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To: Don Lloyd who wrote (28914)	2/19/2003 4:28:39 AM
From: Stock Farmer	Read Replies (2) \| Respond to of 74559

Don, I did read the bold part. It's not the stock that's the expense here. I was quit clear that the COMPENSATION is an expense. Not the Stock itself. If a company issues shares and gets cash in return, this is not an expense item. We are agreed. Read my reply carefully too and you will see this. However, if the company then spends this cash to fund operating activities, this is an expense item. You have to agree with this, otherwise you would argue that the use of proceeds from a secondary offering could never show up in the expense statement. Where the cash came from to pay for an activity is irrelevant in classifying the activity as an expense or not! Financing sources (cash, asset liquidation, debt, equity) are distinct from payment obligations (materials, labor, taxes...) Also, whether proceeds are used to satisfy liabilities incurred prior to or after the offering itself is irrelevant. Timing of cash flows in relation to a payment obligation does not alter the nature of the obligation. For example, we can hardly say that the proceeds of a secondary offering used to pay off a huge Accounts Payable obligation suddenly evaporates these activities from the expense line. Let's put this all together one step at a time. First step. If a company owes me a wage of $100 as a consequence of employment, this should be recorded as an expense and entered into accounts payable as the obligation is incurred. Right? The existence of a wage debt is a legitimate expense. Second step. Some time later, if the company turns around and issues a secondary offering of $1,000 worth of shares to some bloke, my $100 accounts payable still shows up on the expense statement. That bloke's cash ends up in the corporate kitty. If they take $100 from the corporate kitty, and pay their debt to me, that $100 to me still shows up on the expense line. That $1,000 secondary offering doesn't appear on the expense line. It makes a proper appearance on the statement of cash flows and on the balance sheet. how you pay me doesn't matter whether or not it's a legitimate expense. Third step. The person who buys the shares in the secondary offering is irrelevant. That bloke could even be me and it wouldn't change a thing. I could pay the company the $1,000 that they put in the kitty from which they give back to me $100 in satisfaction of that $100 expense sitting there in Accounts Payable? Which is still an expense, right? And that $1,000 secondary offering still doesn't show up on the expense line. Who supplies the financing doesn't change whether or not the expense is legitimate. Fourth step. What if we do the whole thing in one transaction? Like, I net off the $100 owed to me against the $1,000 I owe for the shares and the company can give me $1,000 worth of shares in exchange for $900 of my cash. I can then turn the whole $1,000 worth of shares around and sell 'em to yet another bloke to pocket the $100 you owed me. And isn't that $100 still an expense item? So "paying me in shares" doesn't change whether or not a cost is or isn't an expense. A combination of transactions does not alter whether one of them is or is not an expense. Fifth step. What if that $100 was a contractual bonus based on a $100 increase in share price from $900 worth of shares back then to $1,000 worth now? Does that disqualify the expense yet? Nope. That $100 remains a legitimate expense of the company all the way through. Despite the fact that the company issued a small secondary offering of $1,000 worth of shares to satisfy the expense. Why you and I agreed I would be compensated, and the basis for the compensation doesn't change whether or not it's an expense. Sixth step. What if we write the fact that we'll go through the fifth step process up front. Namely that I'll be able to pay $900 and whatever the price turns out to be I'll get today's value worth of shares. Which turned out (in this example) to be $1,000. The timing of when we actually agree how to pay me my bonus doesn't determine whether or not it is an expense either. Seventh step. We could give this specific process a name. Call it a "stock option". But a name doesn't change whether the wage component exists either. That $100 the company owes me is, was and always will be compensation, and properly belongs on the P&L statement. That $1,000 worth of equity financing in which it was wrapped? Is, was and always will be something to record elsewhere. Like on the Balance Sheet as "paid in capital", and on the statement of cash flows under proceeds from financing and under cash flow from operations via a reduction in accounts payable. This is what I've been saying all along. It's the $100 wage expense of my example belongs on the P&L. The coupled $1,000 equity financing deal does not. It's the nature of the activity that determines whether or not the resulting cost is an expense. And compensation is an expense activity. This is what the FASB is saying too. It may be my limited comprehension ability, but you appear to be asserting that since there is some equity financing piece going on that nothing should show up on the P&L. Or, to my example, that because the $1,000 transaction shouldn't show up on the P&L means that the $100 transaction shouldn't go their either. I took issue with this: Stock options cannot possibly be an expense to the company unless stock itself is an expense and tried to point out that it's not the stock part that is being expensed, but the obligation stock is being issued to compensate with that is. My $100, in to be specific. The nature of the financing activity by which the funds necessary to satisfy the obligation are raised? That's not an expense item. When the company issues shares, to anybody, this is purely an equity financing event. Equivalent to a secondary offering. Doesn't matter whether it's Goldman Sachs who recieves the shares or Joe the Janitor. 100 Million shares or $100 bucks worth. Registration and Sale or Stock Option. Doesn't matter. And this, as you rightly point out, is not ever an item for the profit and loss account. By stepping through the process it should be abundantly clear that there are two separate activities. One of which belongs on the expense statement, the other of which does not. But just because one doesn't belong there is hardly a valid argument that the other one does not as well. "Stock based compensation" is the same thing. In this case a $1000 compensation liability satisfied by a $1000 secondary offering. Skip the option. The compensation part deserves to be expensed. The secondary offering does not. The fact that they are equal? Merely a special case of the general theory. John