SOX: Profitable for the accounting firms

Jan 16, 2007

 

With greater regulation in the accounting industry and a higher number of services of accounting firms being used by companies, the accounting industry is seeing a higher growth rate. The CCH’s Public Accounting Report, a biweekly newsletter for accounting professionals, released its findings and its Top 100 list on Aug. 31. According to the report, the majority of the accounting companies reported a growth rate of 16.5% compared to 9.1% in 2005. The rate is the highest for these companies since 2000.

Sarbanes Oxley led to the demise of one public accounting firm, but the survivors are now reaping the benefits of higher regulations. Changes in the accounting rules, recent one being change in recording of stock options as an expense, companies relying on public accounting firms for not just audit, but also other consultancy services has brought about a higher growth rate for accounting firms.

Stock Options: Motivation tool

Jan 16, 2007

 

One of the main reason companies state for issuing stock options is to motivate employees. When employees have a stake in the company they are motivated to put in extra effort for the growth of the company. So the motivating reason does hold true. My thought on this is that company growth means increasing shareholder value, but it seems like that stock options mean increasing top executives bank accounts, because they are the ones who get the maximum benefits of the stock options.

With the new change of expensing stock options, the cost of these options would now hit the income statement, thereby reducing the margin. When the margin reduces, the shareholder’s returns will reduce, unless the options really motivate the company employees to grow the company. The options should be able to generate higher revenue, so as to cover the expense of the options, or else it will be diluting the margin.

With backdated options some (most) of which are already in the money when they are issued, the executives are guaranteed a return when the option is issued, so then how are they being motivated. It seems like stock options will now instead of being a motivating toll be a margin dilutive activity. The companies might have to revisit the whole concet of granting stock options.

Risks and Principles approach for Complex structured financial transactions

Jan 16, 2007

 

Enron’s failure led to a number of changes, though most were in the accounting and auditing field, one big change was in the banking industry. In 2004 the Federal Reserve and other authorities recommended a higher degree of scrutiny by the banking industry on the complex structured financing transactions of their corporate clients. The authorities wanted the banks to take on the role of policing its clients. The banks were to review how companies planned to account for and disclose the complex structured finance transactions(CSFT) in both their financial and tax reporting. In some cases, the banks were to go directly to the independent auditors of the client.

There are still some unanswered questions, most importantly the lack of a precise definition of CSFTs. The regulators have however mentioned that some structured finance deals, including , “standard public mortgage-backed securities transactions, public securitizations of retail credit cards, asset-backed commercial paper conduit transactions, and hedging-type transactions involving ‘plain vanilla’ derivatives and collateralized loan obligations,” wouldn’t typically be considered CSFTs.

On the risk management side, the regulators suggest setting up clear framework for review and approval of CSFTs, the policies and procedures should clearly lay down the duties of the people that work on these deals, the banks should have proper controls over the approval procedure of such deals.

Though the guidelines are much more relaxed from the 2004 proposals, the financial institutions will face numerous issues in implementing the changes, like defining what constitutes CSFT, how to design the review and approval procedure. Compliance with the new rule will also have cost implications, like, training costs for employees, costs to enhance control systems, designing procedures.

With the consumer lending market facing a volatile market, with decreased demand for loan products, higher delinquencies and defaults due to higher interest rates, now the banks have another issue to deal with, this time in corporate banking, the complex structured financial transactions.

Infosys sets an example in Corporate Governance

Jan 16, 2007

Srinath Batni, an executive director who heads up the Strategic Groups unit for the Bangalore-based software and IT consultancy firm Infosys, was fined about $10,700 for failing to notify the company, in a timely manner, that he sold 10,000 company shares the week before, according to a regulatory filing. Infosys’ insider trading rules state that directors and officers may buy or sell company stock only after prior notification is given to the company. Further, notification must also be given within one working day of the stock sale.

Batni notified the company of his intent to sell shares; however, he was eight days late reporting the completed transaction to the company. Although the company said Batni’s violation was inadvertent, it was considered a technical violation in the eyes of the Infosys audit committee, which is responsible for monitoring management’s compliance with business conduct standards.

Source: www.cfo.com 08/30/2006

A good example of the independence and strict monitoring that should be done by the audit committee. By imposing the fine the audit committee showed its intent to keep a good eye on the financial working of the company and being proactive about compliance with rules and regulations.

Even though the fine amount looks like a meager $10.7K, the severity of it can be seen by the fact that it is actually is a quarter of Batni’s salary for the year. There are rules and one needs to adhere to them or face the stiff consequences.

What is the brouhaha about backdating?

Jan 16, 2007

Backdating of stock options is one of the latest hot topics in the accounting world. There are around 100 companies which have declared that they have backdated their options, there have been restatements on the account of backdating and a dozen or so lawsuits on this issue. So what exactly is backdating?

Backdating involves assigning a stock option contract an earlier date than its actual grant date. The date assigned is an earlier date when the underlying stock traded at a lower price than it did on the day of the grant. By doing this the stock option holder gets an “in the money” options grant. In the money in literal terms means that the option has some value, this happens when the strike price is less than the market price. Such grants need to be expensed. Some companies, however, accounted for them as at-the-money grants, which under old accounting rules, did not need to be expensed. (Under FAS 123R, all options need to be expensed.)

Backdating of employee stock options is not necessarily illegal provided no documents have been forged, backdating is clearly communicated to company’s shareholders, it is properly reflected in the earnings, and backdating is properly reflected in the taxes.

The new FAS 123R maybe blamed for this change in the stock option backdating landscape. Under the old accounting rule for stock options, firms did not have to expense options at all unless they were in-the-money. However, under the new FAS 123R, the expense is based on the fair market value on the grant date, such that even at-the-money options have to be expensed.

Once again the companies will have to take a look at their internal controls and strengthen their option accounting and record keeping.