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1. They do indeed pay cash (would you part with your shares if Boeing tried to pay in trade?). The cash is reduced on the BS and a contra-account called "treasury stock" is credited. Treasury stock is in the shareholders' equity section of the BS.

2. Many times the shares just sit in the "treasury stock" account. This suggests that they may be reissued at some point, and in fact that is usually what happens. A stock acquisition is done, incentive options get exercised or maybe the company needs to raise capital, and the shares are re-sold. However, sometimes a company will permanently retire the shares, effectively ripping up the stock certificates. In this case, the treasury stock contra account is reduced and retained earnings is reduced. Since the corporation can re-issue the shares at will, this is mostly symbolic.

3. These shares may be the ones bought on the open market, but it doesn't affect the accounting as explained above.

4. The difference in value is not recognized anywhere under current accounting, regardless of whether the company issues new shares to the option-holder or buys them in the open market. That's what all the fuss is about WRT options accounting.
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