Tag Archives: Accountant

10-K Tip Number One for 2016

Happy New Year from all of us at the SEC Institute Division at PLI! We hope your new year is beginning well and if you are working on closing year-end December 31, 2015 that all is proceeding smoothly.

Last week, on January 7, 2016, Carol and George (that being us of course, the bloggers you are reading now!) presented a One-Hour Briefing, “PLI’s Second Annual Form 10-K Tune-up”. In the briefing we discussed three broad groups of issues to think about this year-end. These were New and Emerging Issues, Recurring Issues, and SEC Staff Focus Areas. Here is the complete list of the topics we discussed in the One-Hour Briefing:

  • New and Emerging Issues
    • Customer accounting for fees paid for cloud computing arrangements
    • PCAOB AS 18 Related Parties – impacts both auditors & registrants
    • PCAOB AS 17 Auditing Supplemental Info Accompanying Audited F/S
    • Audit Committee disclosure
    • ICFR and COSO
  • Recurring Issues
    • SAB 74 disclosures for Revenue Recognition and others
    • Disclosure effectiveness
    • Cybersecurity
    • Conflict minerals & Form SD disclosure
  • SEC Staff Focus Areas
    • Segments – focus on ASU 280
    • Statement of Cash Flows
    • Income taxes
    • Fair value
    • Foreign Exchange Rates, Commodity Prices, and Interest Rates

 

You can hear everything we discussed in an On-Demand version of the Briefing that will be available soon.

To augment the Briefing we are writing a series of blog posts to dive more deeply into each of the areas we discussed than the one-hour time limit allowed.

The first issue, customer accounting for fees paid for cloud computing arrangements, relates to ASU 2015-5. This ASU is effective for public business entities for periods beginning after December 15, 2015. For other entities the effective date is one year later.

One of the major issues in this new standard is that costs associated with a contract may be accounted for differently depending on whether the contract involves a software license or is only a service contract.

To get to that issue we need to review the major provisions of the ASU.

This project arose with the increase in the use of “cloud” based computing systems. These generally include “software as a service agreements” (SaaS) and other types of “software hosting” arrangements. There was no clear guidance about how customers should account for such arrangements. As a consequence, it was unclear whether these were software contracts subject to software accounting guidance or simply service contracts or perhaps a hybrid of the two accounting areas.

The ASU puts paragraph 350-40-15-4A into the ASC section dealing with internal use software:

“The guidance in this Subtopic applies only to internal-use software that a customer obtains access to in a hosting arrangement if both of the following criteria are met:

  1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
  2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.”

If the above criteria are not met then the contract does not involve a software license and is a service contact.

The key issue here is that if the two criteria are met, then the agreement is treated as a multiple element arrangement and the costs are allocated between the software license and a service element associated with the hosting contract. The costs associated with the software license fall into the guidance for costs related to internal use software, or if appropriate, another software model such as software to be used in research and development.

On the other hand, if there is no software license element, then the contract is treated as any other service contract.

The financial reporting implications of this distinction can affect issues such as balance sheet classification, since a software license would be accounted for as an asset in appropriate circumstances, i.e. if it was paid for in advance. Income statement geography can also be affected as software amortization versus service contract expense could be in different income statement line items. And, it is possible that the amount of costs recognized in each period could be different.

This perhaps more complex issue depends on whether the arrangement includes a software license. If it does include a software license the internal use software guidance applies. The expense recognition part of this guidance is articulated in ASC 350-40-30:

30-1     Costs of computer software developed or obtained for internal use that shall be capitalized include only the following:

  1. External direct costs of materials and services consumed in developing or obtaining internal-use computer software. Examples of those costs include but are not limited to the following:
  2. Fees paid to third parties for services provided to develop the software during the application development stage
  3. Costs incurred to obtain computer software from third parties
  4. Travel expenses incurred by employees in their duties directly associated with developing software.
  5. Payroll and payroll-related costs (for example, costs of employee benefits) for employees who are directly associated with and who devote time to the internal-use computer software project, to the extent of the time spent directly on the project. Examples of employee activities include but are not limited to coding and testing during the application development stage.
  6. Interest costs incurred while developing internal-use computer software. Interest shall be capitalized in accordance with the provisions of Subtopic 835-20.

These costs can even include the costs of data conversion.

For service contracts, there is no such guidance. And here in fact lies the more problematic issue. If a cloud based computing arrangement includes a software license the internal use software guidance for costs may require capitalization of costs that would not be capitalized if the contract is only a service contract. Thus the amount of expense recognized for an arrangement could be different if it has a software license or does not have a software license. If you have this situation, careful analysis is crucial!

As always, your thoughts and comments are welcome!

Audit Committee Evolution – Some Next Steps

Over the last two months we have done a series of posts about the evolution of the role of the audit committee and related disclosures:

Part One – Overview and Some History seciblog.pli.edu/?p=447
Part Two – Independence Oversight seciblog.pli.edu/?p=450
Part Three – Audit Fee Disclosures –A Few Common Problem Areas in This Independence Disclosure  seciblog.pli.edu/?p=456
Part Four – The SEC’s Concept Release seciblog.pli.edu/?p=462
Part Five – Voluntary Disclosures in the News   seciblog.pli.edu/?p=486

 
In this last post in the series we discuss two resources for audit committees:

  1. The PCAOB’s outreach to audit committees, and
  2. Our PLI programs for audit committee members

 

PCAOB Outreach to Audit Committees

Recognizing the importance of audit committee oversight of the audit process, the PCAOB has included information for audit committees on their webpage to help audit committees in their oversight role. They have also begun a regular newsletter, “Audit Committee Dialogue”. The newsletter is on the same webpage, along with a number of other resources.
pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

 

PLI Programs for Audit Committee Members

And, lastly, here are some of our PLI programs that will help audit committee members and other directors build and maintain the knowledge and expertise to appropriately fulfill their responsibilities. Most of these programs are available via web archives, webcast and live attendance. You can learn more about all our programs at www.pli.edu.

Audit Committees and Financial Reporting 2016: Recent Developments and Current Issues
www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z11i36?fromsearch=false&ID=259781

Audit Committees and Financial Reporting 2015: Recent Developments and Current Issues www.pli.edu/Content/OnDemand/Audit_Committees_and_Financial_Reporting/_/N-4nZ1z129aq?ID=221250

Corporate Governance — A Master Class 2016

www.pli.edu/Content/Seminar/Corporate_Governance_A_Master_Class_2016/_/N-4kZ1z11ij4?fromsearch=false&ID=259397

 
Directors’ Institute on Corporate Governance (Thirteenth Annual)www.pli.edu/Content/OnDemand/Directors_Institute_on_Corporate_Governance/_/N-4nZ1z129if?fromsearch=false&ID=221435

 

As always, your thoughts and comments are welcome!

Debt Versus Equity – More on Ratchets

On November 3 we blogged about debt versus equity issues and how in late stage financings investors were demanding price adjustment and conversion rate adjustment features such as ratchet provisions. In essence this was to protect late round investors if the valuations they used for their investment was substantially higher than the IPO valuation.

As you may have been following, Square has just completed their IPO. Here is an excerpt from Square’s stockholder’s equity note in their financial statements:

The initial conversion price for the convertible preferred stock is $0.21627 for the Series A preferred stock, $0.71977 for the Series B-1 preferred stock, $0.95369 for the Series B-2 preferred stock, $5.79817 for the Series C preferred stock, $11.014 for the Series D preferred stock, and $15.46345 for the Series E preferred stock. In the event the Company issues shares of additional stock, subject to customary exceptions, after the preferred stock original issue date without consideration or for a consideration per share less than the initial conversion price in effect immediately prior to such issuance, then and in each such event the conversion price shall be reduced to a price equal to such conversion price multiplied by the following fraction:

the numerator of which is equal to the deemed number of shares of common stock outstanding plus the number of shares of common stock, that the aggregate consideration received by the Company for the total number of additional shares of common stock so issued would purchase at the conversion price immediately prior to such issuance; and

the denominator of which is equal to the deemed number of shares of common stock outstanding immediately prior to such issuance plus the deemed number of additional shares of common stock so issued.

Series E preferred stock contains a provision for the adjustment of conversion price upon a public offering. In the event of such offering, in which the price per share of the Company’s common stock is less than $18.55614 (adjusted for stock splits, stock dividends, etc.), then the then-existing conversion price for the Series E preferred stock shall be adjusted so that, as of immediately prior to the completion of such public offering, each share of Series E preferred stock shall convert into (A) the number of shares of common stock issuable on conversion of such share of Series E preferred stock; and (B) an additional number of shares of common stock equal to (x) the difference between $18.55614 and the public offering price, (y) divided by the public offering share price.

The language above is not very easy to understand, but there are various price adjustment features and the instruments that have them were entered into at various points in time, including some later stage investments. So, the debt versus equity issues is present.

Square’s IPO priced at $9, (actually below the expected price range, but the company did get a nice day one price rise on the exchange) so Square will have to make up shares to these later stage investors. This is a simple example where late stage financing valuations were higher than the IPO price.

Here are two links to information about the transaction. Buzzfeed has a nice summary of the deal at:

www.buzzfeed.com/williamalden/square-valued-at-29-billion-in-ipo-short-of-expectations?utm_medium=email&utm_campaign=News+-+1119+Thursday&utm_content=News+-+1119+Thursday+CID_8ba44ca9bcced29cacc07f7e086f01c4&utm_source=BuzzFeed%20Newsletters&utm_term=.uxrLvq8pj#.amezg5KWJ
Here is a WSJ article where the WSJ somehow wanted to call this ratchet a “penalty”:

blogs.wsj.com/digits/2015/11/18/square-pays-93-million-penalty-to-some-investors-in-ipo/

As always, your thoughts and comments are welcome!

 

 

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

Revenue Recognition Help From FinREC

As you know the new FASB and IASB revenue recognition standards supersede all our existing revenue recognition guidance. Here in the US the new standard was such a major change that it was placed in a brand new codification section (ASC 606). One of the major changes with the new model is how it treats “specialized industries”. Many industries, such as software and construction, had specialized industry revenue recognition guidance. All those standards are also superseded. These industries now face many questions and uncertainties about how to apply the new revenue recognition model to unique and different transactions.

The new model, designed to make revenue recognition principles consistent across all industries, is much more general and does not include the detailed kind of guidance that old GAAP frequently provided. This potentially increases the risk that there could be diversity within industries in the application of the new standard.

FinREC, the Financial Reporting Executive Committee of the AICPA, and the AICPA’s Revenue Recognition Task Force have been working to help deal with these issues. They have established 16 industry groups and are developing a new “Accounting Guide for Revenue Recognition”. These resources will be developed with participation and review of standard setters, but will not be authoritative. The groups describe them as eventually providing “helpful hints and illustrative examples for how to apply the new Revenue Recognition Standard.”

They have published a list of potential implementation issues identified to date which you can find at:

www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/DownloadableDocuments/RRTF_Issue_Status.pdf

As always, your thoughts and comments are appreciated!

Leases – News on the International Front

As we all wait with baited breath for news from Norwalk as the FASB staff completes drafting the final version of the new standard on Lease Accounting, the IASB has announced that they have formally finished their project. In their project summary the IASB now states:

“The IASB has completed its decision making for the Leases project. The new Leases Standard will be effective from 1 January 2019. The IASB plans to issue the new Leases Standard before the end of 2015.”

You can find the project summary at:

www.ifrs.org/Current-Projects/IASB-Projects/Leases/Documents/Definition-of-a-Lease-Oct-2015-FINAL.pdf

  1. If the link above does not work for you, paste it into your browser.

A Bit of SEC Trivia – Form 10

During our Workshops we discuss a lot of detailed information, some of which does not come up often in practice. With this in mind, we thought we would start a series of blog posts about some of these “trivia” topics.

The first trivia question is “What is Form 10 all about?”

Turns out Form 10 is a behind the scenes issue in a current news story. On November 1, 2015, HP officially completed the process of splitting itself up into two separate companies:

HP, Inc. (ticker HPQ) which has the legacy HP PC and printer businesses. This company describes itself with these words:

“Our vision is to create technology that makes life better for everyone, everywhere — every person, every organization, and every community around the globe. This motivates us — inspires us — to do what we do. To make what we make. To invent, and to reinvent. To engineer experiences that amaze. We won’t stop pushing ahead, because you won’t stop pushing ahead. You’re reinventing how you work. How you play. How you live. With our technology, you’ll reinvent your world.” (From www.hp.com)

 Hewlett Packard Enterprise (ticker HPE) which has the HP services and corporate hardware businesses uses these words:

Hewlett Packard Enterprise is an industry leading technology company that enables customers to go further, faster. With the industry’s most comprehensive portfolio, spanning the cloud to the data center to workplace applications, Hewlett Packard Enterprise’s technology and services help customers around the world make IT more efficient, more productive and more secure. (From www.hpe.com)

Behind this split is a myriad of fascinating business reasons, which will doubtless become business school cases in the future. What is fun about the transaction for SEC geeks is how it was accomplished in the public company reporting world. HPE was separated out from HP, essentially a “spin-off” transaction. There were a lot of legal steps in the process, but in essence there was no public offering of HPE stock, it was distributed to the existing HP shareholders.

After the spin-off both companies wanted to trade on the NYSE. For HP Inc. this was easy; this is the corporate entity that was already listed, so no big deal. But what about the newly created HPE?

There is no transaction here to register under the 1933 Act, as stock is not being offered or sold to the public; it is being directly distributed to the existing HP shareholders. So there is no S-1 or S-3 or S-4 to file.

This is where the Form 10 comes in. It is a company’s first, and probably only, 1934 Act registration statement, and is the way a company “registers” under the 1934 Act when it trips over the size tests in the 1934 Act, which HPE did when it distributed stock to more than 2,000 persons. As a result, HPE will start the corresponding periodic and current reporting requirements. So the only SEC filing that HPE had to make in connection with the distribution of its stock to the existing HP shareholders was a Form 10.

To simplify a bit, 1934 Act registration is required if a company has a class of equity security held by 2,000 or more persons or 500 persons who are not accredited investors and over $10 million in assets or if the company wants to list on a national security exchange. Of course HPE met the requirements, and so HPE filed a Form 10. (There is of course more complexity to the registration issue, so if you have to deal with it careful research is required!)

Form 10 is a lot like a Form 10-K and you can see HPE’s Form 10 at:

www.sec.gov/Archives/edgar/data/1645590/000119312515338732/0001193125-15-338732-index.htm

In this filing, the Form 10 itself is a shell, and you will find all the relevant information in Exhibit 99.1.

If you have any SEC trivia you would like us to explore, please let Carol or George know, and as always, your thoughts and comments are welcome and appreciated.

One last little trivia note – if you do a ticker search for HP, guess what company has this ticker? Helmerick and Payne, a contract oil and gas drilling company. Who would have guessed?

Comment of the Week – Debt Versus Equity Issues on the Rise?

The genesis of this post is actually a panel discussion from PLI’s 47th Annual Institute on Securities Regulation. This program is one of our major events in the CLE world. The roster of speakers is amazing, starting with a keynote address from Chair White and featuring so many SEC alums, current staffers and industry professionals that an SEC geek simply can’t resist the program.

Anyway, on the first day of the conference the first panel discussed capital market “health” in the current environment. One of the market developments they discussed was financing rounds companies complete shortly before an IPO. In the current environment more and more late round investors are demanding “price protection”. This “price protection” includes instruments like warrants with adjustable prices (ratchets or down-rounds) and preferred stock with adjustable conversions options.

(The staff does write comments about these kinds of instruments, and we have a few examples below.)

It turns out that sometimes the valuations used for these private placements shortly before an IPO don’t follow through to the valuations in the IPO. So the late round investors ask for price protection so they won’t seem to have overpaid shortly before an IPO. (This dovetails very nicely with the recent discussion in the financial press about how valuations for “unicorn” companies may be overstated in the current tech world.)

This is exactly the kind of price protection that has been common in emerging companies that have been far from the IPO process, and it is these kinds of instruments that have been the cause of so many restatements.

If you have ever attended any of our Midyear, Annual or Mid-Sized and Smaller Company SEC Reporting & FASB Forums you are familiar with the continuously updated list of restatement issues we discuss at those conferences. For the last seven years, the number one cause of restatements by public companies has been debt versus equity accounting. Instruments such as warrants with repricing provisions combined with the convoluted, complex accounting guidance in this area have caused more restatements than any other issue.

Being one of the few accountants in the Institute on Securities Regulation it was fascinating listening to the lawyers discuss these complex instruments. The discussion of disclosures that should surround these complex instruments and their unique features was deep and rich. No one however mentioned the accounting issues that they create, and the risk of restatement that goes along with this accounting complexity.

It was a great reminder that as accounting professionals we need to be on the watch for this issue and when we see it raise the accounting issues and assure they are dealt with effectively. This is one of the times when communication between finance, legal and accounting professionals is crucial.

If you would like to review an example of the accounting these instruments create, one of the participants on the panel was from BOX, a successful IPO which had this exact situation. In their first Form 10-K and their S-1 you can find a derivative liability on their balance sheet and a related fair value adjustment in their income statement related to redeemable preferred stock warrants they issued which were derivatives. You can find their Form 10-K at:

www.boxinvestorrelations.com/sec-filings

And, last, here are a couple of example comments. All of this really emphasizes the need to be aware of this issue and build the skills to recognize the issue and deal with it effectively.

It appears the exchangeable senior notes issued in August 2014 contain redemption features. Provide us your analysis that supports your conclusion that none of the redemption features are required to be bifurcated in accordance with ASC 815-15. Specifically address whether the debt involves a substantial discount in accordance with ASC 815-15-25-40 through [25-43].

We note your disclosure that the 1.25% Notes contain an embedded cash conversion option and that you have determined that this option is a derivative financial instrument that is required to be separated from the notes. Please provide us with the details of your analysis in determining that this conversion option should be accounted for separately as a derivative and refer to the specific accounting literature you relied on.

As always, your thoughts and comments are welcome!

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

 

A Fall Return to Our Comment of the Week (or So) Blog Posts

Now that summer vacation is over, and we’ve gotten through a very busy September with lots of SECI programs, we are ready to resume our comment of the week blog posts.

One topic in the news, thanks to all the political campaigning underway, is taxes. As the candidates discuss their plans to reform the tax code, we thought it would make sense to explore in a bit more depth Corp Fin’s comments about tax issues. As you likely know this has been a “frequent comment” hot topic for a while.

Here is a first comment, and a frequent theme in comments, international taxes. As you’ll see, the staff frequently asks for more detail about reconciling items. All of this of course to help readers understand the likelihood of such rates being sustainable.

2. We note from your disclosure in Note 9 that there is a significant reconciling item in the effective income tax reconciliation due to differences between foreign and United States statutory rates, which are primarily attributable to your Luxembourg holding company structure and tax rulings received from Luxembourg tax authorities. Please tell us the nature of the items included in the reconciling line item titled “differences between foreign and U.S. statutory rates.” Also, please provide us with the pre-tax income, statutory rate, and effective tax rate in Luxembourg for all periods presented. Additionally, please tell us the nature of the factors that are driving the changes in this line item from year to year, including the nature of any significant tax rulings.

This second comment in the tax arena is about tax benefits, and even mixes international issues along with the recoverability issue. You can almost hear the next comment asking about “positive and negative” evidence.

  1. Please tell us the facts and circumstances associated with the extraterritorial income tax benefit recognized in each of 2014 and 2013, including the basis for the amount recognized and changes therein. Also, tell us the nature of the reserve applied against such benefits and the amount of the reserve for each year.

Notice how this comment combines domestic versus foreign tax issues along with the theme of disaggregation:

  1. Please revise to disclose the components of income before income taxes as either domestic or foreign. See guidance in Rule 4-08(h) of Regulation S-X. Also, we note that in your reconciliation between the federal statutory rate and the effective income tax rate disclosed in Note L, foreign and state income taxes are combined in one line item. Please note that if either of these items (foreign income taxes or state income taxes) affect the statutory tax rate by more than 5% (either positively or negatively) they should be separately presented on the reconciliation.

And, in this last comment, the significant question of the repatriating the earnings of foreign operations is murky and the staff asks for clarification in disclosure.

  1. You disclose in note 15 that the income tax provision in fiscal 2014 includes $33.7 million of U.S. income and applicable foreign withholding taxes on dividends of $473.7 million due to repatriating foreign subsidiaries earnings to the U.S. parent entity to fund the share repurchase program. You also disclose you have not provided for U.S. and foreign withholding taxes on $471 million of accumulated undistributed earnings of foreign subsidiaries at February 1, 2015 because you intend to reinvest these earnings for the foreseeable future. It is not clear from your present disclosures how management overcame the presumption that all undistributed earnings of subsidiaries will be transferred to the parent and therefore require the accrual of an income tax payable as outlined in ASC 740-30-25-3. Please tell us how you have determined that you have both the ability and intent to indefinitely prevent accumulated undistributed foreign earnings from being repatriated without tax consequences. See ASC 740-30-25-17 and 25-18. In doing so, tell us the following:
    • Explain the specific evidence (e.g. experience of the entity, definite future plans and past remittances, etc.) to substantiate the parent’s assertion of the indefinite postponement of remittances from foreign subsidiaries;
    • Identify the entities and periods where the parent claims permanent reinvestment;
    • Tell us why you have not disclosed that the remittance of undistributed earnings is postponed indefinitely as opposed to the foreseeable future, which is the point used in ASC 740-30-25-19 to describe when it is apparent that a temporary difference reverses and a deferred tax liability is required to be recognized; and
    • Tell us how your decision to repatriate the $473.7 million of funds during 2014 in order to fund your share repurchase program was considered as part of your determination that the $471 million of accumulated undistributed earnings of foreign subsidiaries referenced above continue to be permanently reinvested as of February 1, 2015.

 

Taxes! Well, for now, we will forgo any jokes about how inevitable they are. We do know that tax comments asking for more clarity in disclosure will continue!

 

As always, your thoughts and comments are welcome!

Audit Committee Evolution

Over the last 15 years the role of the audit committee has been discussed, regulated and disclosed in ever increasing and expanding ways.

(Yes, this was true even longer than 15 years ago, but we will focus on the last 15 years for now! Maybe more history later?)

As you have likely heard, in the last several months the SEC and the PCAOB have both been active in developing the next steps of audit committee evolution. All public companies need to deal with these possible changes, and to do that well it helps to have a perspective on how these changes fit into the longer-term change process.

It was way back in pre-SOX years, actually December 1999, that the SEC enacted rules to require the S-K Item 407 Audit Committee Report and related disclosures. Even in this pre-SOX period the importance of the audit committee was clear. The final rule mentions the “Blue Ribbon Committee” that had been formed to deal with this issue:

“We are adopting new rules and amendments to current rules to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies. As more fully described in the Proposing Release, the new rules and amendments are based in large measure on recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the “Blue Ribbon Committee”)”

The Sarbanes – Oxley Act continued the evolution of the audit committee’s role. SOX’s provisions went well beyond disclosure, actually impacting audit committee member qualifications, structure and function. It enacted provisions dealing with:

  • Independence of audit committee members
  • The audit committee’s responsibility to select and oversee the issuer’s independent accountant
  • Procedures for handling complaints regarding the issuer’s accounting practices (whistleblower provisions)
  • The authority of the audit committee to engage advisors
  • Funding for the independent auditor and any outside advisors engaged by the audit committee

Because SOX’s changes go well beyond disclosures, the SOX requirements were implemented by requiring the exchanges to put the provisions in their listing rules.

The PCAOB has also been involved in this process and Audit Standard 16, Communications with Audit Committees, formalized the content and timing of the auditor’s communications with the audit committee. This requirement became effective for years beginning after December 15, 2012.

That is all history, prelude to the future.

As audit committees strive to hold themselves to best practices looking to the future is crucial.

So, what might the future hold?

PCAOB “Dialogue”

In May of 2015 the PCAOB also issued a document titled “Audit Committee Dialogue” to formalize issues it considered important for audit committee members to be aware of and deal with in the evolving focus on audit quality. You can find the “Dialogue” at the PCAOB’s under the “Information for Audit Committee Members”tab.:

http://pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

SEC Concept Release

The SEC issued a broad and potentially far-reaching Concept Release in July. It seeks comment on areas including audit committee oversight of the audit process, how the audit committee selects the auditor and the role of the audit committee in selecting and evaluating key audit team personnel. You can find the concept release at:

www.sec.gov/rules/concept/2015/33-9862.pdf

Auditor Independence

A kind of wild-card issue that is evolving with enforcement cases is how the audit committee deals with auditor independence issues. The days when this was an issuer for only the auditor are clearly over!

These are issues that need some deeper discussion! So, our next few posts will focus on the “Dialogue”, the concept release, independence and other issues.

If you have any topics you would like to see included, as always, your thoughts and comments are welcome!

The Mystery of Public Float (or, Does Everything have to be Gray?)

A question that frequently arises in our workshops is how to compute the “public float” number that is used to determine whether a company is a large accelerated, accelerated or non-accelerated filer. This is an important computation as it determines deadlines, SOX external audit requirements and Smaller Reporting Company status. The SEC also sometimes uses it when they phase in new rules. This number is disclosed on the cover page of Form 10-K, and is more formally called “common equity held by non-affiliates”.

While this might at first seem like a nice, simple, mechanical computation, like so many of the issues we deal with in the SEC world, it can get gray!

The whole process starts with this definition from Exchange Act Rule 12b-2:

Accelerated filer and large accelerated filer—

  • Accelerated filer. The term accelerated filer means an issuer after it first meets the following conditions as of the end of its fiscal year:

(i)The issuer had an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter;

(ii) The issuer has been subject to the requirements of section 13(a) or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) for a period of at least twelve calendar months;

(iii) The issuer has filed at least one annual report pursuant to section 13(a) or 15(d) of the Act; and

(iv) The issuer is not eligible to use the requirements for smaller reporting companies in part 229 of this chapter for its annual and quarterly reports.

The definition of Large Accelerated filer is exactly the same except the dollar threshold is raised to $700 million. This rule also contains the definition of a smaller reporting company. You can find the complete exchange act rule at:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:4.0.1.1.1&rgn=div5#se17.4.240_112b_62

The same information comes into play on the cover page of Form 10-K, in these familiar sections from the instructions to the form:

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

[] Large accelerated filer                                                                   [] Accelerated filer

[] Non-accelerated filer                                                                     [] Smaller reporting company
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

So, what we commonly refer to as “public float” is, in the SEC’s guidance, defined as “aggregate market value of the voting and non-voting common equity held by non-affiliates”. To properly compute this number, there are two more definitions we need to deal with, both again from Exchange Act Rule 12b-2:

Affiliate. An “affiliate” of, or a person “affiliated” with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified.

Control. The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

Now, to the computation! First, we must compute the number of shares “held by non-affiliates”. The logical starting point is total number of shares outstanding. Treasury shares that have not been canceled are clearly held by an “affiliate”, that is the company itself, and are omitted from the calculation. Once the total shares outstanding is computed, the next step is to determine how many of these shares are held by “affiliates”.

Here is where the number can get a bit gray!

The definition of affiliate is clearly subjective. What does it mean, as in the definition above, to be a person who “directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified”?

When the definition of control above, that is control means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise”, is factored into this determination, it is even more gray!

The categories of people who will fall into the affiliate category would clearly include all the company’s directors, as they “direct or cause the direction of management and policies” for the company. Additionally, executive officers, those officers with a policy or strategy setting role, are also clearly affiliates.

Major shareholders of the company may not fall as clearly into the definition of an affiliate. Generally, if a person owns enough shares, they have an ability to impact on the board and management. They may be able to “direct or cause the direction of management or policies”. In this day of activist shareholders, that is very clear. But there is no simple bright line for this determination. Judgment must be used. And, in very close cases, since this is in essence a legal determination, it may be appropriate to consult with counsel!

So, to get the shares held by non-affiliates, excluding shares held be directors and executive officers is fairly clear, shares held by major shareholders will require some judgment!

The next question is why do we use the price on the last business day of the most recently completed second fiscal quarter? We will leave that question our next post!

As always, your thoughts and comments are welcome!