How Unrefined Expected Term Approaches Create Audit Risk

In this Issue Brief, we compare the differences between rigorously developed expected terms and “simplified” or “unrefined” expected terms among a sample of 25 companies. Simplified or unrefined estimates are those developed without analysis as to how historical data should be used in a representative manner, whether different employee groups exhibit distinct exercise patterns, and which expected term estimation technique is most appropriate.

Our results illustrate how simplified expected term estimates can differ substantially from estimates produced by expert and judgment-driven analyses, and that this difference can have material financial statement implications. As standard-setters think increasingly in terms of principles over rules, corporate issuers will need to reassess how they form input assumptions within valuation techniques and the extent to which those assumptions faithfully represent the assets, equity, or liability being measured.

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