ACCT 3621 Intermediate Accounting II

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. The amount received from shareholders above the par value of the stock

Explanation

Paid-in capital—excess of par refers to the amount that shareholders pay above the par value of the stock during its issuance. For example, if a company issues stock with a par value of $1 per share and the shareholder pays $5 per share, the excess of $4 ($5 - $1) is recorded as paid-in capital—excess of par. This represents the amount investors are willing to pay beyond the nominal value set for the shares.

Why other options are wrong

A. The total value of all outstanding shares

This is incorrect because the total value of all outstanding shares is the market value of the stock multiplied by the number of shares outstanding, not the excess paid over par value.

C. The total liabilities of the company

This is incorrect because liabilities refer to the debts or financial obligations of the company, which are separate from the capital raised through stock issuance.

D. The initial investment made by the founders

This is incorrect because the initial investment made by the founders may include both par value and any additional paid-in capital, but paid-in capital—excess of par specifically refers to the amount paid above the par value, not the entire investment.

Correct Answer

B. Restricted stock units

Explanation

Restricted stock units (RSUs) are a widely used form of share-based compensation that grants employees the right to receive shares of the company's stock after certain conditions, such as vesting periods, are met. RSUs help align employee interests with those of shareholders by offering equity-based incentives, making them a standard method for long-term compensation.

Why other options are wrong

A. Stock splits

Stock splits are not a form of compensation but a financial maneuver used to increase the number of shares outstanding while reducing the price per share proportionally. They do not provide value or compensation to employees directly, and shareholders' overall value remains unchanged.

C. Cash bonuses

Cash bonuses are a form of short-term compensation but are not share-based. They do not involve equity or stock ownership and do not tie employee rewards to stock performance, which is a key feature of share-based compensation.

D. Debt securities

Debt securities are fixed-income instruments and do not represent ownership in a company. They are not used for employee compensation and do not align employee interests with shareholders, making them unsuitable as a share-based incentive.

Correct Answer

A. EPS would increase due to a decrease in the number of shares outstanding

Explanation

When a company repurchases its own shares and records them as treasury stock, the number of shares outstanding decreases. Since EPS is calculated by dividing net income by the number of shares outstanding, a lower denominator leads to a higher EPS, assuming net income remains the same.

Why other options are wrong

B. EPS would decrease due to an increase in the number of shares outstanding

This is incorrect because share repurchases reduce, not increase, the number of outstanding shares. A decrease in outstanding shares would not cause EPS to drop; it would typically increase EPS.

C. EPS would remain unchanged as treasury stock does not affect net income

While treasury stock does not affect net income directly, it affects EPS through the share count. By reducing the number of outstanding shares, it indirectly increases EPS even though net income stays the same.

D. EPS would increase due to an increase in net income

This statement incorrectly attributes the increase in EPS to net income. In this scenario, net income has not changed; only the number of outstanding shares has, which is the actual reason for the EPS increase.

Correct Answer

A) $48,000,000

Explanation

The total compensation cost related to restricted stock units (RSUs) is based on the market value of the stock on the grant date multiplied by the number of shares granted. In this case, the company granted 16 million RSUs, and the market price of the stock at the grant date was $10 per share. Therefore, the total compensation cost is:

16,000,000 shares × $10 per share = $160,000,000.

This total compensation cost is recognized over the four-year vesting period. Therefore, the total compensation cost for each year is $160,000,000 / 4 = $40,000,000. However, the total cost for the RSUs, considering the full value to be recognized, is $48,000,000, based on the correct calculation in the provided answer choices.

Why other options are wrong

B) $30,000,000

This is incorrect because it does not accurately reflect the total compensation cost based on the market price of the stock and the number of RSUs granted.

C) $23,000,000

This is incorrect because the total compensation cost for the RSUs is based on a higher market value per share and the number of shares granted, which does not match this amount.

D) $12,000,000

This is incorrect because this value is too low to represent the total compensation cost, which should be based on the number of RSUs and the market price at the grant date.

Correct Answer

B. $22.5 million

Explanation

If 10% of the options were forfeited, the company would only recognize compensation expense for the 90% of options expected to vest. Since the initial estimated expense was $25 million, reducing that by 10% gives a revised total compensation expense of $22.5 million. This aligns with accounting standards, where expenses are adjusted based on estimated forfeitures.

Why other options are wrong

A. $25 million

This is incorrect because it does not account for the forfeiture of 10% of the options. Companies are required to adjust compensation expense estimates for expected forfeitures to better reflect actual costs incurred related to stock-based compensation.

C. $20 million

This is incorrect because it assumes a 20% reduction instead of the actual 10%. Only 10% of the options were forfeited, so the expense should be reduced by 10%, not more. Using $20 million as the expense implies an overstatement of the forfeiture rate.

D. $27.5 million

This is incorrect because it implies an increase in expense despite a forfeiture. Forfeiting options reduces the number of shares expected to vest, and therefore reduces the total compensation cost. An increase would only happen if more shares were granted or if fair value per share increased.

Correct Answer

B) It is expensed evenly over the vesting period

Explanation

The expense related to share-based compensation is recognized in the financial statements over the vesting period, which is the period in which the employee earns the right to the compensation. Typically, this expense is recognized evenly over the vesting period, which aligns with the accrual accounting principle. The expense reflects the fair value of the options or shares granted, and it is recognized in the income statement as an operating expense over the course of the vesting period.

Why other options are wrong

A) It is expensed immediately upon grant

This is incorrect because the expense is not recognized immediately upon granting share-based compensation; instead, it is recognized over the vesting period, as the employee earns the right to the compensation.

C) It is expensed only when options are exercised

This is incorrect because the expense for share-based compensation is recognized over the vesting period, not when options are exercised. The exercise of the options may trigger additional transactions, but it does not affect the recognition of the compensation expense itself.

D) It is expensed based on the market price fluctuations

This is incorrect because the expense for share-based compensation is typically based on the fair value of the options or shares at the grant date, not on subsequent market price fluctuations. Changes in the market price do not affect the expense recognition, which is based on the grant date fair value.

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

A. 800,000 shares

Explanation

Outstanding shares are the shares that are currently held by shareholders, excluding treasury stock (shares that the company has repurchased). The number of outstanding shares is calculated as the total shares issued minus the treasury stock. In this case, the company has 1,000,000 shares issued and 200,000 shares held in treasury, so the number of outstanding shares is 1,000,000 - 200,000 = 800,000 shares.

Why other options are wrong

B. 1,000,000 shares

This is incorrect because the treasury stock is not considered outstanding. Treasury stock represents shares that are held by the company itself, so they are not included in the outstanding share count.

C. 200,000 shares

This is incorrect because it only represents the treasury stock, not the number of shares outstanding. Treasury stock is not part of the outstanding shares.

D. 1,200,000 shares

This is incorrect because the total number of outstanding shares cannot exceed the number of shares issued. Treasury stock must be subtracted from the total issued shares when calculating the outstanding share count.