Let’s hope it’s not that way for your spreadsheets.
Does sweat start to bead on your brow when you realize the auditors are
coming in next month and you haven’t had time to check and re-check the formulas in your stock option spreadsheets? Or when you try to
figure out which is the most recent version of the spreadsheet? Do you get
a cold chill when you realize that because of all the new FAS 123R regulations, your auditors are going to be putting your
valuation assumptions under greater scrutiny than last year? Have you
discussed in advance what they are going to want to see?
Because Financial Accounting Standard (FAS) 123R moved
equity compensation expense from a pro forma footnote to a line item in
the income statement, CFOs and controllers have felt a storm brewing.
I've referred to it in other articles as the “Perfect Storm” when thinking about SOX, FAS 123R, option backdating, and new executive compensation disclosures.
Since your goal is to make the annual audit as painless and brief
as possible, have you thought about how you are going to put it
altogether? If it’s your first time, how would you begin to comply
with FAS 123R and satisfy the auditors? Well, there are a few general
steps that you can take to create auditable stock option records, comply
with FAS 123R, and ensure the perfect storm by-passes your next audit.
First, organize all your legal documents.
Before anything else, start properly recording and documenting the legal
actions of the Board, the company, and each employee as they relate to
option grants, exercises, and cancellations. Because your option
records and equity compensation expense reports will later reflect these actions and the supporting documents, you want to avoid
any inconsistencies that may show up in an audit.
Second, centralize your records.
Consider consolidating all transactions that relate to stock option
administration, valuation and expensing, and legal compliance in a single, integrated system. This is particularly important as
stock option data tends to come from a number of different areas within a
company, typically in documents most commonly related to legal, finance, and human resources. When each department retains and
manages its own collection of information, it can lead to errors,
inconsistencies, and missing documentation – in addition to duplicate effort and wasted time.
Third, automate the transactions. Over the
course of hundreds of transactions and many years, the risk of error
increases. The best way to reduce potential errors is to let your computer do the work. When you automate, you know you are
tracking, calculating, and reporting similar transactions the same way,
every time. It saves time and it creates an audit trail showing who made
the changes and when. Based on this higher level of reliability,
auditors are more comfortable with automated systems and typically can
sample fewer records which will save audit time and expense.
Fourth, determine the variables. Now that the
new regulations require companies to include stock option-related
compensation expense in the income statement, auditors are even more careful when reviewing how each variable used in the valuation model
is determined – particularly fair market value, volatility, and expected
life. You must be able to document that you followed a reasonable
process to determine each variable. If the valuation and expensing
variables are properly documented, based on a reasonable process, and
supported by an integrated system, it will provide the auditors with greater confidence and raise fewer red flags.
Fifth, prepare your reports. The final and
perhaps ultimate goal of stock option administration is to produce a clear
and concise set of reports that provide the necessary information for a
company's quarterly and annual financial statements. More specifically, your company will want to prepare a standard set
of reports that it can use each quarter to generate the stock option-related expense items. Using the same system for
generating both the stock plan administration and valuation and expensing
reports will help to avoid inconsistency and increase accuracy. To ensure
a smooth audit, prepare the list of reports in advance and organize them in a format that is easy to review.
If you would like a few more details or a visual chart that lays out these actions and describes the documents, click here to read a white paper I recently authored regarding setting up a Framework to Create Auditable Stock Option Records and Comply with FAS 123R.