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Except that there is no cost to the company, so what is it doing as an entry on the P&L?

Let's resort to bookkeeping. Debits and Credits. And let's run an example.

So you compensate an employee by giving them an option for 100 shares of stock. When they exercise the option, they get the stock. And to temporarily bypass timing issues, let's say the employee immediately exercises the option. So what do we record on the company books?

Well, compensatory options are not typically recorded on the books, so there is no entry there. But now the employee exercises the option and is issued 100 shares of stock. We need to record the issuance on the books. That's a credit to common stock. But what is the dollar amount of that credit? Par value is one possibility. So you credit common stock for the par value of those shares. To keep the books in balance, we need to make an offsetting debit. What account do you propose to debit?

Not cash - no cash changed hands. Not any other asset. The company didn't receive an asset. Not a liability - the company didn't discharge (pay off) any liability here. (There's an argument they paid off the liability for the stock option, but that just moves the bookkeeping question to the entry to record that liability. What account to debit in that transaction still remains the question.) Not an equity account - no one contributed or removed any equity in exchange for the stock. That leaves the P&L. And if you need to make an entry on the P&L, the only account that makes any sense is employee compensation.

Now that you've established the entry as a debit to employee compensation and a credit to common stock, all that's left to argue about is the dollar amount. The accounts remain the same. And the timing might change if the employee doesn't immediately exercise the option. But the journal entry remains the same whether its recorded today or tomorrow or the day after. It's always a debit to employee compensation and a credit to common stock.

Maybe you want to argue that the stock, and therefore the option, is worthless. If it were worthless, why would an employee agree to accept it as compensation for their services? And if the stock were worthless, why is it selling for actual money on a stock exchange somewhere? If the stock is worth something, an option to acquire that stock is also worth something. You can argue about the exact value, but to argue it's worthless flies in the face of reason. It is clearly worth something, or no one would want it.

Therefore, stock options are employee compensation and belong as an expense on the books of the company.

--Peter
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