If an employee exercises...

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When an employee exercises stock options, the accounting entry typically involves two equity accounts: Common Shares for the par value of the shares issued, and Contributed Surplus (or a similar equity reserve) for the excess of the option price over par value.

Option 1: Accumulated Other Comprehensive Income. This account tracks items not included in net income or retained earnings, such as certain hedging gains or foreign currency translation adjustments. It is not affected by the exercise of employee stock options, so this choice misstates the direct impact on equity when options are exercised.

Option 2: Retained Earnings. This account accumulates net income that is not distributed as dividends. The exercise of options changes paid-in capital and contributed surplus, not retained earnings, so this option incorrectly assigns the impact to the wrong part of equity.

Option 3: Compensation Expense. Compensation expense is recognized at grant or vesting of options (or over the service period), influencing income statement accounts or equity through a related entry, but the exercise itself does not create a compensation expense. The exercise primarily affects equity accounts (par value and any contributed surplus), making this option inaccurate for describing the immediate effect of exercising options.

Option 4: Contributed Surplus - available stock options. Upon exercise, the excess over par value is typically recorded to contributed surplus. This reflects the amount paid over par through the exercise price and represents an appropriate part of the equity impact at exercise in many accounting frameworks. However, since the primary immediate effect presented in many question prompts focuses on the issuance of shares themselves, this account is also involved but is not the sole component of the effect.

Option 5: Common Shares. The par value of the newly issued shares is recorded in Common Shares. This is the fundamental entry required when options are exercised and new shares are issued, representing the primary and most direct change in equity from the exercise event. In many standard treatments, this is the most clearly correct single account affected by the exercise, especially when asked to identify which account is directly increased by the exercise of options.

Overall, the exercise of employee stock options most directly increases Common Shares to reflect the par value of the issued shares, while also potentially increasing Contributed Surplus for any amount above par. The other options either describe related concepts not immediately affected by the exercise event or refer to accounts that are not the direct, primary impact of exercising options.

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If an employee exercises...

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