FAS 123R Year-End Reporting: Will Your Auditors Catch You Off Guard?

Create auditable stock option records and comply with FAS 123R in five easy steps.

November 1, 2007
Sponsored by Two Step Software, Inc.
by Gary Levine

In the past few years, there has been a perfect storm of stock option administration and accounting challenges starting with Sarbanes-Oxley in 2002, FAS 123R in 2004, stock option backdating scandals in 2006 and the final IRC Sec. 409A regulations in 2007. Most importantly, the new Financial Accounting Standard (FAS) 123R moved equity compensation expense for most companies from a pro forma footnote to a line item in the income statement.

In light of the current environment, auditors are using much higher standards and CFOs are struggling to integrate stock option administration, tax and accounting reporting and good corporate governance practices. During the first audit season under the new FAS 123R regulations, many companies found themselves with insufficient recordkeeping that made calculating stock option related expenses difficult, time-consuming and subject to error. Transactions were not recorded properly nor well documented and there was no audit trail to follow.

Corporate attorneys, general counsels, CFOs and stock plan administrators now realize that in order to satisfy the higher levels of scrutiny and comply with the new stock option expensing requirements, they can no longer rely on error-prone, manual spreadsheets. Instead, they are looking to implement automated FAS 123R solutions capable of simplifying the process while providing critical information faster and with greater accuracy and accountability. More specifically, financial executives now require systems that enable all participants to rely on the same set of consolidated records and be capable of combining stock plan administration, stock option expensing, and corporate governance management.

A Five-Step Framework to Impress Auditors and Ensure FAS 123R Compliance

Today, financial executives are looking to gain a greater understanding of how FAS 123R applies to them. Instead of continuing with a manual approach that is subject to potential errors and increased scrutiny, organizations should consider these five steps to simplify FAS 123R compliance and satisfy their auditors:

  1. Organize Legal Documents: Before anything else, organizations should start by ensuring they are 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.

    The recent stock option scandals announced in 2006 uncovered examples of option grants that pre-dated Board meetings or Board meetings that were allegedly held but never documented. This led to incorrect financial statements and tax reporting errors. Such problems could have been avoided if these companies had properly integrated their legal documentation with their stock option records.

    Companies can avoid these types of problems by properly recording, retaining and managing the legal documentation at each step in the process.
  2. Centralize Records: Organizations should also 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 as well as duplicate effort and wasted time.

    As an example, imagine a situation where the HR department is using one date for an employee termination and the related option cancellation while the finance department is using a different date as they determine when to stop expensing the option. Duplicate data entry creates these types of problems.

    Consequently, organizations need to create a single, consolidated repository for all legal documents and data related to stock option records available to all members of the equity compensation team.
  3. Automate Transactions: The next consideration involves automating your organization’s stock option administration and equity compensation expensing as these activities typically involve large numbers of transactions. On the administration side, you need to record information related to the date of hire, the option grant, the

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About Two Step Software, Inc.
Founded in 1995, Two Step Software, Inc. develops, markets, and supports Corporate Focus™ and Equity Focus™, market leading corporate governance and stock plan administration solutions used by financial executives, stock plan administrators, law firms and corporate legal departments. For more information or to arrange a complimentary demonstration, please call (800) 223-8900.

Gary D. Levine is the President and Founder of Two Step Software, Inc., which provides corporate governance and stock plan administration solutions. He was previously the General Counsel of Pilot Software, Inc. and before that a corporate attorney at Hutchins & Wheeler in Boston, MA. Mr. Levine received his JD from the Boston College Law School and his MS from the MIT Sloan School of Management. He is the author of the popular blog “Capitalization Matters.” Contact him or visit Two Step on the Web at: www.twostep.com.