How is stock-based compensation accounted for in financial statements?

• A. Recognized as a cash outflow when options are granted
• B. Recognized as an expense over the vesting period based on fair value, with a credit to additional paid-in capital; expense reduces net income
• C. Not recognized until options are exercised
• D. Recognized as revenue

Answer: (B)

Stock-based compensation reflects the cost of the employee services provided in exchange for stock options, recognized as an expense over the vesting period using the grant-date fair value. The offset goes to additional paid-in capital, an equity account, since no cash is paid out at grant. This treatment reduces net income in the periods when the employee earns the award, even though the cash effects occur later if and when employees exercise the options (and possibly for tax withholding). It is not treated as cash outflow at grant, not deferred until exercise, and not recorded as revenue.