Employee Share Options

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Employee Share Options Audit Case Example: ABC Manufacturing Company

Context

If ABC Manufacturing Company grants share options to its employees as part of their compensation package, it is critical to accurately account for these transactions under the applicable financial reporting framework, such as IFRS 2 Share-based Payment or ASC 718 Compensation—Stock Compensation under US GAAP.

Audit Objective

To obtain reasonable assurance that employee share options are appropriately accounted for in terms of recognition, measurement, and disclosure, and that the financial statements reflect the company’s obligations and expenses associated with these share-based transactions.

Types of Audit Evidence and Documentation for Employee Share Options Assertions

1. Existence

• Case: Verify the existence of share option plans approved by the company’s board of directors and shareholders.

• Documentation: Document inspection of board and shareholder meeting minutes approving the share option plans, including details of the plans such as eligibility criteria, vesting conditions, and exercise terms.

2. Rights and Obligations

• Case: Assess the company’s obligations under the share option agreements, including the conditions for vesting and the exercise of options.

• Documentation: Summarize the review of the share option agreements and related documentation to verify the company’s obligations to provide shares upon exercise of the options and any conditions attached.

3. Completeness

• Case: Ensure that all share option grants made during the period are recorded and disclosed in the financial statements.

• Documentation: Outline procedures for testing the completeness of the share option transactions, such as reconciling the list of grants to employee records and the share option register.

4. Valuation and Allocation

• Case: Assess the fair value of share options at the grant date, considering the terms and conditions of the options and using appropriate valuation models like the Black-Scholes or binomial models.

• Documentation: Document the valuation techniques and assumptions used in determining the fair value of share options, including expected volatility, option life, risk-free interest rate, and expected dividends.

5. Presentation and Disclosure

• Case: Review the financial statements to ensure that share option transactions are correctly classified, described, and disclosed, including the nature and extent of share-based payment arrangements, how their fair value was determined, and their effect on the financial statements.

• Documentation: Evaluate the presentation and disclosure of employee share options, verifying that disclosures comply with the financial reporting framework and provide clear information about the share-based payment transactions, including the accounting policies applied and the impact on the financial statements.

Additional Considerations

• Impact on Financial Statements: Assess the impact of recognizing share-based payment expense on the income statement and the related increase in equity on the balance sheet, and document any significant findings or concerns.

• Internal Controls Assessment: Evaluate the design and implementation of internal controls over the accounting for share-based payment transactions, including controls over the grant process, valuation, and disclosure.

• Inquiries of Management: Perform inquiries with management regarding the rationale for share option grants, the selection of valuation models and assumptions, and any changes to share-based payment arrangements.

• Communication with Governance Bodies: Discuss significant findings related to the audit of employee share options with management and those charged with governance, focusing on the adequacy of disclosures, the reasonableness of valuation assumptions, and the recognition of share-based payment expense.

Conclusion

Auditing employee share options is vital for ensuring that these complex transactions are accurately accounted for and disclosed in the financial statements. Documenting the audit procedures and findings for each relevant assertion provides a basis for the auditor’s opinion, enhancing the transparency and reliability of financial reporting related to share-based compensation.