Options Should be Reflected in the Bottom Line

Summary) First, some argue that grants of stock options do not involve cash outlays, and therefore no expense should be recorded. This reasoning violates the basic accrual principle of accounting. Not every cash outflow is recorded as an expense in the period in which it occurs, nor does every expense recognized in a period involve a cash outflow. For example, when a company compensates employees by making outright grants of stock or promising future pension benefits, no cash outflows occur. Yet the company would record, as compensation expense, the value of the stock granted or the present value of the pension benefit promised. Stock-option grants should receive comparable treatment. A second error is to argue that the expensing of stock options would be double counting because the diluting effect of granting the options is recognized by an increase in the number of shares in the denominator of a fully- diluted earnings per share calculation. But by extension this argument would apply to shares of stock granted to employees as well as to stock options. If accepted, companies could issue stock in lieu of salary to employees, ignore the value of the stock issued, and just record the increase in the number of shares outstanding. This erroneous argument would also enable a company to issue stock options to, say, a supplier of materials or energy, and not record the materials or energy consumed as an expense because the effect would show up in the higher number of shares in an earnings-per-share calculation. Curious reasoning.