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Equity Considerations for Audit Preparation

March 24, 2016

As with any other component of the financials, equity requires a good amount of scrutiny and judgment. Knowing what to expect and how to prepare for the equity part of an audit is important to make for a smooth experience. I'll highlight a few steps for equity considerations for audit preparation to ensure your company has a painless audit season.

Most important to your preparation is reviewing the accounting guidance. ASC 718 includes all the details you'll need for this aspect of the financials. While reading through every detail of the standard is not necessary, at least skim the Table of Contents and highlight those aspects that impact your company. Also, it's important to read and fully understand the basics.

Much of the guidance allows for management judgment and this can be open to criticism by the auditors. For example, the guidance within ASC-718-10-55-2 describes the minimal inputs to determining fair value of a stock option. The guidance does not specify using a particular model, such as Black-Scholes-Merton, but this model does fulfill the requirements. As a result, the guidance does not eliminate the possibility of using a different option pricing model. Of course, the time and effort it takes to create your own model results in most companies going with a widely recognized model such as Black-Scholes-Merton. But at least you know you have options.

Similarly, the expected term component prescribed by the guidance is also open to management interpretation. The guidance SAB 107 Simplified Method is often used by companies as it takes into account the vesting schedule and contractual life of the option. However the guidance is open to using any method which management considers reasonable in determining how long they expect the options to remain outstanding.

Regardless of which option pricing model you use, discussing any intended alternative methods with your auditors is always a good idea. Waiting to share that information with your audit team until after the audit is well underway and you have already booked expense can often lead to revisions and the related audit headaches that accompany them. Understanding your options and discussing with your audit team is essential when evaluating the equity considerations for audit preparation.

Learn more about considerations for equity solutions for your team.

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