CEP Auditing Principles & Procedures 2 — Questions and Answers
Question 1: When auditing an equity plan, which document serves as the primary authoritative source for verifying share reserve limits?
- Board resolution approving the plan
- The plan document approved by shareholders (Correct answer)
- The most recent Form 10-K filing
- The company's stock ledger
Correct answer: The plan document approved by shareholders
The shareholder-approved plan document establishes the legally binding share reserve and its terms govern all grants made under the plan.
Question 2: An equity auditor discovers that option grants were backdated to a date with a lower stock price. Which regulatory body's rules are most directly violated?
- Department of Labor
- SEC and IRS (Correct answer)
- FINRA only
- State securities regulators only
Correct answer: SEC and IRS
Backdating violates SEC disclosure rules (material misstatement) and IRS rules regarding the strike price requirement for ISOs and Section 409A compliance.
Question 3: During an audit, you find that an employee received an RSU grant but no related 83(b) election was filed. What is the correct audit conclusion?
- This is a reportable error requiring immediate correction
- No error exists because 83(b) elections do not apply to RSUs (Correct answer)
- The company must refile the grant at fair market value
- The employee must repay the tax differential
Correct answer: No error exists because 83(b) elections do not apply to RSUs
Section 83(b) elections apply to restricted stock with a substantial risk of forfeiture, not to RSUs, which are taxed upon settlement.
Question 4: A dual-trigger RSA accelerates vesting only upon both a change in control AND termination without cause. When auditing this feature, what document must be reviewed?
- The company's bylaws
- The individual award agreement and the plan document (Correct answer)
- The board minutes only
- The employment contract only
Correct answer: The individual award agreement and the plan document
Both the individual award agreement and the plan document must be reviewed to confirm the dual-trigger language is consistently defined and enforceable.
Question 5: Which audit procedure best detects errors in the calculation of shares available for future grants?
- Reviewing the list of current grantees
- Recalculating the share reserve rollforward from inception or last audit date (Correct answer)
- Confirming the transfer agent's records
- Testing payroll deductions for ESPP participants
Correct answer: Recalculating the share reserve rollforward from inception or last audit date
A reserve rollforward recalculation traces all grants, cancellations, forfeitures, and exercises to independently verify the remaining share balance.
Question 6: Under Sarbanes-Oxley Section 302, which equity-related assertion must the CEO and CFO certify in each quarterly and annual filing?
- That all outstanding options are in-the-money
- That disclosures related to equity compensation are accurate and complete (Correct answer)
- That stock option exercises are reported within 24 hours
- That all equity grants were made at the closing price
Correct answer: That disclosures related to equity compensation are accurate and complete
SOX 302 requires executives to certify that all disclosures, including equity-related disclosures in financial statements and footnotes, are accurate and complete.
Question 7: During an ISO audit, which test confirms that the aggregate FMV limit of $100,000 per year was not exceeded for a particular employee?
- Verify the number of shares granted does not exceed 10,000
- Calculate the FMV at grant date multiplied by shares becoming exercisable in each calendar year (Correct answer)
- Confirm the option term does not exceed 10 years
- Review the employee's W-2 for prior ISO exercises
Correct answer: Calculate the FMV at grant date multiplied by shares becoming exercisable in each calendar year
The ISO $100,000 annual cap is measured by multiplying the FMV at grant date by shares first exercisable in each calendar year, and any excess is treated as an NQSO.
CEP Auditing Principles & Procedures 2
When auditing an equity plan, which document serves as the primary authoritative source for verifying share reserve limits?