Question

Chief executive officer compensation can be a material amount and is often scrutinized by regulators, analysts, competitors, and investors. For CEOs of publicly traded companies, compensation can consist of salary, bonus, stock option grants, or other stock awards that can be restricted in terms of how long the officers and directors are required to hold the stock. Publicly traded companies are required by the Securities and Exchange Commission to provide disclosures about the components of executive compensation in the company’s annual proxy statement.

How would the auditor test the fair value of the stock option/stock appreciation rights (SAR)?

Why are the presentation and disclosure-related audit objectives so important for stock-based compensation?

Answer 1

Solution:

The auditor can test the fair value of the stock options and stock option appreciation rights(SARs) by the examination of the minutes of the meeting of the board of directors in which the SARs were approved. He should also verify whether the fair value has been estimated on proper terms. For this he should he should examine the fair values of the stock options and SARs on the grant date, and also the methodologies and assumptions used by the company to value the rights to evaluate the accuracy and reasonableness. The auditor may also use a compensation specialist to assist with the examination.

Presentation and disclosure audit objectives are important for stock based compensation as this information is evaluated by investors,regulators,competitors,and analysts. Since there is a criticism that top executive officers are overpaid relative to the workers, there is demand for this information to be disclosed in the footnotes of the financial statements as well as in proxy statements for publicly traded companies.