Question

Ferraro, Inc. established a stock-appreciation rights (SARs) program on January 1, 2017, which entitles executives to receive cash at the date of exercise for the difference between the market price of the stock and the pre-established price of \(20 on 5,000 SARs. The required service period is 2 years. The fair value of the SARs are determined to be \)4 on December 31,2017, and $9 on December 31, 2018. Compute Ferraro’s compensation expense for 2017 and 2018.

Short answer

Ferraro’s compensation expense for 2017 and 2018:

2017= $10,000

2018= $35,000

Step-by-step solution

 Step 1: Computation of Ferraro’s compensation expense for 2017

Pre-established price of $20 on 5,000 SARs

The fair value of the SARs on December 31, 2017, $4$\begin{array}{c}\mathbf{Compensation}\mathbf{}\mathbf{expense}\mathbf{}\mathbf{for}\mathbf{}\mathbf{2017}\mathbf{=}\mathbf{(}\mathbf{SARs}\mathbf{\times }\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{)}\mathbf{\times }\mathbf{50}\mathbf{\%}\\ \mathbf{=}\mathbf{(}\mathbf{5000}\mathbf{\times }\mathbf{\$}\mathbf{4}\mathbf{)}\mathbf{\times }\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{000}\\ =\$10,000\end{array}$

Computation of Ferraro’s compensation expense for 2018

Pre-established price of $20 on 5,000 SARs

The fair value of the SARs on December 31, 2018, $9

$\begin{array}{c}\mathbf{Compensation}\mathbf{}\mathbf{expense}\mathbf{}\mathbf{for}\mathbf{}\mathbf{2017}\mathbf{=}\mathbf{(}\mathbf{SARs}\mathbf{\times }\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{)}\mathbf{-}\mathbf{Compensation}\mathbf{}\mathbf{expense}\mathbf{}\mathbf{2017}\\ \mathbf{=}\mathbf{(}\mathbf{5000}\mathbf{\times }\mathbf{\$}\mathbf{9}\mathbf{)}\mathbf{-}\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{000}\\ =\$35,000\end{array}$