As requested, below is a brief summary of accounting issues surrounding share-based and special purpose entity reporting.
A share-based payment is a transaction whereby Team A Company receives something of value in exchange for an equity instrument or by incurring a liability for the value of the acquired goods/services.[i] GAAP Codification 718 ??“ Compensation ??“ Stock Compensation requires that cost relating to share-based transactions be recognized in the financial statements. These costs must be measured on the fair value of the instrument issued. The instruments typically found are share options, restricted share plans, performance based awards, share appreciation rights and employee share purchase plans.[ii]
To be consistent with Codification 718, Team A Company must record a debit entry to the expense when payment does not represent an asset. In keeping with the matching principle, the expense should be recorded as the benefits are received. The exception is when there is a vesting period involved. In such cases, the expense should be recorded in a pro-rata manor over the vesting period.[iii] As a general rule, we should make sure that Team A Company has recorded expense related to equity-settled share based payments that equals the appropriate pro-rata amount of the instrument plus any expenses directly related to the financial reporting period (utilizing fair market value). If the fair value cannot be reliably measured, IFRS 2 permits the use of intrinsic value, which must be remeasured at each report date until settlement.[iv]
Team A Company is also required to disclose the nature and extent of share-based payment arrangement that exist during the reporting period, regardless of when they were consummated. Disclosure must also include a description of the determination of the fair value and the effect the transactions had on the profit/loss for the reported periods.[v]
To be in accordance with SFAS 123R, the PCAOB staff has recommended procedures for the auditor when conducting an examination relating to the reporting of share-based payments. These recommendations include:[vi]
1. Examining the process of estimating the expected term of the option and verifying the length of the vesting period, number of options per optionee and the grant date
2. Verifying the process and consistency in estimating price volatility
3. Evaluating the reasonableness of the methodology used in calculating expected dividends, if applicable, as well as ensuring funds available to pay the dividends
4. Evaluating the schedule of share-based payments for compensation costs to be included/disclosed in the current financial statements
According to Codification 860-40-15 the following conditions are used as guidance for a Qualifying Special Purpose Entity (SPE).[vii]
??? The entity must be demonstrably distinct from the transferor. The fair value of the interest held is at least 10% or the transfer is a guaranteed mortgage securitization.
??? Any transformation is done and approved by the holders and is supported by legal documentation. An agent from another SPE is not allowed to perform any activities other than those of that particular SPE.
??? There are limits on the types of assets held in that they must be only those that are specified in SPE.
??? There are limits on the sales/dispositions of assets according to various circumstances outlined in the Codification.
The target of FASB Interpretation 46(R) is to provide explanation on the identification of variable interest entities (VIE) and how to determine if the activities of the VIE should be consolidated into the financial statements of the sponsor. Some entities meeting the requirements of an SPE are not subject to this interpretations, while others meet the criteria of a VIE and thus must be consolidated. Interpretation 46(R) defines a VIE as an entity that meets one of the following:[viii]
??? The total equity investment at risk is not sufficient to finance the activities of the entity independently.
??? The equity investors lack at least one of the following characteristics of a controlling financial interest:
o Ability to make decisions about significant entity activities
o The obligation to absorb expected losses
o The right to received expected returns
According to this Interpretation, such VIEs are required to be consolidated. Consolidations occur when one business gains control over another company. This occurs with a cash purchase or by purchasing a substantial portion of the stock of the lesser company. If the lesser company maintains a separate tax identity, it becomes a subsidiary; if not, the operations are folded into another part of the organization and its individuality is lost.
According to ARB No. 51, a consolidation exists when the parent company plans to have control over the subsidiary for more than a short time, the parent exercises control over the subsidiary, the parent owns more than 51% and the subsidiary operates as a combined unit.[ix] Since Team A Company is a publicly traded company, the entity theory of accounting applies and the profits/losses as well as the assets/liabilities belong to Team A Company. This will hold true for any subsidiary that is recorded on the subsidiaries books.
The main idea underlying the preparation of consolidated financial statements is to present the consolidated financial statements showing the financial position and all results from operating of both companies, parent and subsidiaries, as if they were one. Without this consolidation, it is difficult for an investor to understand the resources controlled by a company. A consolidated financial statement provides the best information regarding who has control over the assets.
If you have any further questions with respect to these matters, please do not hesitate to contact me.
[i] Deloitte.? (2010).? IAS Plus.? Retrieved from http://www.iasplus.com/standard/ifrs02.htm
[ii] U.S. GAAP Codification of Accounting Standards. (2010). Codification Topic 718: Compensation ??“ Stock Compensation. Retrieved from http://asc.fasb.org/section&trid=2228967&search_marker=searchresult&query=share+based+payments
[iii] Deloitte.? (2010).? IAS Plus.? Retrieved from http://www.iasplus.com/standard/ifrs02.htm
[iv] Deloitte.? (2010).? IAS Plus.? Retrieved from http://www.iasplus.com/standard/ifrs02.htm
[v] U.S. GAAP Codification of Accounting Standards. (2010). Codification Topic 718: Compensation ??“ Stock Compensation. Retrieved from http://asc.fasb.org/section&trid=2228967&search_marker=searchresult&query=share+based+payments
[viii] Soroosh, J., & Ciesielski, J. T. (2009). Accounting for Special Purpose Entities Revised: FASB Interpretation 46(R). The CPA Journal Online,. Retrieved from http://www.nysscpa.org/cpajournal/2004/704/essentials/p30.htm