The Public Company Accounting Oversight Board (PCAOB) on Tuesday issued staff questions and answers providing direction for auditing a company’s estimation of the fair value of stock options granted to employees pursuant to Statement of Financial Accounting Standards No. 123 (Revised), Share-Based Payment (FAS 123R).

This series of questions and answers is limited to addressing auditing the fair value measurements associated with determining compensation cost. In addition to addressing the auditor’s consideration of the process for developing a fair value estimate, significant assumptions used in options pricing models and the role of specialists in fair value measurements, the guidance highlights risk factors that auditors should be aware of, including:

• Reducing the fair value below what it would have been by using an assumption based on adjusted historical information.
• Excluding a historical period of time from the inputs to the valuation model when the effect of the exclusion is lowering the expected term or expected volatility.
• Adjusting the historical exercise behavior or historical share price volatility.
• Not applying adjustments to historical exercise behavior or historical share price volatility consistently to each option grant.

“I appreciate that many firms currently are auditing the fair value of share options and have developed their auditing approaches using the general principles in the existing auditing literature,” Tom Ray, PCAOB Chief Auditor and Director of Professional Standards, said in a prepared statement announcing the availability of the guidance. “The staff’s questions and answers were developed to help auditors apply the existing auditing standards to this area appropriately and consistently, and I encourage auditors to review this guidance as they plan for the calendar year-end audits.”