(Effect of employee stock options, LO 5, 6) At its annual meeting in March 2006 the shareholders of Jasper Inc. (Jasper) 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 December 31, 2006 the board granted 200,000 options to its senior executives. The stock options were issued when Jasper’s shares had a market price of $22 per share.

The exercise price of the options is $24 per share.

During fiscal 2006, Jasper earned revenues of $37,345,000, and had cost of sales of

$18,525,000; selling, general, and administrative expenses of $4,560,000; interest expense of $3,535,000; other expenses of $5,700,000; and an income tax expense of

$1,340,000. The economic value of the stock options when they were issued was

$1,200,000.

On December 31, 2005, the equity section showed the following:

Capital stock (unlimited number of common shares authorized, 7,000,000 outstanding) $21,500,000 Retained earnings 18,950,000 During fiscal 2006 Jasper did not issue or repurchase any common shares.

Dividends of $0.10 were declared and paid during the year.

Required:

a. Prepare Jasper’s income statement for the year ended December 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 Jasper’s managers would prefer?

Explain.

e. Which accounting approach do you think gives a better representation of Jasper’s economic performance?

f. If Jasper did not accrue the cost of the options in its financial statements, what information would you want disclosed about them? Explain.