(Effect of employee stock options, LO 5, 6) At its annual meeting in June 2005 the shareholders...
Question:
(Effect of employee stock options, LO 5, 6) At its annual meeting in June 2005 the shareholders of Rusylvia Ltd. (Rusylvia) approved an employee stock option plan that allows the company’s board of directors to grant stock options to certain employees as part of their compensation packages. During the year ended March 31, 2006 the board granted 100,000 options to its senior executives. The stock options were issued when Rusylvia’s shares had a market price of $10 per share. The exercise price of the options is $10.25 per share.
During fiscal 2006, Rusylvia earned revenues of $17,250,000, and had cost of sales of $7,600,000; selling, general, and administrative expenses of $2,400,000; interest expense of $1,750,000; other expenses of $2,950,000; and an income tax expense of $610,000. The economic value of the stock options when they were issued was $900,000.
On March 31, 2005, the equity section showed the following:
On February 1, 2006 Rusylvia issued 300,000 shares of common stock for $10 per share. In March 2006 Rusylvia declared and paid the dividend on the preferred shares and declared and paid a cash dividend of $0.25 per share on the common shares.
Required:
a. Prepare Rusylvia’s income statement for the year ended March 31, 2006.
b. Calculate basic earnings per share and return on shareholders’ equity under the two accounting treatments for employee stock options.
c. What effect on cash flow do the two accounting treatments for employee stock options have?
d. Which accounting approach do you think Rusylvia’s managers would prefer?
Explain.
e. Which accounting approach do you think gives a better representation of Rusylvia’s economic performance?
f. If Rusylvia did not accrue the cost of the options in its financial statements, what information would you want disclosed about them? Explain.
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