treasury stock typically reduces the number of shares outstanding, which could increase EPS only if the number of shares issued is smaller than the number repurchased. However, if more shares are issued, the increase in outstanding shares could decrease EPS.

B. Basic earnings per share will definitely decrease

This is incorrect because the effect on EPS depends on the balance between the number of shares issued and repurchased. If more treasury stock is repurchased than new shares are issued, EPS could increase, not decrease.

D. Basic earnings per share will remain unchanged

This is incorrect because issuing new shares and repurchasing treasury stock usually affects the number of shares outstanding, which in turn affects basic EPS. It is unlikely that these two actions will exactly cancel each other out, leaving EPS unchanged.

Correct Answer

B. Because treasury shares are excluded from the calculation

Explanation

In calculating basic earnings per share (EPS), the number of shares used is the weighted average of shares outstanding during the period. Treasury shares, which are shares repurchased by the company, are excluded from this calculation because they are not considered outstanding. This reduces the number of shares used in the basic EPS calculation. As a result, only the shares that are actively held by shareholders are included in the denominator of the EPS calculation.

Why other options are wrong

A. Because only common shares are considered

This is incorrect because both common shares and certain other types of shares (like those arising from stock options or warrants, for diluted EPS) are considered in EPS calculations, but treasury shares specifically are excluded. The distinction made in this question is not about common vs. other shares but about treasury shares not being counted.

C. Because preferred shares are included in the calculation

This is incorrect because preferred shares are not included in the calculation of basic EPS unless preferred dividends are subtracted from net income in the calculation of earnings available to common shareholders. The number of shares used in basic EPS only accounts for common shares, not preferred shares.

D. Because shares issued for stock options are counted

This is incorrect because shares issued for stock options are counted for diluted EPS, not basic EPS. Basic EPS uses only the weighted average number of common shares outstanding, excluding stock options unless they have already been exercised and converted into common shares.