[IMGCAP(1)]Financial reporting for equity compensation has dramatically increased in complexity since the adoption of FAS 123R (now ASC Topic 718).

Prior to the switch, a large percentage of companies semi-successfully leveraged spreadsheets to track their awards. Auditors applied the “immaterial” label more broadly with regard to the nuances in equity compensation expensing, and grant-tracking spreadsheets met most auditing needs.

Present-day equity compensation programs face new challenges, including exceedingly complicated expensing and reporting requirements, an expansion in award types and situations that require modification accounting, and increased concerns about backdating.

These hurdles have been the death knell for the spreadsheet. Auditor opinion has rapidly shifted from one of tolerance to considering tracking grants by spreadsheet an unacceptable method of managing the complexities involved in equity compensation programs.

Auditors have sharply increased their scrutiny concerning stock plan accounting and require companies to provide better justification than in prior years to obtain signoff on the financials.

Companies large and small, private and public, have moved to Software as a Service, or SaaS-based, equity compensation software systems to reduce their risk and increase their auditability.

Systems feature guardrails that reduce the risk of inadvertent noncompliance during the administrative process while giving auditors a complete view of all actions occurring during the administrative process. Auditors are increasingly demanding standardized reports and system access to both save time and increase the quality of their audits.

Companies are streamlining their audits by allowing their auditors access to their software. The movement to SaaS as the industry standard has enabled secure user login from anywhere with an Internet connection. By granting auditors read-only access to their systems, companies eliminate the disconnection between the end result that the auditor sees and the system administrators use for their equity compensation programs.

Read-only audit logs provide auditors with information on what data has been changed and when, providing a safeguard for both the company in terms of backdating accusations and providing auditors with the confidence that the company’s data is free from improper manipulation. Some software providers are providing drilldown reports to get to “the numbers behind the numbers.”

Auditors are able to get to a level of granularity today that would be extremely difficult or impossible using spreadsheets. While in the recent past, auditor system access has been leveraged as a valuable tool, auditor access is quickly becoming the standard for high quality, reliable audits.

In addition to increasing the quality of audits, SaaS equity compensation software solutions significantly reduce auditing time. Auditors are increasingly becoming familiar with the major equity compensation software, allowing them to leverage standardized data formats from company to company. Most equity compensation software provides auditors with exhaustive whitepapers explaining the system’s operations and calculations, reducing the need for companies to engage in back and forth question and answer meetings with auditors concerning their approach and assumptions.

Alicia Perusse, equity compensation manager for Rearden Commerce, a Web-based commerce platform, describes her experience using “audit friendly” equity compensation software:

“Using a Web-based software tool makes our audits go so much more smoothly. Our ability to give auditors read-only access allows me to give them their login and let them have at it! With auditors paying more attention to modifications, it is great to have all changes to expense data in an audit-friendly format. With expense for equity compensation awards, “getting close” isn’t close enough, and handling accounting complexities without a robust Web-based software system would be nearly impossible.”

Recent trends in equity compensation-granting practices further necessitate the move to SaaS-based software. Shareholders increasingly are demanding that companies grant performance awards, where the number of shares vesting depends on the achievement of certain business goals, versus traditional time-based service awards. This movement towards “pay for performance,” while effective in aligning employee behavior with critical business goals, yields more complicated accounting issues due to varying expected and actual payouts.

Software has made great progress towards handling most performance award situations in-system. From an audit perspective, this represents a significant improvement from the recent past, where auditors were tasked with interpreting one-off spreadsheet changes.

Many companies are moving towards broad-based equity compensation programs. Shareholders consider these plans more effective than those which concentrate equity awards in top management segments, since broad-based equity programs help create an employee ownership culture to drive business goals. Much like the rise of performance awards, broad-based plans trade an increase in the alignment of the company’s and the employees’ goals for an increase in accounting complexity.

These plans mean more grants to a variety of employees, but bring challenges relating to varying forfeiture rates, assumptions of exercise behavior, changes in employee status, and complications involving retirement eligibility provisions. Software has evolved to give auditors the complete story behind each grant in the system, including expense changes that were very difficult to track when spreadsheets were widely used.

Data manipulation outside of the equity compensation software, once considered necessary when certain systems were in their infancy and functionality was limited, is no longer a viable solution. Software systems have evolved significantly to handle most major types of accounting modifications. This has the benefit of maintaining an in-system audit trail where auditors are not tasked with determining the origins of “magically” appearing calculation outputs. The resulting reduction of outside of the system manipulation increases auditability while decreasing risk.

Michael Annessa, manager of accounting and financial reporting for Presidio, an IT solutions an service company, emphasizes the benefits of using SaaS-based equity compensation software in terms of auditability:

“Technology has enhanced auditability as our auditors can simply login to our system and pull the same reports that we use in real time. There is no question as to whether we are manipulating the system data we give to the auditors as they are pulling the data themselves and then performing audit procedures. This helps ensure that the auditors are comfortable with the completeness and accuracy of the information provided.”

SaaS-based software is the clear answer to enhanced auditability for equity compensation plans. As the remaining holdouts abandon their spreadsheets for more robust equity accounting systems, SaaS-based software will solidify its position as the gold standard of accuracy and auditability. And as for the fate of the grant-tracking spreadsheet? It’s an endangered species on the fast track to extinction.

Kimberly Kovacs is the co-founder and CEO of OptionEase, a network connector for complex equity compliance applications delivered on-demand via SaaS.

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