Navigating a Change in Service Providers

1. Navigating a Change in Service Providers Prash Shukla Global Shares Brock Benson iComp LLC

2. Agenda • Introduction • Reasons for moving • Common misunderstandings • Key migration elements

3. Reasons for moving • Cost • Functionality • Global consolidation • M&A • Relationship • Sox/SAS 70 • Accounting • Accuracy

4. Common misunderstanding • Single source migrations are simple • Relatively small process changes • Short migration times • Small involvement from the client (departments) • Old and new providers can sort things out amongst themselves

5. Key migration elements • Data • Reconciliation • Reporting (FAS123R/IASB) • Processes • Audit • Reporting (operational) • Communication

6. Data & Reconciliation Reconciling data between two systems

7. Control Totals: Comfort or No Comfort at All? • For some reason, control totals give people warm-fuzzies • What do control totals really tell us? • Is that enough information? • The following six slides depict data with identical control totals

8. Control Totals: Comfort or No Comfort at All?

9. Control Totals: Comfort or No Comfort at All?

10. Control Totals: Comfort or No Comfort at All?

11. Control Totals: Comfort or No Comfort at All?

12. Control Totals: Comfort or No Comfort at All?

13. Control Totals: Comfort or No Comfort at All?

14. ESO Data as a Distribution

15. ESO Data as a Distribution • Employee stock option data should be viewed as a distribution over time • Creating composite numbers (e.g. shares * price) helps to quickly ensure two data sets are identical • Distributions should be evaluated in tandem with control totals

16. ESO Data as a Distribution • Distributions have key statistics that are easy (with a computer) to calculate and verify between two data sets • Mean • Standard Deviation • Verifying that the Mean, Std Dev, and control totals are identical does not guarantee congruence, but much better likelihood than control totals alone

17. ESO Data as a Distribution • Key Distributions to Verify • Shares Granted x Grant Date FMV • Shares Granted x Option Value • Shares Exercised x Exercise Date FMV • Shares Disposed x Sale Price • Shares Cancelled • Distributions can be broken down by plan, option type, subsidiary...any classification that makes sense for your company

18. Reporting FAS 123R Implications of a Service Provider Change Explanation of the Issue

19. FAS 123R – Challenge with Change • If a new system has a different algorithm for any FAS 123R calculation, this is technically a change in accounting practice and should require a restatement of prior periods • If this was rigidly enforced, audit firms would have a mutiny on their hands because companies change vendors all the time • The key is to understand the differences and be able to make a reasonable assessment of the change, which can be easily explained to your auditor • Large (material) differences may require a restatement

20. FAS 123R Implications • Factors that differ between various accounting systems (Expense) • Application of forfeiture rate (in order of complexity) • Static Method • Dynamic Method • Backing out forfeitures • Immediate vs. at vest

21. FAS 123R Implications (Cont.) • Application of accelerated (FIN 28) method of expense for grants with monthly vesting • If you are aware of this in advance, a fix can be made to your data during the conversion such that this is a non-issue • Straight-Line Expense • How are special cases where more options have vested than would be expensed under a standard straight-line expense handled? • All of these have significant downstream effects on deferred tax entries

22. Application of Forfeiture Rate • Where are the greatest effects seen? • Long cliff vesting options • Later tranches of periodically vesting options • What factors affect the percent difference between systems? • Length of time options vest (longer: > % diff) • Forfeiture rate used (higher: > % diff) • Length of time reporting on old system (longer: > % diff) • Would a change in methodology technically constitute a change in accounting practice? Yes. • Is it reasonable to take an adjustment without restating? Yes. (You would take this expense in the future anyway)

23. Backing Out Forfeitures • Where are the greatest effects seen? • Long cliff vesting options • Periodic vesting options with accelerated expensing • Companies with estimated forfeiture rates significantly different from actual experience • What factors affect the percent difference between systems? • Length of time options vest (longer: > % diff) • Diff between est. and act. (higher: > % diff) • Length of time reporting on old system (longer: > % diff) • Would a change in methodology technically constitute a change in accounting practice? Yes. • Is it reasonable to take an adjustment without restating? Depends.

24. Application of FIN 28 Expense for Periodically Vesting Options • Where are the greatest effects seen? • Monthly vesting options • Specific to one vendor in the US – grandfathered problem. Does not affect grants post FAS 123R. • What factors affect the percent difference between systems? • Length of Periodic Vesting (shorter: > % diff) • Monthly vesting options could be as much as 6% different • Length of time reporting on old system (longer: < % diff) • Number of options outstanding expensed using old method (affects deferred tax) • Would a change in methodology technically constitute a change in accounting practice? Yes. • Is it reasonable to take an adjustment without restating? Depends. N.B. even if no expense differences exist, there could be downstream effects to deferred tax

25. Application of S-L Expense • Where are the greatest effects seen? • Front-loaded vesting options • Erratic vesting options (breaks the straight-line somewhere in the middle) • What factors affect the percent difference between systems? • How front-loaded are the options (More: > % diff) • Is the vesting erratic? • Would a change in methodology technically constitute a change in accounting practice? Yes. • Is it reasonable to take an adjustment without restating? Depends. N.B. even if no expense differences exist, there could be downstream effects to deferred tax

26. Reporting #2 FAS 123R Implications of a Service Provider Change Solutions

27. Options Available When Differences Exist • The “R” word – Restate • Least palatable for everyone involved • A “non-option” at most companies • Run dual systems • Finish old grants on old system, run new grants on new system • Keep in mind that for deferred tax this will have to be done until there are no outstanding options for the old grants – could last as long as 10 years • Other risks: SOX, Cost of two vendors, Time, Etc.

28. Options Available When Differences Exist (Cont.) • Make a one-time adjustment • Probably the most palatable option • Can you get auditor approval? • How material is the difference? • Can the difference be isolated and explained? • Can future differences be accurately forecasted? • Amortize the adjustment over a fixed period • Can you get auditor approval? • What affect will amortized adjustment have into the future? • Is the amortized adjustment material?

29. Options Available When Differences Exist (Cont.) • Ignore the problem, just use the new system • You could do this, but you do so at your own risk • Any auditor with a pulse should catch this during audit • With all the scandal in stock compensation (e.g. backdating), do you really want to do this? • Truly understand ALL differences • Have someone on your side that understands, at a very technical level, each difference

30. Creating an Auditable Explanation • For each difference, walk through the following: • Difference to FAS 123 calculations (if applicable) • Difference in prior period FAS 123R calculations (cover both expense and deferred tax) • Anticipated difference in future period FAS 123R calculations (again, exp. & DT) • Document your argument • Cite FAS 123R and SAB 107 superfluously if at all possible • Explain why your solution fits the spirit, if not the letter, of FAS 123R • Cite other companies that have used the same solution when possible

31. Key migration elements • Data √ • Reconciliation √ • Reporting (FAS123R/IASB) √ • Processes • Audit • Reporting (operational) • Communication

32. Processes Redesigning and simplifying processes

33. Key migration elements • Processes • Fund flows • Share flows • Escalation process • Data change process • Insider process • Expat process

34. Audit Steering clear of pitfalls and corporate hurdles

35. Key migration elements • Audit • Audit requirements • Migration controls • Changes in the operational processes

36. Reporting Ensuring that key internal business processes continue

37. Key migration elements • Reporting • Operational requirements • System requirements • Standardization

38. Communications Avoiding assumptions, misunderstandings and confusions

39. Key migration elements • Communications • Notifications • Losses & gains • Website (internal/external) • Employee guidebooks (migration packs) • Ex-employees!!

40. Questions and Answer Thank you for your time! If you have any questions or comments, please contact either of us at: Brock Benson brock@integratedcompensation.com Prash Shukla pshukla@globalshares.com