In recent speeches SEC Staff members have emphasized the importance of appropriate disclosure of Critical Accounting Estimates. In this blog entry we will go a bit further. We will:
- Review some typical comments the staff has been including in comment letters, and
- Show you how to find and use the actual guidance for disclosure of Critical Accounting Estimates.
In our workshops we unfortunately find a fair amount of confusion about the SEC’s requirements in this area.
Just what is the SEC Staff saying to registrants about this disclosure? Here are some representative comments. (Fortunately most of these comments are “fix in future filings” comments!)
First, a comment that simply tells a registrant what they are, and where to find the guidance. Note the language that makes it clear this is very different from the Summary of Significant Accounting Policies!
- We note your response to our prior comment 3. The proposed disclosure for your Critical Accounting Policies within Management’s Discussion and Analysis appears to be a duplication of the accounting policies already disclosed in the footnotes to your financial statements. Please note that the objective of the Critical Accounting Policies within Management’s Discussion and Analysis is different from that of the Summary of Significant Accounting policies included in the footnotes to your financial statements; the objective of the Critical Accounting Policy disclosure is to address material implications of uncertainties associated with the methods, assumptions and estimates underlying the (application of) your critical accounting measurements. Refer to FR-72, which can be found on our website at: http://www.sec.gov/rules/interp/33-8350.htm. Please modify your proposed disclosure within Management’s Discussion and Analysis to eliminate repetition of the accounting policies disclosed elsewhere in your filing and, to the extent not disclosed elsewhere, include disclosure that addresses the specific methods, assumptions and estimates underlying the your critical accounting measurements
Next, here are three comments to illustrate the level of analysis that the SEC Staff expects in your discussion of the historical and potential future variability in financial results related to Critical Accounting Estimates.
- We refer to the following disclosures from your Critical Accounting Policies found on page 53, “In establishing our credit practices, we seek to strike an appropriate balance between prudent learner credit policies and learner retention. Accordingly, we periodically review and alter learner credit policies to achieve that objective by restricting or expanding the availability of credit we extend.” Please tell us in detail about the facts and circumstances that have caused you to review and alter learner credit policies in the past.
Goodwill impairment uncertainty is a frequent comment area:
- We note your response to prior comment 4 indicating that you will include additional related disclosures if any of your reporting units are at risk of failing step one of the impairment test. If none of your reporting units are at risk of failing step one, please tell us what consideration you gave to disclosing that conclusion. In addition, tell us whether the estimated fair values of any of your reporting units substantially exceed the carrying values, and consider disclosing any such determination. Tell us your threshold for determining that the excess is substantial.
And this last comment is just good, sound analysis:
- We note the reduction in your allowance for doubtful accounts as a percentage of total accounts receivable from July 31, 2013 (18.1%) to July 31, 2014 (14.7%). Please describe to us the factor(s) that resulted in the reduction (e.g. changes in the category of outstanding receivables, the composition of the aging or the Company’s accounting policy or methodology with respect to the allowance from the prior period). Also confirm to us that you will clearly describe any significant factor(s) that influenced management’s judgment with respect to the estimate of allowance for doubtful accounts in future filings.
So, just where is the current guidance for Critical Accounting Estimate disclosure? There is a bit of confusion here! This all started in the post-Enron period with FR 60 (the FRs are Financial Reporting Releases, interpretations that are approved by the SEC Commissioners). This release addressed the aggressive use of accounting principles and required disclosure of “Critical Accounting Policies”. It also required that this disclosure be made in plain English. It was issued very quickly in order to apply to year-end 2001 financial statements, and was called a “Cautionary Advice”. As this disclosure was a very new concept, it did not describe in great detail exactly what a critical accounting policy was or what disclosures should be made. You can find this brief FR, for perhaps historical purposes, at:
The key reason the FR was short was that the SEC planned to make a formal rule concerning this disclosure. The rule was proposed, but was never actually finalized.
The reason the rule was never finalized is that the SEC instead addressed this disclosure in FR 72. You can find the current guidance in FR 72 way towards the end in Section V. Here is the release, just scroll way down:
(Note the evolution in terminology from Critical Accounting Policy to Critical Accounting Estimate.)
If you read this brief Commission interpretation and keep in mind the comments above, you will create meaningful disclosure in this area. A few points to consider:
- Critical accounting estimate disclosure is NOT the same as accounting policy disclosures.
- You could start with the idea that you have far fewer Critical Accounting Estimates than accounting policies, perhaps three to five as a starting point.
- Be sure to address what makes the estimate critical and uncertain, and why the impact could be material.
- Include quantified sensitivity analysis that will help investors understand the potential impact if the estimate were to change.
We hope this helps, and as always, your thoughts and comments are appreciated!