Auditing a Publicly Traded Company

SUBJECT: Share-based Payment Reporting and Special Purpose Entities
The current audit of a publicly traded company involves the evaluation of both share-based payment arrangements and special purpose entity reporting. This memo explains the reporting requirements for share-based payment transactions and special purpose entities and discusses how these requirements relate to the auditing process.
Share-based payment reporting:
Financial Accounting Standards Board (FASB) defines share-based payment arrangements as follows:
“An arrangement under which either of the following conditions is met:
a. One or more suppliers of goods or services (including employees) receive awards of equity shares, equity share options, or other equity instruments.
b. The entity incurs liabilities to suppliers that meet either of the following conditions:
1. The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. (The phrase at least in part is used because an award may be indexed to both the price of the entity’s shares and something other than either the price of the entity’s shares or a market, performance, or service condition.)
2. The awards require or may require settlement by issuance of the entity’s shares” (FASB ASC 718-10-20).
FASB 718-10-25 details specific guidelines for the recognition of share-based payment transactions (FASB ASC 718-10-25).
FASB specifies when the services and costs related to the share-based payment transactions should be recognized; according to FASB:
“25-2 An entity shall recognize the services received in a share-based payment transaction with an employee as services are received. Employee services themselves are not recognized before they are received. The entity shall recognize either a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria (see paragraphs 718-10-25-6 through 25-19). As the services are consumed, the entity shall recognize the related cost” (FASB ASC 718-10-25-2).
Certain disclosures are also required under FASB 718-10-50-1 for any share-based payment arrangements. FASB states:
“50-1 An entity with one or more share-based payment arrangements shall disclose information that enables users of the financial statements to understand all of the following: a. The nature and terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders
b. The effect of compensation cost arising from share-based payment arrangements on the income statement
c. The method of estimating the fair value of the goods or services received, or the fair value of the equity instruments granted (or offered to grant), during the period
d. The cash flow effects resulting from share-based payment arrangements” (FASB ASC 718-10-50-1).
During the audit process, the auditor should verify that the company has properly accounted for any share-based payment transactions as explained in the above paragraphs. The auditor should ensure that the company has recognized the services and costs in accordance with FASB guidelines and Generally Accepted Accounting Principles (GAAP).

Additionally, the auditor should examine FASB 718-10-50-2 in reference to any share-based payment disclosures. FASB 718-10-50-2 establishes and outlines the minimum information that is required for the company’s disclosure objective to be achieved in relation to share-based payment transactions (FASB ASC 718-10-50-2).

Special purpose entity reporting:
A special purpose entity (SPE) was defined as a legal business entity that was formed to fulfill a specific and limited purpose. In the past, many companies would create SPEs to transfer financial risk and expenses off of the company’s balance sheet (Schroeder, Clark, & Cathey, 2011, Chapter 16).

This off-balance sheet financing would allow the parent company to,” increase its financial leverage and return on assets without reporting debt on its balance sheet” (Schroeder, Clark, & Cathey, 2011, Chapter 1).

Previously GAAP did not require many companies to release consolidated financial statements with their SPEs. When consolidation was not required, the financial statements of the parent company were often misrepresented (Schroeder, Clark, & Cathey, 2011, Chapter 16).
Over the years numerous regulations have been released that focus on more accurate reporting of SPEs through the revision of requirements for consolidated statement reporting (Schroeder, Clark, & Cathey, 2011, Chapter 16).
One of these regulations released by FASB was FIN No. 46. This regulation impacted the terminology used to describe such entities by referring to them as “variable interest entities” (VIEs) instead of SPEs. This regulation called for consolidation when the risks and benefits of the VIE agreement were not similarly shared by the different owners of the entity (Schroeder, Clark, & Cathey, 2011, Chapter 16).
When performing an audit, the auditor should evaluate all business segments and entities, and use FASB codification to determine if the entities require consolidated financial statements. This evaluation should focus on the disbursement of financial interest in and ownership of the entity (FASB ASC 810-10-25).
FASB’s current regulations usually require consolidation of financial statements when an entity has a controlling financial interest. FASB states:
“25-1 Consolidation is appropriate if a reporting entity has a controlling financial interest in another entity and a specific scope exception does not apply (see Section 810-10-15). The usual condition for a controlling financial interest is ownership of a majority voting interest, but in some circumstances control does not rest with the majority owner” (FASB ASC 810-10-25-1).
FASB 810-10-15 can be used, by the auditor, to help determine whether or not an entity falls under the scope or scope exceptions for consolidation. FASB has released extensive guidelines related to this topic (FASB ASC 810-10-15).
Conclusion:
The current audit of the publicly traded company will require extensive evaluation of the company’s share-based payment transactions and special purpose entities by the auditing team. The auditors should rely on the FASB regulations mentioned above to determine if the company followed the proper guidelines in relation to the reporting and disclosure of their share-based payment transactions and the consolidation of their special purpose entities’ financial statements.

References
FASB (Financial Accounting Standards Board). (n.d.). ASC 718-10-20. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 718-10-25. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 718-10-25-2. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 718-10-50-1. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 718-10-50-2. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 810-10-15. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 810-10-25. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (n.d.). ASC 810-10-25-1. Retrieved November 28, 2014, from FASB Accounting Standards Codification database.
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2011). Financial Accounting Theory and Analysis. Text and Cases (10th ed.). Retrieved from The University of Phoenix eBook Collection database.