Watson Company is a small, publicly-traded publisher of detective fiction. The company

has a share-based compensation plan that it uses to retain and reward its current executives. In

that plan, executives are granted options with an exercise price equal to market value at the date

of grant, but the options are nonqualified options for tax purposes. Those options are currently

accounted for as equity instruments, and are reported at fair value. The company prefers to have

all share-based compensation plans reported as equity.

Over the past several years, it has become common for the executives to exercise options

and immediately sell part or all of the shares for cash. The compensation committee of Watsons

board of directors is unsure whether this practice indicates (1) that the executives prefer cash

over shares or (2) that the executives are finding the requirement to pay cash at exercise

financially stressful. The board is considering changing the stock-option plan, and has proposed

two alternatives.

Alternative 1: At exercise, the executive could choose between conventional exercise of

options (paying cash and receiving shares) and receiving in cash the difference between

the exercise price and the market price on the exercise date.

Alternative 2: The company would make arrangements for a cashless exercise for the

executives. The company would obtain services of a broker, who would sell enough of

the exercised shares to cover the exercise price and the income tax withholding for the

executive. The executive would retain ownership of the remaining shares.

You are a staff accountant at Watsons CPA firm. The chair of the compensation

committee, Irene Doyle, has approached the CPA firm for guidance about the potential effect of

this change in share-based compensation plans on financial reporting. You have been given the

task of (1) determining whether each of these alternatives would change how Watsons

compensatory stock options are treated for financial reporting, (2) identifying and describing any

differences in the accounting between the current option package and each of the two

alternatives, and (3) responding to the chair of the compensation committee.

I dont need the letter written just help with the concepts and how the reporting would change i just put the whole assignment in for context