Walters Audio Visual, Inc., offers a stock option plan to its regional managers. On January 1, 2011, options were granted for 40 million $1 par common shares. The exercise price is the market price on the grant date, $8 per share. Options cannot be exercised prior to January 1, 2013, and expire December 31, 2017. The fair value of the options, estimated by an appropriate option pricing model, is $2 per option. Because the plan does not qualify as an incentive plan, Walters will receive a tax deduction upon exercise of the options equal to the excess of the market price at exercise over the exercise price. The income tax rate is 40%. Required: 1. Determine the total compensation cost pertaining to the stock option plan. 2. Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2011. 3. Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2012. CEO Restricted Stock Award On March 19, 2003, the Companys Board of Directors granted 10 million shares of restricted stock to the Companys CEO that vested on March 19, 2006. The amount of the restricted stock award expensed by the Company was based on the closing market price of the Companys common stock on the date of grant and was amortized ratably on a straight-line basis over the three-year requisite service period. Upon vesting dur- ing 2006, the 10 million shares of restricted stock had a fair value of $646.6 million and had grant-date fair value of $7.48 per share. The restricted stock award was net-share settled such that the Company withheld shares with value equivalent to the CEOs minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of 4.6 million were based on the value of the restricted stock award on the vesting date as determined by the Companys closing stock price of $64.66. The remaining shares net of those withheld were delivered to the Companys CEO. Total payments for the CEOs tax obligations to the taxing authorities were $296 million in 2006 and are reflected as a financing activity within the Consolidated Statements of Cash Flows. The net-share settlement had the effect of share repurchases by the Company as it reduced and retired the number of shares outstanding and did not represent an expense to the Company. The Companys CEO has no remaining shares of restricted stock. P 197 Stock option plan; deferred tax effect of a nonqualifying plan LO2 P 198 Performance option plan LO2 P 199 Net loss; stock dividend; nonconvertible preferred stock; treasury shares; shares sold; extraordinary loss LO5 through LO7 LO13 P 1910 EPS from statement of retained earnings LO4 through LO6 excel CHAPTER 19 Share-Based Compensation and Earnings Per Share 1123 4. Record the exercise of the options and their tax effect if all of the options are exercised on March 20, 2016, when the market price is $12 per share. 5. Assume the option plan qualifies as an incentive plan. Prepare the appropriate journal entries to record compensation expense and its tax effect on December 31, 2011. 6. Assuming the option plan qualifies as an incentive plan, record the exercise of the options and their tax effect if all of the options are exercised on March 20, 2016, when the market price is $11 per share