This year, Haven Corporation granted a nonqualified stock option to Olivia to buy 5,000 shares of Haven stock for $20 for five years. At date of grant, Haven stock was selling on Nasdaq for $19 per share. For financial statement purposes, Haven recorded $16,500 compensation expense for the estimated value of the option. Five years after Haven granted the option to Olivia, she exercised it on a day when Haven stock was selling for $27 per share. a. How much income must Olivia recognize in the year of exercise? b. What is Haven's tax deduction in the year of exercise? c. What is the effect of the exercise on Haven's book income and deferred taxes?
What will be an ideal response?
a. 5,000 × ($27 ? $20) = $35,000 ordinary income.
b. $35,000.
c. The exercise transaction has no effect on book income. Haven will reverse the original $3,465 deferred tax asset ($16,500 × 21%).
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