The Happy Co. granted one million employee stock options on June 30, 2009. Each option allowed the holder to buy one share of Happy Co. common stock at $6.00 per share, which was also the stock’s selling price at that date. The options can be exercised any date after June 30, 2010.

The Company used Black-Scholes option pricing model to estimate the fair value of the options at the grant date. That amount was $2 million. Assume the service period is one year. Happy Co. has a 12/31 year-end, its tax rate is 40%, and the options are “non-qualifying” for tax purposes.

Required:

A) How should this transaction be reported in Happy’s 12/31/09 year-end financial statements (balance sheet, income statement, cash flow statement)? Give amounts and accounts. Also, the effect on the balance sheet must balance.

B) Assume that 20% of the options were terminated in January 2010 because certain employees had very recently left the company. Would these terminated options result in some sort of an adjustment? If there is an adjustment, make the appropriate entry or entries?