Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Monday, July 31, 2006

PCAOB Issues Alert on Stock Options

On Friday, the PCAOB issued its first Staff Audit Practice Alert. The Alert, entitled "Matters Related to Timing and Accounting for Option Grants," advises auditors of public companies on the appropriate auditing standards to apply and gives practical suggestions. The Alert is available here (http://www.pcaobus.org/News_and_Events/News/2006/07-28_Release.pdf).

The Alert notes that outside auditors should be alert to the risk of improper accounting for stock options. If options have been improperly accounted for, there could be several consequences:

1. The financial statements could be materially misstated. In considering this issue, auditors are reminded that materiality can be either quantitative or qualitative.
2. The actions of corporate executives could be illegal. If auditors discover unlawful acts, this could be qualitatively material even if the amounts involved are small. In such a case, auditors must comply with their reporting obligations under Section 10A of the '34 Act, which requires auditors who become aware of illegal acts to take certain steps.
3. Irregularities could mean that there are significant deficiencies in internal controls. Auditors must consider the impact that irregularities in the granting and accounting for stock options has on internal controls of the company.
4. Auditors should also consider whether irregularities that are discovered mean that the company has contingent liabilities. Companies that are required to restate their financials will likely face shareholder class action lawsuits for the fraud in connection with the original financial statements.

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