Companies typically present considerable details about their stock-based compensation plans in footnotes. As indicated on the next page, Johnson
& Johnson’s 2002 Common Stock, Stock Option Plans and Stock Compensation Agreements footnote discloses the following information, which is commonly found in companies’ footnotes:
• The number of options granted, exercised, and canceled or forfeited for the past three years. Options are cancelled when they expire and they are forfeited when employees leave the company before the options are vested. The note indicates J&J’s options generally expire after 10 years.
• The estimated fair-value of the options J&J granted during the past three years based on the Black-Scholes model and the assumptions behind these estimates (needed for the model).
• The outstanding and exerciseable (vested) options at the end of 2002 grouped by exercise price ranges.
Among other things, this information can be used to estimate the cash J&J received in 2002 when employees exercised options: $413 million
= $21,012 x $19.64 (see the third row from the bottom of the table at the bottom of the first column below). This estimate is close to the $390 recognized in the financing section of the statement of cash flows as Proceeds from the exercise of stock options. The difference may be due to transaction costs expensed and included in cash from operations.
10 Common Stock, Stock Option Plans and Stock Compensation Agreements
At December 29, 2002 the Company had 24 stock-based com-pensation plans. Under the 2000 Stock Option Plan, the Com-pany may grant options to its employees for up to 1.6% of the issued shares of the Company’s Common Stock, plus the num-ber of shares available from the previous year that were not issued, as well as shares issued under the Plan that expired or terminated without being exercised. The shares outstanding are for contracts under the Company’s 1991, 1995 and 2000 Employee Stock Option Plans, the 1997 Non-Employee Direc-tor’s Plan and the Mitek, Cordis, Biosense, Gynecare, Centocor, Innovasive Devices, ALZA and Inverness Stock Option Plans.
Stock options generally expire 10 years from the date they are granted and vest over service periods that range from one to six years. All options are granted at current market price on the date of grant. Shares available, under the 2000 Stock Option Plan, for future grants are based on 1.6% of the issued shares each year, and 49.9 million shares could be granted each year during the years 2002 through 2005, in addition to any other available shares as described above. Shares avail-able for future grants under the 2000 plan were 62.1 million at the end of 2002.
A summary of the status of the Company’s stock option plans as of December 29, 2002, December 30, 2001 and December 31, 2000 and changes during the years ending on those dates, is presented below:
Weighted
Options Average
(Shares in Thousands) Outstanding Exercise Price
Balance at January 2, 2000 181,486 $25.65
Options granted 46,456 48.29
Options exercised (27,130) 15.22
Options canceled/forfeited (6,824) 33.03 Balance at December 31, 2000 193,988 32.27
Options granted 8,975(1) 36.31
Options exercised (30,622) 19.00
Options canceled/forfeited (5,117) 49.38 Balance at December 30, 2001 167,224 34.37
Options granted 48,072 57.30
Options exercised (21,012) 19.64
Options canceled/forfeited (4,543) 50.86 Balance at December 29, 2002 189,741 $41.42
(1)Includes 3,108 options issued to replace Inverness options outstanding at or granted prior to the acquisition.
For the year ended December 30, 2001, there was a change in the timing of granting stock compensation and options to employees from December 2001 to February 2002. This change was enacted to have 2001 results finalized in order to align compensation with performance. The same timing of grants will be followed for fiscal 2002.
The average fair value of options granted was $15.49 in 2002, $13.72 in 2001 and $14.79 in 2000. The fair value was estimated using the Black-Scholes option pricing model based on the weighted average assumptions of:
2002 2001 2000
Risk-free rate 4.39% 4.87% 5.45%
Volatility 26.0% 27.0% 27.0%
Expected life 5.0 yrs 5.0 yrs 5.0 yrs
Dividend yield 1.33% 1.33% 1.40%
The following table summarizes stock options outstanding and exercisable at December 29, 2002:
(Shares in Thousands) Outstanding Exercisable
Average Average
Exercise Average Exercise Exercise
Price Range Options Life(a) Price Options Price
$.79-$11.15 5,572 1.2 $10.29 5,572 $10.29
$11.16-$21.24 16,550 1.8 12.93 16,550 12.93
$21.57-$39.86 43,541 4.0 27.05 42,403 26.85
$40.08-$50.66 40,916 6.7 45.94 35,829 45.76
$50.69-$55.91 36,337 7.8 50.74 306 51.82
$57.30-$61.68 46,655 9.1 57.34 1 57.36
$63.30-$66.50 170 8.0 64.37 41 64.74
189,741 6.3 $41.42 100,702 $30.47
(a)Average contractual life remaining in years.
Stock options exercisable at December 30, 2001 and
December 31, 2000 were 99,176 options at an average exercise price of $24.34 and 90,384 options at an average exercise price of $19.46, respectively.
Pages 47 - 48, Johnson and Johnson’s 2002 Annual Report
Exercise 9.07
The goal of this exercise is to give you an opportunity to practice the entries discussed in the text from the perspective of an insider.
You will need to open the following Excel file to complete this exercise:
Ex_09.07.xls.
Required
Given the assumptions below and assuming the company uses the fair value method, complete the entries and year-end balances in the Insiders_
Tax_ Template worksheet of Ex_09.07.xls.
Year-1
Income tax expense and payment
• $120 current provision recorded on year 1 tax forms
• -$240 deferred provision related to warranties
• $720 deferred provision related to depreciation
• $96 tax payment Options
• $20 option value, as determined on the grant date, is expensed (all options vest in year 1, no option costs capitalized to inventory)
• No options exercised in year 1
• $7 deferred tax
Year-2
Income tax expense and payment
• $2,160 current provision recorded on year 2 tax forms
• $180 deferred provision related to warranties
• $600 deferred provision related to depreciation
• $1,752 tax payment Options exercised
• No option expense in year 2
• $100 exercise price
En
cash +other assets = liabilities + permanent OE+ temporary OE Assets = Liabilities + Owners' Equities
Direct Cash Flows Balance Sheets Income Statements
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This exercise helps you meet the insiders’
record keeping and reporting challenge.
• $300 fair value when exercised
• $200 tax deduction for company when exercised (= $300-$100)
• $70 tax benefit for company (= 35% tax rate * $200)
• $3 of tax benefit previously recorded to deferred tax asset when option expensed
+ Cash +
deferred tax Net assets (liabilities)
= + Incometaxes
payable + stock and Common
APIC - expenseTax
Year-end 2005 + $7,324 + = + + $6,245
-Other (unexplained) + ignore + = + + ignore - ignore
Year-end 2006 + $6,598 + = + + $7,825
-Part 2
This connects your part 1 answers to Intel’s statement of cash flows.
(a) Complete the following table using Intel’s 2006 SCF. For the first three blank columns, indicate the effects of the events on the SCF items. Combine the results of these three columns in the fourth blank column. Do these events largely explain the SCF adjustments?
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This exercise helps you learn how to compute financial measures.
Exercise 9.08
Part 1
This exercise centers on the balance-sheet-equation (BSE) matrix, which pertains to Intel accounts affected by tax entries and stock options during 2006.
(a) Fill in the beginning and ending balances for income taxes payable and net deferred tax assets (liabilities). Note, the net deferred tax assets (liabilities) balance will be negative in this matrix when the deferred tax liabilities exceed the deferred tax assets.
(b) Record the tax expense, tax payment, and issuance of shares to employees through stock plans.
(c) Determine the remaining unexplained amounts (if any) in income taxes payable and the net deferred tax assets (liabilities), meaning the amounts explained by other events.
En
cash +other assets = liabilities + permanent OE+ temporary OE Assets = Liabilities + Owners' Equities
Direct Cash Flows Balance Sheets Income Statements
Record Keeping and Reporting Icon
This exercise helps you meet the outsiders’ record keeping and reporting challenge — reverse engineering entries.
Usage Icon This exercise helps you learn how accounting reports are interpreted and used by outsiders.
Part 2 continued
(b) Intel received $1,046 million from its employees for the shares it issued to them. Where is this cash inflow reported in the SCF?
(c) Why is there a ($123) adjustment included in the SCF reconciliation related to employee stock?
(d) Is the ($60) income taxes payable adjustment the amount you would expect to see given the entries you recorded in part a?
(e) Does the deferred tax adjustment equal: (1) the deferred provision; or (2) the change in the net deferred tax assets (liabilities)?
(f) Which SCF line items might reflect the unexplained entries in part a?
Part 3
Come to class prepared to answer the following:
(a) What amount did Intel recognize at year-ends 2006 and 2005 for deferred tax assets related to accrued compensation and benefits?
(b) Why would an expert state that the tax concepts related to accrued compensation and benefits are essentially the same as those for warranties?
(c) Is the accrued compensation and benefits liability for tax reporting at the end of 2006 smaller (or larger) than the one reported for financial reporting?
(d) Assuming that Intel uses a 35% tax rate for deferred tax computations, estimate the tax basis of the accrued compensation and benefits
liability at the end of 2006.
(e) Would Intel’s 2006 pretax income for financial reporting have been smaller (or larger) if Intel had recognized the same “compensation
expenseTax Tax payment
Employee stock
issue Comb
Net income $5,044
Deferred taxes ($325)
Excess tax benefit of stock plan ($123) Income taxes payable ($60) Cash from operations $10,620
Reported in Intel's 2006 SCF
Effects of Entries on SCF
and benefits” expense for financial reporting as it did for tax reporting during 2006? How much smaller or larger? Hint: The tax effect of such difference in financial and tax reporting pretax income increases or decreases the deferred tax asset.
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cash +other assets = liabilities + permanent OE+ temporary OE Assets = Liabilities + Owners' Equities
Direct Cash Flows Balance Sheets Income Statements
Record Keeping and Reporting Icon
This exercise helps you meet the outsiders’ record keeping and reporting challenge — reverse engineering entries.
Exercise 9.09
This exercise pertains to options-related questions on the 2007 final exam, which was based on a supplement from Motorola’s fiscal 2006 annual report.
Required
Answer final exam 2007 questions 1j, 3m, 3n, and 4f. Be sure to read the directions at the start of question 4 (on page 11).
Usage Icon This exercise helps you learn how accounting reports are interpreted and used by outsiders.