Accounting 541: Audit of Share-Based Payment and Special Purpose Entities

Topics: Balance sheet, Generally Accepted Accounting Principles, International Financial Reporting Standards Pages: 5 (1675 words) Published: February 25, 2013

TO: Senior, Publicly Traded Company

FROM: Team B (Staff I)
DATE: February 4, 2013

SUBJECT: Audit of Share-Based Payment and Special Purpose Entities (SPE) Reporting

This executive memo is a summary and analysis of our audit findings for the client, a publicly traded company, and its financial practices. Please review this correspondence in accordance with your request. We look forward to meeting in person for further discussion and to make an informed recommendation about if this client’s policies are consistent with GAAP. Share-Based Payment Reporting

In 2004 the Financial Accounting Standards Board (FASB) released Statement No. 123 that “established a fair-value-based method of accounting for share-based payment arrangements with employees that supplemented APB Opinion No. 25” (Financial Accounting Standards Board [FASB], 2004). Financial Reporting Standard 20 (FRS) requires accounting treatment be adopted by firms making share-based payments like our client and measure expenses, at fair value with respect to the share-based payments made. The FASB addresses the accounting treatment of share-based payment transactions and reporting where Statement No. 123 requires the fair value of stock options and other shared-based compensation be subtracted from the earnings and reported as an expense on the financial statements. This statement also establishes uniform accounting practices and principles for all types of share-based payment reporting. Accounting for our client, a public enterprise is based on the fair value method for employee-shared payment plans and required to make fair value disclosures. Other factors to consider are the earnings-per-share, modifications, performance conditions, and the terms and conditions of the share-based payments according to FASB disclosing requirements (The Chartered Accountant, 2005). Special Purpose Entities

Originally, a special purpose entity (SPE) was defined as “a partnership, corporation, trust, or joint venture that was created for a limited purpose, with a limited life and limited activities and that was designed to benefit a single company” (Schroeder, et al., 2011). An SPE is created by the transfer of assets to a new firm or corporation controlled by a third party that owns a certain percentage of the SPE. Additionally, the third party assumes the risk of the loss as well as controls the SPE. Typically, the purpose of creating an SPE was to create off-balance sheet financing to avoid reporting liabilities, such as capital leases, on the financials of the primary company that transferred the assets to create the SPE (Schroeder, et al., 2011). In 2009, the FASB released SFAS No. 166, the purpose of which was to change the procedures for accounting for special purpose entities; specifically, it was to improve the relevance, faithfulness, and comparability that a reporting of a firm when a special purpose entity effects the cash-flows of the reporting entity (Colabella., et al, 2009). SFAS No. 166 became effective as of January 1, 2010 but was to be effective to transfers that occurred after November 15, 2009. SFAS No. 166 required that the transfer of assets to a special purpose entity must meet specific qualifications in order for it to eliminate the reporting of the SPE. “A determination must consider the transferor’s continuing involvement in the transferred asset, including all arrangement or agreement s made contemporaneously with, or in contemplation of the transfer of the asset, even if they were not entered into at the time of the transfer” (Colabella, et al., 2009). Under SFAS No. 166, the concept of a qualified SPE, as defined under SFAS No. 140, was eliminated. Under SFAS the following qualifications must be met for the transfer of assets to be considered a sale: • Transferred assets are isolated from the transferor

• SPE has a right to exchange or pledge the assets
• Transferor has no control under the assets, including...
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