Tag Archives: FASB

Going Concern Reporting – The Gap in GAAP Versus GAAS – Part One

By: George M. Wilson & Carol A. Stacey

 

This is the first of three posts about an interesting conundrum in reporting that arose last year. The FASB, with ASU 2014-15, now requires disclosures by companies about going concern issues. However, there can be gaps between what companies are required to disclose and impact of going concern issues on the auditor’s report.

ASU 2014-15 added subtopic 205-40 “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” to the Accounting Standards Codification. This update became effective for periods ending after December 15, 2016. Previously there was no specific requirement for management to make these disclosures. (This is of course Generally Accepted Accounting Principles, or GAAP).

Auditors have had guidance in this area for many years courtesy of the PCAOB’s standard in AU section 341, which is now section AS 2415 in the PCAOB’s reorganized auditing standards. (This is Generally Accepted Auditing Standards, or GAAS).

 

To explore the gap between GAAP for companies and GAAS for auditors when reporting going concern issues we are going to present a series of three posts:

 

This first post will present an example of a going concern disclosure by a company and whether or not the auditor’s report was modified. (Spoiler – there was no mention in the auditor’s report!)

 

The second post will explore company disclosure requirements.

 

The third and last post will review auditor’s reporting requirements and detail the gaps between company and auditor reporting.

 

Sears Holdings, the retailer that owns Kmart and Sears, provided an example of this gap in their Form 10-K for the year ended January 28, 2017. In their financial statements Sears Holdings included this language:

We acknowledge that we continue to face a challenging competitive environment and while we continue to focus on our overall profitability, including managing expenses, we reported a loss in 2016 and were required to fund cash used in operating activities with cash from investing and financing activities. We expect that the actions taken in 2016 and early 2017 will enhance our liquidity and financial flexibility. In addition, as previously discussed, we expect to generate additional liquidity through the monetization of our real estate and additional debt financing actions. We expect that these actions will be executed in alignment with the anticipated timing of our liquidity needs. We also continue to explore ways to unlock value across a range of assets, including exploring ways to maximize the value of our Home Services and Sears Auto Centers businesses, as well as our Kenmore and DieHard brands through partnerships or other means of externalization that could expand distribution of our brands and service offerings to realize significant growth. We expect to continue to right-size, redeploy and highlight the value of our assets, including our real estate portfolio, in our transition from an asset intensive, historically “store-only” based retailer to a more asset light, integrated membership-focused company.

 

Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.

 

If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.

 

Sears Holdings used the term “substantial doubt”, but indicated that they believed their plans mitigated this “substantial doubt”.

 

This was the report of Sear’s Auditors:

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

No mention of a going concern issue at all in the auditor’s report! What is an investor to think? Historically, when the only concrete guidance was in GAAS, it was very rare to see this issue not discussed in both the financial statements and the auditor’s report.

 

This is, of course, part of the gap between GAAP and GAAS. In our next post we will begin to explore the space in this gap!

 

 

As always, your thoughts and comments are welcome!

Frequent Comment Update: Part Two – Cash Flows

By: George M. Wilson & Carol A. Stacey

 

In our blog post “Time Again for a Frequent Comment Update”, we listed the frequent comment areas that CorpFin Staff members have been discussing at our Midyear Forums. In that post, we also highlighted a number of recent comments about non-GAAP measures. In this post, we turn our attention to comments about the statement of cash flows.

 

In the last several years there have been a number of restatements related to the statement of cash flows, some undoubtedly related to comment letters. Additionally, the FASB and EITF have issued two ASU’s to address various issues in the statement of cash flows.

 

ASU 2016-15 in August 2016

Provides guidance on 8 specific cash flow issues

 

ASU 2016-18 in November 2016

Provides guidance on classification and presentation of restricted cash

 

 

There is much discussion about root causes for cash flow statement problems. Theories range from the idea that the statement is prepared late in the reporting process and perhaps tends to be a more mechanical, “do it the way we did it last year” process, to the fact that there are some areas that are ambiguous in the cash flow statement guidance. Whatever the causes, there is clearly a need for care and review in preparing the statement of cash flows.

 

This first comment is about being sure you are familiar with the statement of cash flow requirements and also addresses a frequent problem area of ASC 230, discontinued operations:

 

We note your presentation of the decrease in cash and cash equivalents from discontinued operations in one line item. Please note that ASC 230-10-45-10 requires that a statement of cash flows shall classify cash receipts and cash payments as resulting from investing, financing, or operating activities. Please revise your current presentation to classify the cash flows from discontinued operations within each of the operating, investing and financing categories.

 

Whether to show cash flows from financing activities on a gross or net basis is not a mechanical decision. It requires judgment about the substance of the financing as this comment demonstrates:

 

We note from your financing activities section in your statement of cash flows that you present net proceeds (repayments) of short-term borrowings rather than on a gross basis. Please explain to us your basis for this presentation. Refer to ASC 230-10-45-7 through 9.

 

Another interesting aspect of cash flow statement preparation is how to treat hybrid items that have an element of two different types of cash flows. This comment demonstrates this is not always a mechanical process:

 

We note your presentation of payments for the costs of solar energy systems, leased and to be leased. Given that approximately 61% of your revenues for the year ended December 31, 2015 and 64% of your revenues for the period ended June 30, 2016 represented solar energy systems and product sales, please tell us how you reflect the costs of solar energy systems sold on your statements of cash flows pursuant to ASC 230.

 

These last two comments are not strictly speaking financial statement comments. They are common MD&A comments, and definitely needs to be part of the statement of cash flows conversation. Frequently MD&A tries to explain operating cash flows with confusing or mechanical language relating to items in the indirect method reconciliation from net income to operating cash flows.

 

Note the mention of drivers in this comment:

 

We note that your discussion of cash flows from operating activities is essentially a recitation of the reconciling items identified on the face of the statement of cash flows. This does not appear to contribute substantively to an understanding of your cash flows. Rather, it repeats items that are readily determinable from the financial statements. When preparing the discussion and analysis of operating cash flows, you should address material changes in the underlying drivers that affect these cash flows. These disclosures should also include a discussion of the underlying reasons for changes in working capital items that affect operating cash flows. Please tell us how you considered the guidance in Section IV.B.1 of SEC Release 33-8350.

 

Lastly, note the focus on underlying reasons for change in this comment:

 

You say that in the statement of cash flows, you provide reconciliation from net loss to cash flows used in operating activities where you have provided quantitatively the sources of your operating cash flows. However, as you use the indirect method to prepare your cash flows from operating activities, merely reciting changes in line items reported in the statement of cash flows is not a sufficient basis for an investor to analyze the impact on cash. Therefore, please expand your disclosure of cash flows from operating activities to quantify factors to which material changes in cash flows are attributed and explain the underlying reasons for such changes. Refer to Section IV.B.1 of “Interpretation: Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations” available on our website at http://www.sec.gov/rules/interp/33-8350.htm for guidance. Provide us a copy of your intended revised disclosure.

 

 

As always, your thoughts and comments are welcome!

Fake SEC Filings and Enforcement in the Electronic Age

By: George M. Wilson & Carol A. Stacey

 

Over the many decades that equity securities have traded in the U.S., and over the centuries that equities have traded around the world, unscrupulous people have always tried to find ways to cheat others. From pump and dump schemes to fake analyst reports new ways are constantly evolving as less than ethical people look for a quick buck. One of the more recently developed sneaky tricks is to create a fictitious user ID in the SEC’s EDGAR system and try to manipulate a company’s stock with fake SEC filings such as tender offer documents. In a way this is kind of a “pump and dump” strategy, and it is all about fake news.

 

In February of this year an artist in Chicago used this trick to try and manipulate Alphabet’s stock. In May 2015, Avon stock was used in a similar scheme. In September 2015, a person used an SEC filing in the name of “LMZ & Berkshire Hathaway Co.” to try and manipulate Phillips 66 and Kraft Heinz. The report was signed with a false name.

 

That same false name was used on a filing to announce a fake tender offer for Fitbit in November 2017.

 

When there are new kinds of crimes, the SEC sets out to develop the right tools and techniques to find the perpetrators and protect investors and the markets from bad actors. They are making progress with this new kind of electronic and internet based crime. On May 19, 2017, fairly soon after the Fitbit false filing, the SEC announced an enforcement action against Robert W. Murray, the alleged perpetrator of this fraud, with a parallel criminal action by the U.S. Attorney’s Office for the Southern District of New York. Mr. Murry is a mechanical engineer based in Virginia.

 

According to the SEC Murray wove a tangled technical trail:

 

The SEC alleges that Murray created an email account under the name of someone he found on the internet, and the email account was used to gain access to the EDGAR system.  Murray then allegedly listed that person as the CFO of ABM Capital and used a business address associated with that person in the fake filing.  The SEC also alleges that Murray attempted to conceal his identity and actual location at the time of the filing after conducting research into prior SEC cases that highlighted the IP addresses the false filers used to submit forms on EDGAR.  According to the SEC’s complaint, it appeared as though the system was being accessed from a different state by using an IP address registered to a company located in Napa, California.

 

In the words of enforcement, this attempt to hide his actions did not work:

 

“As alleged in our complaint, Murray used deceptive techniques in a concerted effort to evade detection, but we were able to connect the dots quickly and hold him accountable,” said Stephanie Avakian, Acting Director of the SEC Enforcement Division.

 

For all his effort, and for the potential consequences, Murray’s ill-gotten gains in this scheme were only about $3,100!

 

Always fun to see how new ways to try and cheat don’t evade the consequences!

 

As always, your thoughts and comments are welcome!

 

SEC Reporting and FASB Updates Specific to Small and Mid-Sized Companies Take Center Stage

The Financial Reporting Regulatory landscape is chock full of recent updates and new regulations, chief among them is the new FASB Revenue Recognition Standard and revised Lease Accounting. Most surveys agree that filers are well behind schedule in implementing the changes needed to comply. Practitioners at small and mid-sized companies will receive the essential information and advice needed to get up to speed by attending SEC Reporting & FASB Forum live program September 14-15 in Las Vegas.

http://www.pli.edu/Content/13th_Annual_SEC_Reporting_FASB_Forum_for/_/N-1z10lptZ4k?ID=298604

 

Demystifying Alternative Financing Solutions for Emerging and Growing Companies

Auditors and Financial Officers of companies who raise capital with complex financial instruments often find themselves drowning in convoluted accounting issues and restatements. Avoid the confusion by attending the live workshop, Debt vs. Equity Accounting for Complex Financial Instruments being held June 23rd in San Francisco. Through a detailed review of the accounting literature and numerous examples and case studies this Workshop will help you build the knowledge and experience to appropriately recognize, initially record and subsequently account for these complex financing tools

http://www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z10odmZ4k?ID=290521&t=WLH7_PDAD

Projects, Pronouncements and Developments Affecting Your SEC Reporting

How do the latest SEC, EITF, PCAOB and FASB updates affect your reporting? Attend FASB, SEC and PCAOB Update for SEC Reporting Professionals Workshop being held August 23rd in Grapevine, Tx. Get up to date in-depth information on all the latest developments and practical tips on applying existing financial reporting requirements, including pushdown accounting, debt issuance costs and commitment fees, discontinued operations and dispositions, segment reporting and goodwill impairment.

http://www.pli.edu/Content/FASB_SEC_and_PCAOB_Update_for_SEC_Reporting/_/N-1z10odqZ4k?ID=290526

Learn About Recent Whistleblower Developments

By: George M. Wilson & Carol A. Stacey

 

We have done several posts about whistleblowing and the related SOX and Dodd-Frank whistle blower regimens. It is hard to overstate the importance of whistleblowers in the SEC’s enforcement efforts.
On April 25, 2017, the SEC announced a $4 million payout to a whistleblower who provided industry-specific experience and expertise to the staff as they conducted their investigation. In that release they also announced that whistleblower payouts now total approximately $153 million!
Keeping abreast of whistleblowing developments is an important part of governance and compliance.   To help in this process we are offering our Corporate Whistleblowing program on June 28. This program will provide in-depth perspectives on recent regulatory and legal developments, including:

  • What direction the federal whistleblower protection programs will likely take under the new administration
  • What to expect in case law and regulatory enforcement developments in the coming year
  • Best practices in responding to whistleblower reports
  • Key ethical considerations in conducting internal investigations of issues raised by whistleblowers.

 

As always, your thoughts and comments are welcome!

Are There Consequences for Reporting ICFR Problems? – The Chief Accountant Speaks!

By: George M. Wilson & Carol A. Stacey

In a recent speech SEC Chief Accountant Wesley Bricker, towards the end of his remarks, made some interesting overall comments about the evaluation of ICFR. These comments are an interesting step in the ongoing conversation about whether the SOX 404 evaluation of ICFR makes any difference in investor behavior. There has been a lot of anecdotal evidence and much discussion about this question. Mr. Bricker’s comments are not based on supposition, inference or piecemeal observation. His comments have their roots in articles from various academic journals, including the Accounting Review and The Journal of Accounting Research. Research in these peer-reviewed journals is based on statistical analysis of quantitative data. (If you have never heard of these journals, they are very prestigious academic journals, so if you decide to read any of the articles grab a cup of coffee and a calculator!)

Here are some excerpts from his remarks. The footnote numbers are references to the academic papers which support his points. We left them in so you could follow-up if you would like to review the quantitative research underlying his comments.

 

Recent experience with disclosures 

Another point related to ICFR is consideration of disclosures.  Investors tend to incorporate disclosure of ICFR deficiencies in the price they are willing to pay for a stock.  For example, companies disclosing material weaknesses are more likely to experience increased cost of capital, and to face more frequent auditor resignations and restatements.[11]

 

Recent academic research suggests:

 

Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies; [12] and

 

After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points. [13]

 

Remediation of ineffective ICFR tends to be followed by improved financial reporting quality, reduced cost of capital, and improved operating performance.[14]   For example,

 

Companies that have remediated their prior disclosed internal control deficiencies exhibit an average decrease in market-adjusted cost of equity of 151 basis points; [15]  and

 

Remediating companies also experience increases in investment efficiency and in operating performance, suggesting that accounting information generated by effective ICFR is more useful for managerial decision-making. [16]

 

A disclosure of material weaknesses, combined with demonstrating progress toward remediation, can provide investors with information about the company’s ability to function as a public company.  Some companies, for example, voluntarily disclose material weaknesses in their registration statements along with their plans for remediating those weaknesses. [17]

 

You can find citations in to the relevant articles in the text of the speech.

As always, your thoughts and comments are welcome!

ICFR Changes and the New Revenue Recognition, Leases, and Financial Instrument Impairment Transitions

By: George M. Wilson & Carol A. Stacey

 

In his recent, much publicized speech, Chief Accountant Wesley Bricker discussed the transition to the new revenue recognition standard. A bit later in the speech he addressed a not so frequently discussed issue, the requirement to disclose material changes in ICFR as it relates to implementation of the new revenue recognition, leases, credit losses and other standards. Here is an excerpt:

 

Over the next several years, updating and maintaining internal controls will be particularly important as companies work through the implementation of the significant new accounting standards. Companies’ implementation activities will require careful planning and execution, as well as sound judgment from management, as I have mentioned earlier in illustrating areas of judgment in the new GAAP standards.

 

In his remarks, well worth the read, he also comments on two crucial ICFR concerns in these new standards:

Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and

Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.

 

We did a post about reporting changes in ICFR in November 2016. To refresh your memory, or if you are not familiar with this area, here is a summary of the disclosures required for material changes in ICFR. This applies to material changes made to implement new accounting standards as well as any other material changes.

 

These requirements begin with Item 9A in Form 10-K and Part I Item 4 in Form 10-Q. They both refer to S-K Item 308(c):

 

(c) Changes in internal control over financial reporting. Disclose any change in the registrant’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of §240.13a-15 or 240.15d-15 of this chapter that occurred during the registrant’s last fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

 

With changes to ICFR for revenue recognition for information about contracts and estimates, like stand-alone selling price and when control transfers, and changes to ICFR for capitalization of all leases, these new standards could require material changes to ICFR. Are these the types of changes included in the S-K 308(c) disclosure requirement?

 

This is an excerpt from the ICFR C&DI’s, number 7, about SOX reporting which you can find here:

 

After the registrant’s first management report on internal control over financial reporting, pursuant to Item 308 of Regulations S-K or S-B, the registrant is required to identify and disclose any material changes in the registrant’s internal control over financial reporting in each quarterly and annual report. This would encompass disclosing a change (including an improvement) to internal control over financial reporting that was not necessarily in response to an identified material weakness (i.e. the implementation of a new information system) if it materially affected the registrant’s internal control over financial reporting. Materiality, as with all materiality judgments in this area, would be determined upon the basis of the impact on internal control over financial reporting and the materiality standard articulated in TSC Industries, Inc. v. Northway, Inc. 426 U.S. 438 (1976) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). This would also include disclosing a change to internal control over financial reporting related to a business combination for which the acquired entity that has been or will be excluded from an annual management report on internal control over financial reporting as contemplated in Question 3 above. As an alternative to ongoing disclosure for such changes in internal control over financial reporting, a registrant may choose to disclose all such changes to internal control over financial reporting in the annual report in which its assessment that encompasses the acquired business is included.

 

 

The SEC Regulations Committee of the CAQ has also discussed a particularly intricate issue in this transition. What if you change your ICFR this year, but the change is for future reporting when you begin to report under the new standard next year? This issue is still in play, as this excerpt from the minutes discusses:

 

Changes in ICFR in preparation for the adoption of a new accounting standard

Item 308(c) of Regulation S-K requires disclosure of changes in internal control over financial reporting (“ICFR”) during the most recent quarter that have materially affected or are reasonably likely to materially affect the registrant’s ICFR. The Committee and the staff discussed how this requirement applies to changes in ICFR that are made in preparation for the adoption of a new accounting standard when those changes are in periods that precede the date of adoption and do not impact the preparation of the financial statements until the new standard is adopted.

 

The staff indicated that they are evaluating whether additional guidance is necessary for applying the requirements of Item 308(c) in connection with the transition to the new revenue standard.

 

So, as you begin implementing systems and processes for these new standards, don’t forget this part of the reporting!

 

As always, your thoughts and comments are welcome!

Significant New Changes in SEC Accounting & Auditing Demand Clarity

The world of financial reporting is complicated and ever-changing. 2017 brings a host of new issues. Implementation deadline of the FASB’s revenue recognition standard is fast approaching and the new lease accounting challenges filers. Attend SECI’s 32nd Midyear SEC Reporting & FASB Forum. This live program is being held May 18-19 in Dallas, June 8-9 in New York City along with a live webcast and June 19-20 in San Francisco. Get practical advice on how to successfully tackle these challenges and more.

http://www.pli.edu/Content/32nd_Midyear_SEC_Reporting_FASB_Forum/_/N-1z10oddZ4k?ID=290510&t=LLM7_9DPAD