Example Memo: Guest lecturer – Morgan Watson, Assurance Partner, Ernst & Young Congratulations, you have just won the audit for the year ended December 31, 2012, for a new client, ResearchPlus (the Company), which provides market research to companies through online surveys that leverage the Company’s significant panel of members that take surveys and provide feedback on potential products, services or advertising campaigns. The Company has experienced significant growth over the past 10 years. Much of this growth was funded by various rounds of equity funding from its private equity investors via preferred stock issuances. As is typical of a high-growth company, a significant portion of the compensation package that the Company has provided to its key employees is options to purchase common stock. On June 30, 2012, the Company issued 2 million options to its employees. The options have the following criteria: • Vesting - 25% per year for four year • Exercise price - $2.00/share (fair value of the common stock at the date of the grant) • Estimated fair value of the options - $1.00 • Estimated forfeiture rate - 10% Based on your review of the prior year financial statements, you note that the Company has applied equity accounting for these options. The Company is planning to file an Initial Public Offering document with the SEC in the next 6-12 months, and based on your experience you expect several questions from the SEC staff related to stock compensation as it is common topic of comments from the staff. During 2012, the Company raised $100 million of equity funding in exchange for issuing Series D preferred stock to new investors. The Company utilized approximately $50 million to repurchase its Series A preferred stock from its initial investors. Prior to year-end, management approaches the audit team to discuss its plans to re-constitute its repurchase of common stock from its employees as a reward for the successful equity raise utilizing $20 million of the proceeds as Management has agreed to allow employees to exercise their options and then repurchase those shares of common stock. Questions: 1. What is the proper accounting treatment for each of the following? a. The stock options b. The preferred stock c. The treasury stock 2. What additional investigation should the audit team do into how the repurchase program has operated in the past? Example Answer (okay…: Memorandum To: Morgan Watson, CPA CC: Dr. Calk, CPA From: XXX, YYY, ZZZ, AAA, BBB Date: 2/6/2019 Re: Case Study Fact Pattern The Company, a high growth corporation that is preparing to go public, had the following transactions and plans for the year ended 2012: On June 30, 2012 the company issued two million stock options to employees. The options will vest at a rate of 25% a year, for four years. The exercise price was $2.00/share and the company estimated the value .

1. Example Memo:
Guest lecturer – Morgan Watson, Assurance Partner, Ernst &
Young
Congratulations, you have just won the audit for the year ended
December 31, 2012, for a new client,
ResearchPlus (the Company), which provides market research to
companies through online surveys that
leverage the Company’s significant panel of members that take
surveys and provide feedback on
potential products, services or advertising campaigns.
The Company has experienced significant growth over the past
10 years. Much of this growth was
funded by various rounds of equity funding from its private
equity investors via preferred stock
issuances.
As is typical of a high-growth company, a significant portion of
the compensation package that the
Company has provided to its key employees is options to
purchase common stock. On June 30, 2012,
the Company issued 2 million options to its employees. The

2. options have the following criteria:
• Vesting - 25% per year for four year
• Exercise price - $2.00/share (fair value of the common stock
at the date of the grant)
• Estimated fair value of the options - $1.00
• Estimated forfeiture rate - 10%
Based on your review of the prior year financial statements, you
note that the Company has applied
equity accounting for these options.
The Company is planning to file an Initial Public Offering
document with the SEC in the next 6-12
months, and based on your experience you expect several
questions from the SEC staff related to stock
compensation as it is common topic of comments from the staff.
During 2012, the Company raised $100 million of equity
funding in exchange for issuing Series D
preferred stock to new investors. The Company utilized
approximately $50 million to repurchase its
Series A preferred stock from its initial investors.
Prior to year-end, management approaches the audit team to
discuss its plans to re-constitute its

3. repurchase of common stock from its employees as a reward for
the successful equity raise utilizing $20
million of the proceeds as Management has agreed to allow
employees to exercise their options and
then repurchase those shares of common stock.
Questions:
1. What is the proper accounting treatment for each of the
following?
a. The stock options
b. The preferred stock
c. The treasury stock
2. What additional investigation should the audit team do into
how the repurchase program has
operated in the past?
Example Answer (okay…:
Memorandum
To: Morgan Watson, CPA

4. CC: Dr. Calk, CPA
From: XXX, YYY, ZZZ, AAA, BBB
Date: 2/6/2019
Re: Case Study
Fact Pattern
The Company, a high growth corporation that is preparing to go
public, had the following transactions and plans for
the year ended 2012:
On June 30, 2012 the company issued two million stock options
to employees. The options will vest at a rate of 25%
a year, for four years. The exercise price was $2.00/share and
the company estimated the value of the options at
$1.00 per option using the Black-Scholes pricing model. The
options have an estimated forfeiture rate of 10%.
During 2012 the company issued $100 million in Series D
preferred stock to new investors. The series D preferred
stock is redeemable at the election of the shareholders. The
company took $50 million of the proceeds, from the
issue, and used them to repurchase the Series A preferred stock.

5. Management has agreed to allow employees to exercise their
options and then repurchase those shares of common
stock. The shares are not puttable to the company.
Issues
1) Our group must determine the proper accounting treatment
for the following:
a. The stock options
b. The preferred stock
c. The treasury stock
2) Are there any additional investigations the audit team should
perform into how the repurchase program has
operated in the past?
Conclusion
Issue #1
a) The stock options must be recorded as equity pursuant to
ASC 718.10.25.2 through 12.
b) Preferred stock must be reported by the company as equity
pursuant to ASC 480.10.65.1.

6. c) Treasury stock will ultimately not be shown on the balance
sheet for acquired shares due to retirement
Issue #2
Additional investigation includes obtaining the following
information:
The audit team needs to obtain documentation verifying that the
stock options are in fact not puttable
to the company, in order to support the audit team’s current
stance that the stock options be reported
as equity, for SEC registration purposes.
Discussion
Stock Options
The conditions requiring an award to be classified as a liability
are not met. The first conditions cited in
ASC 718.10.25.9 pertain to “puttable shares” awarded to an
employee. The company has confirmed that
the options are not puttable to the employer, thus this condition
has not been met.
Neither condition cited in ASC 718.10.25.11 have been met

7. either: the underlying shares are classified as
equity, not liabilities and the entity cannot be required under
any circumstances to settle the option by
transferring cash or other assets because the options may not be
“put” to the company. Additional
conditions cited in ASC 718.10.25.12 are not applicable as the
Company is not yet a SEC Registrant. As
none of these conditions have been satisfied, the shares shall be
classified as equity, pursuant to ASC
718.10.25.10.
As the stock options shall be recorded as equity, ASC
718.10.35.2 mandates that the compensation shall
be recognized over the requisite service period with a
corresponding credit to equity (generally, paid-in
capital).
According to ASC 718.10.25.2, “an entity shall recognize share-
base payment transaction with an
employee as services are received” and continues, “As services
are consumed, the entity shall recognize
the related cost”. Unless otherwise stated, the service period is
the vesting period. Thus, the company
will continue to expense the compensation at 25% a year for

8. four years per the vesting period.
Preferred Stock
The preferred securities are not mandatorily redeemable
according to ASC 480-10-65-1 because the
shares within the Company do not obligate the repurchase at a
stated redemption date. Therefore, the
preferred securities are recorded as equity. Preferred stock is
reported at par value on the balance sheet
as the first line item and any excess over par is listed as a part
of additional paid-in capital with the
number of shares issued and outstanding parenthetically
included according to ASC.210.10.S99.1. To
comply with the disclosure requirements stated in ASC
505.10.50.4, The Company must state the
applicable rights of each series within the notes of the financial
statements in summary form. This will
include the liquidation preferences, redemption requirements,
and conversion or exercise prices or
rates. Terms of potential conversion are also stated. Also, to
help users better understand the impact of
contingently convertible securities, all terms and conditions
relevant to the potential conversion are

9. stated in the notes of the financial statements according to ASC
505.10.50.6.
Treasury Stock
According to ASC 505.30.45.1, the cost of acquired stock is
shown as a deduction of capital stock. When the
common shares are repurchased from employees, upon exercise
of the employee’s options, the shares will be treated
as treasury stock and recorded at par, per ASC 505.30.45.1
before the subsequent retirement of the shares. Upon
retirement of the treasury shares stockholder’s equity will be
reduced. Treasury stock will ultimately not be shown
on the balance sheet for the shares repurchased.
TAMUCT Accounting 5365
Business Combinations
Case from - Brandon Haines, Meyners + Company
Facts
· ABCE is owned by three individuals (“A” with 70% interest,
“B” with 26% interest and “C” with 4% interest).
· The stockholders of ABCE are proposing the creation of a new
limited liability company, ABC Holdings LLC (Holdings).
· ABCE will contribute its 100% wholly owned subsidiaries -

10. ABC Services, LLC (ABCS), ABC Leasing, LLC (ABCL) and
XX Daisy Logistics, LLC (XX Daisy) to Holdings.
· Two of the stockholders (“A” & “B”) intend to contribute their
interest in ABC Moving LP (ABC LP) and ABC Moving
Management LLC (ABC Mgmt) to Holdings. ABC LP owns the
property that ABCL, ABCS and XX Daisy lease for their
facilities. In 2005 and 2006 this entity was consolidated with
ABCE under FIN46(R) Consolidation of Variable Interest
Entities.
· One stockholder (“A”) intends to contribute his 100% interest
in a newly formed LLC which will own real estate (HHH
Property) and associated debt. It is the intention of ABCE to
eventually build a facility to be used in its operations on this
property.
· “A” intends to contribute his 100% interest in ZZ Leasing
LLC (ZZ Leasing) and ZZ Leasing Management LLC (ZZ
Mgmt) to Holdings. ZZ Leasing operates the EZ Lease
franchise for ZIP (another entity owned by some of the
stockholders).
· Also, “A” intends to contribute his receivable from ABCS and
his personal debt associated with this receivable.
· ABCE will receive an LLC membership interest in Holdings
(approximately 79%) for the contribution of ABCS, MLTL and
XX Daisy. B will receive an LLC membership interest in
Holdings (approximately 8%) for his contribution of his interest
in ABC LP and ABC Mgmt. “A” will receive an LLC
membership interest in Holdings (approximately 13%) for his
contribution of his interest in ABC LP, ABC Mgmt, ZZ Leasing
and ZZ Mgmt, the new HHH property LLC and the receivable
from ABCS with the associated debt.
· Anticipated ownership of ABCE after the restructure will
remain the same with “A” with 70%, “B” with 26% and “C”
with 4%.
· See the following table for voting stock percentages.

11. ABCS, ABCL
& XX Daisy
ABC LP &
ABC Mgmt
ZZ Leasing
& ZZ Mgmt
HHH property (new LLC)
“A” receivable and debt
Control structure before restructure (voting stock ownership)
“A” (5.67%)
“B” (5.67%)
“C” (0.24%)
Combined:
“A” - 50%
“B” - 50%
“A” – 100%
“A” – 100%
“A” – 100%
Control structure after restructure (voting stock ownership)
“A” (5.67%)
“B” (5.67%)
“C” (0.24%)
“A” (5.67%)
“B” (5.67%)
“C” (0.24%)
“A” (5.67%)
“B” (5.67%)
“C” (0.24%)
“A” (5.67%)
“B” (5.67%)
“C” (0.24%)
Holdings 100%

12. Questions
How should these various contributions be recorded?
Are these transactions between entities under common control?
If under common control, is there a change in control?