My Auditor Says I Need A Stock Option Valuation

GAAP (ASC 718), IFRS (IFRS 2), and UK GAAP accounting rules indicate that when a company issued stock-based compensation such as shares, options, warrants, phantom stock, stock appreciation rights, or profits interests, the fair value of such compensation is recorded as an expense in the period during which it was issued.

Determining the fair value of such issuances can become complex as the company’s capital table becomes more complex. Not only must the strike price, volatility of the company’s stock price, stock option exercise history, and time to expiration be considered, but so must the fair value of the underlying equity.

Determining the fair value of the company’s underlying equity rapidly increases in complexity if the company’s capital structure includes preferred stock, and more so if the preferred stock includes features such as convertibility, caps, antidilution, and participation features.

Further, nearly half of the audit deficiencies identified by the PCAOB (Public Company Accounting Oversight Board) are connected to a fair value element of the audit. Thus, stock based compensation events often pose the greatest risk of causing an audit deficiency.

Generally, audit rules require that an independent professional perform the equity valuation. As the company being audited is not independent, they are generally prohibited from furnishing the stock valuation to the auditor. Similarly, the auditor is not independent because, were they to provide the valuation for the audit, they would be placed in a position of auditing their own work.

Because of the high risk of an audit deficiency arising from a fair value assessment such as equity compensation, your financial statement auditor will pay close attention to the valuation that you submit for the audit work file. The auditor is within their rights to ask as many questions as they wish, require corrections, or even reject the valuation altogether and force you to retain another firm. To manage this risk, you must select a provider that understands the proper procedures to facilitate auditor acceptance of the purchase price allocation and marginalize the potential for an audit deficiency.

If you have been directed to provide a stock-based compensation valuation for your financial statement audit and are interested in managing your financial statement audit risk, contact High Score Strategies for a consultation.


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