In a comment, Terence Lim takes exception to my suggestion that stock options should be on the balance sheet rather than the income statement:

Would you believe me if I told you my company had zero costs? I pay everyone in stock options, from the supplier to the worker for contributing to my company's "intellectual capital". My profit margin is 100%! Amazing company, but would you touch the stock with a barge pole?

Sure I'd be happy to invest--if I thought that all those people really were contributing to intellectual capital that would produce a successful product in the future. Let's consider a company which is in the business of the creation of new products, and all the actual manufacturing/production is farmed out to a supplier (pretty common these days). We can do the accounting in two different ways--one where all the costs are put on the income side, and one where they are all put on the balance statement.

Company 1 (stock options on income statement):
Labor payments=$100,000 (expensed value of stock options)
Supplier payments=$20,000
Outstanding shares held by the public=1000
Current revenues from current product=$60,000
Future revenues if new product works=$200,000
Reported profits=-$60,000

Company 2 (stock options on balance statement):
Labor payments=0
Supplier payments=$20,000
Stock options given to workers=1000 shares, fully vested
Outstanding shares held by the public=1000
Current revenues from current product=$60,000
Future revenues if new product works=$200,000
Reported profits=$40,000

In the first case, it looks like the company is running a big loss on current production. Moreover, there's no place on either the income or balance statement where the investment in intellectual capital for the next generation of products is being reported.

In fact, the second company is presenting a much more accurate picture. It's making a profit on the current generation of products, and the stock options really represent compensation for investment in intellectual capital, which will pay off in the future on the next generation of products.

Of course, we don't know whether the investment in intellectual capital is going to pay off or not...but that's where the risk comes in.

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