Auditing a Publicly Traded Company

Auditing a Publicly Traded Company Memo: To: Senior Staff Member From: Team A Date: September 13, 2010 Subject: Share-based payment reporting and special purpose entities reporting December 16, 2004 the Financial Accounting Standards Board issued Statement 123, Shared- Based Statement, which took the place of Accounting for Stock-Based Compensation and replaced Accounting Principal Board Opinion No. 25 Accounting for Stock issued to Employees. Share-based payment is “a transaction in which the entity receives or acquires goods or services either as consideration for its equity instruments or by incurring liabilities for amounts based on the price of the entity's shares or other equity instruments of the entity. The accounting requirements for the share-based payment depend on how the transaction will be settled, that is, by the issuance of (a) equity, (b) cash, or (c) equity or cash” (Deloitte, 2010). Statement No 123 covers a variety of compensation agreements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Shared-based payment will give financier and other financial statement users with additional comprehensive and unbiased financial information by having the reimbursement cost relate to the share-based payment documented on the financial statement. This cost is measured by the fair value of the company’s equity or liability tools issued. This Statement is the result of a two-year effort to respond to requests from investors and many others that the FASB improve the accounting for share-based payment arrangements with employees” (Financial Accounting Standards Board, 2004). “A special purpose entity is a partnership, corporation, trust, or joint venture that is created for a limited purpose, with a limited life and limited activities, and that is designed to benefit a single company. ” Special purpose entities derive from the transfer of assets, which are then sold to the SPE. Consolidation is not required because the transaction reported as a sale of assets. (Schroeder, Clark, & Cathey, 2005, p. 518). In order for an SPE to qualify for non-consolidation, it must meet the criteria outlined in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. ” According to SFAS No. 140, the transferor company has surrendered control over the transferred assets when all of the following conditions are met: 1. The transferred assets have been put beyond the reach of the transferor and its creditors. . Each transferee (SPE) has the right to pledge or exchange the assets, and no conditions constrain the transferee from taking advantage of its right to pledge or exchange. 3. The transferor does not maintain effective control over the transferred assets through either (1) an agreement that entitles and obligates the transferor to repurchase or redeem the transferred assets before maturity or (2) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call (Schroeder et al. 2005, p. 218) The FASB issued the “Consolidation of Certain Special Purpose Entities” in June 2002 in order to address the concern of “identifying situations in which a company may have a controlling financial interest in an SPE, but no voting interest. The FASB’s intent is to require consolidation only if the SPE does not effectively disperse the risks and benefits of ownership among the various parties involved” (Schroeder et al. , 2005, p. 518). The pronouncement would modify the first of the above three SFAS No. 40 conditions as follows: “The transferred assets have been put beyond the reach of the powers of a bankruptcy trustee or other receiver for the transferor or any consolidated affiliate of the transferor that is not a SPE. The exposure draft adds that a qualifying SPE may have the power to dispose of the assets to a party other than the transferor, its affiliate or agent when the SPE terminates and the manner of disposal is not specified at the inception of the SPE” (Schroeder et al. , 2005, p. 518). The primary motive for most SPEs is off-balance sheet financing, often to avoid reporting capital leases under SFAS No. 13. Under GAAP, companies are able to avoid consolidation of SPEs in which they do not have a majority voting interest. To achieve off-balance sheet treatment, a minimum 10% investment from an independent third-party investor is required, in exchange for which the third-party investor controls the SPE and bears the risk of loss (Schroeder et al. , 2005). Interpretation no. 46(R) uses the term variable interest entities (VIE) instead of SPE. Statement no. 67 is a revision to FASB Interpretation no. 46(R), Consolidation of Variable Interest Entities, and changes how a company determines when an entity is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly affect the entity’s economic performance. Statement no. 167 requires companies to provide additional disclosure associated with VIE and changes in exposure connected with the association. Disclosure is required by a company showing how VIE affects the financial statements of the company (Journal of Accountancy, 2009). FASB Statement No. 123: Share-Based Payments provides investors and users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans (Financial Accounting Standard Board, 2004). References Deloitte. (2010). IFRS 2 shared-based payment. Retrieved on September 12, 2010 from https://www. iasplus. com/standard/ifrs02. htm Financial Accounting Standards Board. (2004). FASB issues final statement on accounting for share-based payment. Retrieved on September 12, 2010 from https://www. asb. org/news/nr121604_ebc. shtml Financial Accounting Standard Board. (2004, December 16). FASB issues final statement on Accounting for share-based performance. Retrieved from https://www. fasb. org/news/nr120604_ebc. shtml Journal of Accountancy. (2009, June 12). FASB Issues Standards on Securitizations, SPEs. Retrieved from https://www. journalofaccountancy. com/Web/20091801 Schroeder, R. G. , Clark, M. W. , & Cathey, J. M. (2005). Accounting for Multiple Entities. In Financial Accounting Theory and Analysis, 8e (pp. 504-541).

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