Problem

Arts Corporation offers a generous employee compensation package that includes employee stock options. The exercise price has always been equal to the market price of the stock at the date of grant. The corporate controller, John Jones, believes that employee stock options, like all obligations to issue the corporation's own stock, are equity. The new staff accountant, Marcy Means, disagrees. Marcy argues that when a company issues stock for less than current value, the value of preexisting stockholders' shares is diluted.

Required:

a. Describe how Arts Corporation should account for its employee stock option plan, under existing GAAP.

b. Pretend you are hired to debate the issue of the proper treatment of options written on a company's own stock. Formulate your argument, citing concepts and definitions to buttress your case, assuming

i. You are siding with John

ii. You are siding with Marcy.