On January 1, 2021, Evans Company granted Tim Telfer, an employee, an option to buy 5,000 shares of Evans Co. stock for $25 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $37,500. Telfer exercised his option on September 1, 2021, and sold his 5,000 shares on December 1, 2021. Quoted market prices of Evans Co. stock during 2021 were
    January 1         $25 per share
    September 1    $30 per share
    December 1     $34 per share
The service period is for three years beginning January 1, 2021.  As a result of the option granted to Telfer, using the fair value method, Evans should recognize compensation expense for 2021 on its books in the amount of

Show all calculations.

To determine the compensation expense Evans Company should recognize in 2021 using the fair value method, we must understand the mechanics of stock option accounting under ASC 718 (Stock Compensation). This involves recognizing the fair value of stock options as compensation expense over the vesting (service) period.

### Key Information:
- **Grant Date:** January 1, 2021
- **Number of Shares:** 5,000 shares
- **Exercise Price:** $25 per share
- **Total Compensation Expense (Fair Value):** $37,500
- **Service Period:** 3 years, starting January 1, 2021
- **Option Exercised Date:** September 1, 2021
- **Market Price on September 1, 2021:** $30 per share
- **Market Price on December 1, 2021 (when shares were sold):** $34 per share

The service period (also known as the vesting period) refers to the time over which the employee earns the right to exercise the option. In this case, the service period is 3 years, from January 1, 2021, to December 31, 2023. Although Telfer exercised the option on September 1, 2021, the compensation expense is recognized over the entire vesting period.

### Steps to Calculate Compensation Expense for 2021:

1. **Total Compensation Expense Over 3 Years:**  
   The total fair value of the stock options is $37,500. This expense will be recognized over the 3-year vesting period (2021–2023).

2. **Annual Compensation Expense:**  
   To recognize the compensation expense on an annual basis, divide the total compensation expense by the number of years in the service period.

   \[
   \text{Annual Compensation Expense} = \frac{37,500}{3} = 12,500
   \]

3. **2021 Compensation Expense:**  
   The compensation expense for 2021 is the full annual expense because the service period started on January 1, 2021.

   \[
   \text{2021 Compensation Expense} = 12,500
   \]

### Conclusion:
Evans Company should recognize a compensation expense of **$12,500** for 2021 related to the stock options granted to Telfer.

### Important Notes:
- The fact that Telfer exercised the option and sold the shares in 2021 does not affect the total compensation expense recognized for that year. The expense is based on the service period, not the timing of the exercise.
- The remaining compensation expense will be recognized over the next two years (2022 and 2023).

Would you like more details or have any questions?  
Here are 5 follow-up questions to deepen your understanding:

1. How does the market price at exercise affect the accounting of stock options?
2. What would happen to the compensation expense if Telfer left the company before the vesting period ended?
3. How does the fair value method differ from the intrinsic value method in stock option accounting?
4. Can compensation expense change if the stock price fluctuates significantly during the vesting period?
5. How are unexercised stock options treated at the end of the vesting period?

**Tip:** Always check the service period when calculating stock option expenses, as it determines how the total compensation is spread across financial periods.

On January 1, 2021, Evans Company granted Tim Telfer, an employee, an option to buy 5,000 shares of Evans Co. stock for $25 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $37,500. Telfer exercised his option on September 1, 2021, and sold his 5,000 shares on December 1, 2021. Quoted market prices of Evans Co. stock during 2021 were January 1: $25 per share, September 1: $30 per share, December 1: $34 per share. The service period is for three years beginning January 1, 2021. As a result of the option granted to Telfer, using the fair value method, Evans should recognize compensation expense for 2021 on its books in the amount of. Show all calculations.

Learn how to calculate compensation expense for stock options using the fair value method. This example involves Evans Company granting stock options to an employee, and breaking down how the total $37,500 compensation expense is recognized over a three-year service period. This problem is relevant to accounting students studying ASC 718 Stock Compensation rules.

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