Q:

On 1^st January, 2010, as an incentive to improved performance of duties, Recycling Corporation adopted a qualified stock option approach to grant corporate executives nontransferable stock options to 500,000 shares of its unissued $1 par value common stock. The options were granted on 1^st May, 2010, at $25 per share, the market price on that date. All the options were exercisable one year later and for four years thereafter, giving that the grantee was employed by the corporation at the date of exercise.

The market price of this stock was $40 per share on 1^st May, 2011. All options were exercised before 31^st December, 2011, at times when the market price varied between $40 and $50 per share.

Required:

a. What information on this option plan could be shown in the financial statements of Recycling Corporation at (1) 31^st December, 2010, and (2) 31^st December, 2011? Explain.

b. It has been said that the exercise of such a stock option would dilute the equity of existing stockholders in the corporation.

i. How could this happen? Show.

ii. What conditions could avoid a dilution of existing equities from taking place in this transaction? Discuss.