I need a detailed explanation, step by step. Thanks. Several years ago, the John

Question

I need a detailed explanation, step by step. Thanks.

Several years ago, the Johnson Co. granted options on 5,000 shares of its common stock. The fair market value of each option on the grant date was $3 per share. The exercise price is $2. The tax rate (all years) is 20%. The options are exercised at the end of the current year. At the beginning of the current year "Paid-in capital tax effect of stock options" had a credit balance of $10,000

1. What is the ending balance of Paid-in capital tax effect of stock options if the fair market value of the stock on the exercise date was $3 per share?

2. What is the balance of Paid-in capital tax effect of stock options at the end of the current year if the fair market value of Johnson's stock on the exercise date was $11 per share?

3. What is the ending Paid-in capital tax effect of stock options, if the market price of the stock on the exercise date is $5.

Explanation / Answer

1). The fair market value of the options on the exercise date is same ($3) as per share value, there will be no

increase in tax effect.

2). The fair market value of the options on the exercise date is $3 per share, where as the fair market value of the

stock on the exercise date was $11 per share. It results in per share gain is $8 ($11 - $3).

Hence, the total Capital gain would be $40000 ($8 * 5000).

The Above gain will reduce the current year paid in capital tax effect of stock options credit balance of $10000.

Hence, The revised taxable balance will be $30000.

3). The fair market value of the options on the exercise date is $3 per share, where as the fair market value of the

stock on the exercise date was $5 per share. It results in per share gain is $2 ($5 - $3).

Hence, the total capital gain would be $10000 ($2 * 5000).

The Above gain will reduce the current year paid in capital tax effect of stock options credit balance of $10000.

Hence, the revised taxable balance will be $0.

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