Ssg cycles manufactures and distributes motorcycle parts and supplies. employees are offered a variety of share-based compensation plans. under its nonqualified stock option plan, ssg granted options to key officers on january 1, 2018. the options permit holders to acquire 5 million of the company’s $1 par common shares for $29 within the next six years, but not before january 1, 2021 (the vesting date). the market price of the shares on the date of grant is $31 per share. the fair value of the 5 million options, estimated by an appropriate option pricing model, is $8.7 per option.
required:
1. determine the total compensation cost pertaining to the incentive stock option plan.
2. prepare the appropriate journal entries to record compensation expense on december 31, 2018, 2019, and 2020.
3. record the exercise of the options if all of the options are exercised on may 11, 2022, when the market price is $32 per share.

1. Total compensation cost pertaining to the incentive stock option plan:

= Number of shares permitted by the option × Fair value per option

= 5 million × $8.7 per option

= $43.5 million

2. The Journal entries are as follows:

(i) On December 31, 2018

Compensation expense A/c                                    Dr. $14.5

To paid-in-capital stock option [$43.5 million ÷ 3]                  $14.5

(To record the compensation expense for the year 2018)

(ii) On December 31, 2019

Compensation expense A/c                                    Dr. $14.5

To paid-in-capital stock option [$43.5 million ÷ 3]                  $14.5

(To record the compensation expense for the year 2019)

(iii) On December 31, 2020

Compensation expense A/c                                    Dr. $14.5

To paid-in-capital stock option [$43.5 million ÷ 3]                  $14.5

(To record the compensation expense for the year 2020)

3. The Journal entry is as follows:

Cash A/c                                        Dr. 145

Paid-in-capital stock option A/c   Dr. 15

To common stock                                              5

To Paid-in-capital Excess of par (Bal. fig)         155

(To record the exercise of options)

Workings:

Cash =  $29 exercise price × 5 million shares

         = $145 million

Paid-in-capital stock option = 5 million shares × 3 years

                                              = 15 million

common stock = 5 million shares × $1 par per share

                         = 5 million shares