Tag Archives: Financial Accounting Standards Advisory Committee

A Revenue Recognition and LEASES Trailblazer

By: George M. Wilson & Carol A. Stacey

As we discussed in this post enumerating Rev Rec early adopters, Microsoft disclosed in their SAB 74 disclosures plans to early adopt both the new Rev Rec and Lease Accounting standards as of July 1, 2017, the beginning of their fiscal year 2018. As you will see in their Form 10-K for the year-ended June 30, 2017, they have executed their plan. (New Microsoft financial reporting motto: “Sleep is for the Weak”?)

 

As you review their disclosures you will see that Microsoft adopted the Rev Rec standard with a full retrospective approach, making this disclosure:

 

The standard will be effective for us beginning July 1, 2018, with early adoption permitted. We elected to early adopt the standard effective July 1, 2017. In preparation for adoption of the standard, we have implemented internal controls and key system functionality to enable the preparation of financial information and have reached conclusions on key accounting assessments related to the standard, including our assessment that the impact of accounting for costs incurred to obtain a contract is immaterial.

 

The most significant impact of the standard relates to our accounting for software license revenue. Specifically, for Windows 10, we will recognize revenue predominantly at the time of billing and delivery rather than ratably over the life of the related device. For certain multi-year commercial software subscriptions that include both distinct software licenses and Software Assurance, we will recognize license revenue at the time of contract execution rather than over the subscription period. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will depend on contract-specific terms and in some instances may vary from recognition at the time of billing. Revenue recognition related to our hardware, cloud offerings such as Office 365, LinkedIn, and professional services will remain substantially unchanged.

Adoption of the standard will result in the recognition of additional revenue of $6.6 billion and $5.8 billion for fiscal year 2017 and 2016, respectively, and an increase in the provision for income taxes of $2.5 billion and $2.1 billion, respectively, primarily due to the net change in Windows 10 revenue recognition. In addition, adoption of the standard will result in an increase in accounts receivable and other current and long-term assets of $2.7 billion and $4.2 billion, as of June 30, 2017 and 2016, respectively, driven by unbilled receivables from upfront recognition of revenue for certain multi-year commercial software subscriptions that include both distinct software licenses and Software Assurance; a reduction of unearned revenue of $17.8 billion and $11.7 billion as of June 30, 2017 and 2016, respectively, driven by the upfront recognition of license revenue from Windows 10 and certain multi-year commercial software subscriptions; and an increase in deferred income taxes of $5.2 billion and $4.8 billion as of June 30, 2017 and 2016, respectively, driven by the upfront recognition of revenue.

 

One of the interesting aspects of this disclosure is the conclusion that contract acquisition costs are not material, making commissions accounting much simpler! And it is worth noting that the new revenue recognition guidance will require Microsoft to recognize some revenue earlier than the old guidance.

 

For the new lease standard Microsoft included this disclosure:

 

The standard will be effective for us beginning July 1, 2019, with early adoption permitted. We elected to early adopt the standard effective July 1, 2017 concurrent with our adoption of the new standard related to revenue recognition. We elected the available practical expedients on adoption. In preparation for adoption of the standard, we have implemented internal controls and key system functionality to enable the preparation of financial information.

The standard will have a material impact on our consolidated balance sheets, but will not have a material impact on our consolidated income statements. The most significant impact will be the recognition of ROU assets and lease liabilities for operating leases, while our accounting for capital leases remains substantially unchanged.

 

Adoption of the standard will result in the recognition of additional ROU assets and lease liabilities for operating leases of $6.6 billion and $5.2 billion as of June 30, 2017 and 2016, respectively.

 

 

Microsoft’s discussion of new internal controls and system functionality are key issues in implementing the new lease accounting model.

 

Microsoft also included a tabular disclosure entitled “Expected Impacts to Reported Results” detailing the impact on selected statement of operations and balance sheet amounts from adopting both standards. You can find it on pages 61 and 62 of the          Form 10-K.

 

When Microsoft files their Form 10-Q for their first Quarter Ended September 30, 2017, the full impact along with all required disclosures will be interesting to see!

 

As always, your thoughts and comments are welcome!

The MD&A Know Trend Test – Staying Out of Trouble!

By: George M. Wilson & Carol A. Stacey

 

In our last post we reviewed a recent MD&A enforcement case focused on failure to disclose bad news. This forward looking “known-trend” disclosure requirement arises when management is aware of some “trend, demand, commitment, event or uncertainty” that could cause a material problem and fails to disclose this information to shareholders.   The S-K Item 303(a)(3)(ii) language creating this requirement is:

 

Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.

 

One of the challenging parts of this requirement is the “reasonably expects” probability threshold. What exactly does this mean? The Staff addressed this requirement in FR 36 with this language:

 

Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments:

 

(1) Is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required.

 

(2) If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.

Each final determination resulting from the assessments made by management must be objectively reasonable, viewed as of the time the determination is made.

 

The language that makes this test challenging is the first part of paragraph (2). In essence, if management cannot make the assumption that a known trend is “not reasonably likely to come to fruition” in step one it must assume that it will come to fruition.

 

What would this mean if there were a 50/50 chance of something bad happening? As an example, suppose that your goodwill is not impaired this year-end, but the numbers in step one of the impairment test have been deteriorating with this trend:

 

                                                                                                                                                                                                                                                                         2014              2015              2016

Fair value of reporting unit                $3,000             $2,500             $1,900

Carrying value of reporting unit         $1,800             $1,800             $1,800

Excess of FV over CV                                 $1,200             $   700             $   100

 

 

There is clearly a trend here, and while management is likely doing all they can to make the business work, what if their assessment is that there is a 50/50 chance that the goodwill may be impaired next year? While there is no accounting recognition, the MD&A known trend disclosure requirement would say that this potential impairment, if it is material, should be disclosed.

 

This is not an easy determination, but the enforcement case in the last post makes it clear that it is crucial to get this disclosure right!

 

As always, your thoughts and comments are welcome!

Revenue Recognition – The Clock is ticking!

Are you ready to implement the FASB/IASB New Revenue Recognition Standard? With just a handful of months to go – The countdown is on! SECI is conducting training workshops throughout the U.S. to prepare filers for the changes and arm them with the tools for implementation. Workshop leaders use interactive lecture, examples and case studies to impart solid knowledge of the provisions of the FASB’s and IASB’s new revenue recognition standard and build an understanding of how the new standard changes revenue recognition accounting and also how it affects the related estimates and judgements. Upcoming workshops include August 24-25 in Grapevine, September 11-12 in Las Vegas and December 13-14 in New York City.

http://www.pli.edu/Content/Implementing_the_FASBIASB_New_Revenue_Recognition/_/N-1z10od3Z4k?ID=290619

MD&A: A New Known-Trend Enforcement Case

By: George M. Wilson & Carol A. Stacey

 

One of the “golden rules” of MD&A we discuss in our workshops is “no surprise stock drops”. (Thanks to Brink Dickerson of Troutman Sanders for the rules!) Actually, it is OK if management is surprised with a stock drop. However, it can be problematic if management previously knew of some issue that, when disclosed, causes a surprise stock drop for investors.

 

The classic start to a known trend enforcement case is a company announcement that results in a stock price drop. On February 26, 2014, UTi, a logistics company, filed an 8-K with news of a severe liquidity problem. UTi’s shares fell to $10.74, a decline of nearly 30% from the prior day’s close of $15.26.

 

The reason this is an SEC reporting issue is this paragraph from the MD&A guidance in Regulation S-K Item 303 paragraph (a)(3)(ii):

 

Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed. (emphasis added)

 

If management knows of some sort of uncertainty that could result in a material impact if it comes to fruition, they must evaluate whether they “reasonably expect” this to happen. If they do “reasonably expect” this to happen then it should be disclosed in MD&A.

 

When there is a surprise stock drop like the one experienced by UTi, the questions the SEC Enforcement Division will ask, to borrow from another context, are “what did management know about the problem” and “when did they know it?”

 

Enforcement Release, AAER 3877 revealed that the genesis of UTi’s liquidity problem was an issue in the implementation of a new IT system that created billing problems. And, it was clear from the facts, including an internal PowerPoint presentation, that management knew they had a problem well before they filed the 8-K.

 

However, in their 10-Q for their third quarter ended October 31, 2013, which was filed in December of 2013, UTi did not disclose the liquidity problem. In fact, they said:

 

Our primary sources of liquidity include cash generated from operating activities, which is subject to seasonal fluctuations, particularly in our Freight Forwarding segment, and available funds under our various credit facilities. We typically experience increased activity associated with our peak season, generally during the second and third fiscal quarters, requiring significant disbursements on behalf of clients. During the second quarter and the first half of the third quarter, this seasonal growth in client receivables tends to consume available cash. Historically, the latter portion of the third quarter and the fourth quarter tend to generate cash recovery as cash collections usually exceed client cash disbursements.

 

They also made no mention of the implementation problems with their new IT system. They actually said:

 

Freight Forward Operating System. On September 1, 2013, we deployed our global freight forwarding operating system in the United States. As of that date, based on a variety of factors, including but not limited to operational acceptance testing and other operational milestones having been achieved, we considered it ready for its intended use. Amortization expense with respect to the system began effective September 2013, and accordingly, we recorded amortization expense related to the new application of approximately $3.3 million during the third quarter ended October 31, 2013.

 

Hence the surprise when the 8-K disclosed the problems. Both the CEO and CFO are also named in the Enforcement Release and paid penalties.

 

As mentioned above, the probability standard for disclosure is “reasonably expects”. More about this complex probability assessment in our next post!

 

As always, your thoughts and comments are welcome!

Business Combinations Accounting Guidance Now Delivered in a Pragmatic, Practical Way

Gain an in-depth understanding of how to apply the FASB standard (codified in ASC 805) on business combinations, including recent related ASUs, how to make journal entries in specific situations, the areas where estimation and judgment is required, the SEC requirements for financial statements and pro forma information for significant business combinations, and the appropriate financial statement disclosure. Attend SECI’s live interactive workshop, Accounting for Business Combinations being held August 16th in New York City. http://www.pli.edu/Content/Accounting_for_Business_Combinations_Workshop/_/N-1z10od5Z4k?ID=290625&t=WLH7_ADDP

Master SEC Reporting and Prepare to Tackle New Challenges

The complicated world of SEC reporting has now gotten even more complicated! Be sure you are prepared to comply with the recently enacted changes and have a plan in place to deal with the SEC staff “hot buttons”. Attend SECI’s live workshop SEC Reporting Skills Workshop 2017 being held July 20-21 in Las Vegas, August 17-18 in New York City and August 21-22 in Grapevine with additional dates and locations listed on the SECI website.

http://www.pli.edu/Content/SEC_Reporting_Skills_Workshop_2017/_/N-1z10oe8Z4k?ID=290534

Revenue Recognition – The Clock is ticking!

Are you ready to implement the FASB/IASB New Revenue Recognition Standard? With just a handful of months to go – The countdown is on! SECI is conducting training workshops throughout the U.S. to prepare filers for the changes and arm them with the tools for implementation. Workshop leaders use interactive lecture, examples and case studies to impart solid knowledge of the provisions of the FASB’s and IASB’s new revenue recognition standard and build an understanding of how the new standard changes revenue recognition accounting and also how it affects the related estimates and judgements. Upcoming workshops include August 24-25 in Grapevine, September 11-12 in Las Vegas and December 13-14 in New York City.

http://www.pli.edu/Content/Implementing_the_FASBIASB_New_Revenue_Recognition/_/N-1z10od3Z4k?ID=290619

Overcome the Challenges Resulting from the FASB’s New Lease Accounting Standard & Build your Implementation Plan Now!

The FASB’s new lease accounting standard presents complex accounting, internal control, systems and implementation challenges. Attend SECI’s live interactive workshop, Implementing the FASB’s New Leases Accounting Standard Workshop being held September 8th & November 3rd in New York City and October 16th in San Francisco. Attendees will learn the conceptual underpinnings, overall structure and details of this new standard as it applies to both lessees and lessors. Implementation considerations, system issues and related topics will be discussed in detail and concepts will be reinforced by use of examples and case studies.

http://www.pli.edu/Content/Implementing_the_FASB_s_New_Lease_Accounting/_/N-1z10dmcZ4k?ID=309314&t=WLH7_DPAD

An IPO Benefit for All – And Perhaps a Look at Policy Direction?

By: George M. Wilson & Carol A. Stacey

One of the most popular parts of the IPO on-ramp created by the JOBS Act allows Emerging Growth Companies (EGCs) to request confidential review of their initial 1933 Act registration statements. Confidential review allows EGCs to keep sensitive financial and other information out of the public spotlight until 15 days before they begin marketing their stock.

 

On June 29, the SEC announced that they will provide this kind of confidential review to all companies in the IPO process. The new benefit will begin July 10. Additionally, the SEC will also permit confidential review for most offerings made within one year of a company’s IPO. The Staff also posted FAQs related to the announcement.

 

 

New Chair Jay Clayton said this about the policy change:

 

“By expanding a popular JOBS Act benefit to all companies, we hope that the next American success story will look to our public markets when they need access to affordable capital. We are striving for efficiency in our processes to encourage more companies to consider going public, which can result in more choices for investors, job creation, and a stronger U.S. economy.”

 

Capital formation is an important part of the SEC’s mission, and this change clearly supports that process.

 

As always, your thoughts and comments are welcome!

Going Concern Reporting – The Gap in GAAP Versus GAAS- Part Three

By: George M. Wilson & Carol A. Stacey

 

Our first two posts in this series have presented an example of a company (Sears Holdings) and auditor reporting requirements for going concern issues as well as reviewed reporting requirements for companies. In this last post we review reporting requirements for auditors and explore the gaps in more detail.

 

Auditor Requirements

 

For auditors of public companies the PCAOB did not change existing GAAS when the FASB Issued ASU 2014-15. Auditors follow this guidance in section AS 2415 of the PCAOB’s auditing standards:

 

02        The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited (hereinafter referred to as a reasonable period of time). The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in AS 1105, Audit Evidence.

 

02        The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited (hereinafter referred to as a reasonable period of time). The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in AS 1105, Audit Evidence.

 

The Gaps

 

There are gaps between what companies disclose and how auditors report. Two of the gaps are:

 

  1. The time period for going concern considerations, and

 

  1. The probability level for the company compared to the auditor for these disclosures

 

Time Period Gap

 

The auditor’s GAAS reporting requirement clearly states that the period over which going concern issues are evaluated is a “reasonable period of time, not to exceed one year beyond the date of the financial statements being audited”. The requirement under GAAP for companies is “within one year after the date that the financial statements are issued”. In practice, many auditors have actually used the period of one year after the financial statements are issued as their going concern disclosure threshold, but they are not strictly required to do this.

 

Probability GAP

 

The disclosure requirement for management in GAAP is that if it “is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued” then they must make disclosures. This threshold of “probable” has its roots in one of the earliest FASB standards (SFAS 5, now ASC 450) dealing with contingencies. This standard set out the definition of “probable” as:

 

“The future event or events are likely to occur”.

 

The auditor’s GAAS standard uses the probability threshold “substantial doubt”:

 

The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time

 

So, what is the difference between “probable that an entity will not be able to meet its obligations as they become due” and “substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time”? This is of course a matter of judgment. Many practitioners would believe that probable is a higher threshold than substantial doubt. What is clear is that this is a subjective evaluation.

 

The PCAOB addressed this difference in their guidance about the new disclosure requirements. This language is from Staff Audit Practice Alert No. 13:

In evaluating whether the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework, including whether they contain the required disclosures, auditors should assess management’s going concern evaluation. In making this assessment the auditor should look to the requirements of the applicable financial reporting framework

In addition, auditors should continue to look to the existing requirements in AU sec. 341 when evaluating whether substantial doubt regarding the company’s ability to continue as a going concern exists for purposes of determining whether the auditor’s report should be modified to include an explanatory paragraph regarding going concern. The AU sec. 341 requirements for the auditor’s evaluation, and the auditor’s reporting when substantial doubt exists, have not changed and continue to be in effect. Under AU sec. 341, the auditor’s evaluation of whether substantial doubt exists is qualitative based 341.Accordingly, a determination that no disclosure is required under the ASC amendments or IAS 1, as applicable, is not conclusive as to whether an explanatory paragraph is required under AU sec. 341. Auditors should make a separate evaluation of the need for disclosure in the auditor’s report in accordance with the requirements of AU sec. 341.

 

This is of course another gap between GAAP and GAAS. Time will tell how the market reacts to this kind of presentation. And this explains why Sears Holdings disclosed their going concern uncertainty and their auditors did not modify their report.

 

There is one more interesting aspect to all this disclosure and auditor reporting discussion. What happens in a Form 10-Q where generally there is no auditor’s report?

 

The requirements in ASC 205-40-50 for interim periods are:

 

If conditions or events continue to raise substantial doubt about an entity’s ability to continue as a going concern in subsequent annual or interim reporting periods, the entity shall continue to provide the required disclosures in paragraphs 205-40-50-12 through 50-13 in those subsequent periods. Disclosures should become more extensive as additional information becomes available about the relevant conditions or events and about management’s plans. An entity shall provide appropriate context and continuity in explaining how conditions or events have changed between reporting periods. For the period in which substantial doubt no longer exists (before or after consideration of management’s plans), an entity shall disclose how the relevant conditions or events that raised substantial doubt were resolved.

 

Sears Holdings’ Form 10-Q for the first quarter of F/y 18 includes this disclosure:

 

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 the first quarter of 2017, when excluding significant items noted in our Adjusted Earnings Per Share tables, and were required to fund cash used in operating activities with cash from investing and financing activities. We expect that the actions outlined above will further enhance our liquidity and financial flexibility. In addition, as previously discussed, we expect to generate additional liquidity through the monetization of our real estate, additional debt financing actions, and potential asset securitizations. 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 monetizing our real estate portfolio and exploring potential asset securitizations, in our transition from an asset intensive, historically “store-only” based retailer to a more asset light, integrated membership-focused company.

 

We believe that the actions discussed above are probable of occurring and mitigate the liquidity risk raised by our historical operating results and satisfy our estimated liquidity needs during the next 12 months from the issuance of the financial statements. 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 actions described above or through some combination of other actions, while not expected, then our liquidity needs may exceed availability 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 our outstanding second lien debt) falls below the principal amount of such second lien debt plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for such debt on the last day of any two consecutive quarters, it could trigger an obligation to repurchase or repay second lien debt in an amount equal to such deficiency.

 

No more use of the term “substantial doubt”. It might be helpful if the change from year-end to quarter-end was explained in more detail.

 

As always, your thoughts and comments are welcome!