Tag Archives: INTERNAL AUDITING

A New Look

Hey, if you haven’t been there in a while, go check out the SEC’s home page!

As always, your thoughts and comments are welcome!

 

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Master SEC Reporting and Prepare to Tackle New Challenges – August & September Dates Announced

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 August 17-18 in New York City, August 21-22 in Grapevine and September 25-26 in San Francisco with additional dates and locations listed on the SECI website.

 

http://www.pli.edu/Content/SEC_Reporting_Skills_Workshop_2017/_/N-1z10oe8Z4k?ID=290537

 

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!

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

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

By: George M. Wilson & Carol A. Stacey

 

In our last post, we looked at Sears Holdings’ disclosures about its going concern issues and saw that the company used the language “substantial doubt exists related to the Company’s ability to continue as a going concern” in the footnotes to their financial statements. We also saw that Sears Holdings’ auditors did not mention this issue in their report.

 

While this might seem like a bit of a disconnect, it turns out that there is a gap between the disclosure requirements for companies and the reporting requirements for auditors. (Actually, there are multiple gaps!)

 

This post reviews the GAAP requirements of ASU 2015-15, which became effective for companies for years ending after December 15, 2016.

 

In the third and last post of this series we will explore the auditor’s reporting requirements and the “gaps” between company requirements and auditor’s requirements.

 

Company Requirements

 

Here is a brief summary with some excerpts from the requirements for companies in ASC 205-40-50:

In connection with preparing financial statements for each annual and interim reporting period, an entity’s management shall evaluate whether there are conditions and events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable).

 

……………………………..

 

Management shall evaluate whether relevant conditions and events, considered in the aggregate, indicate that 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. The evaluation initially shall not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date that the financial statements are issued (for example, plans to raise capital, borrow money, restructure debt, or dispose of an asset that have been approved but that have not been fully implemented as of the date that the financial statements are issued).

 

……………………………..

 

When relevant conditions or events, considered in the aggregate, initially indicate that 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 (and therefore they raise substantial doubt about the entity’s ability to continue as a going concern), management shall evaluate whether its plans that are intended to mitigate those conditions and events, when implemented, will alleviate substantial doubt about the entity’s ability to continue as a going concern.

 

……………………………..

 

With this as the general requirement for an evaluation, the disclosure requirement comes with a binary determination about the impact of management’s plans:

 

Disclosures When Substantial Doubt Is Raised but Is Alleviated by Management’s Plans (Substantial Doubt Does Not Exist)

 

ASC 240-40-50-12

 

If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is alleviated as a result of consideration of management’s plans, an entity shall disclose in the notes to financial statements information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the notes):

 

  1. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

 

 

 

Disclosures When Substantial Doubt Is Raised and Is Not Alleviated (Substantial Doubt Exists)

 

ASC 240-40-50-13

 

If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, the entity shall include a statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Additionally, the entity shall disclose information that enables users of the financial statements to understand all of the following:

 

  1. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

 

An interesting difference between these two levels of disclosure is that there is no requirement to use the terminology “substantial doubt” when management’s plans alleviate the uncertainty.

 

The language Sears Holdings used was:

 

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.

 

 

The company used the term “substantial doubt” even though they believed their plans mitigated this “substantial doubt”. Their disclosure went beyond the requirements of the standard.

 

In our next post, we will explore how this interacts with GAAS for auditors.

 

As always, your thoughts and comments are welcome!

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!

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

Breaking News: Late last week, the PCAOB voted to make a significant change in auditing standards:

 

“The standard will create the first significant change to the standard form auditor’s report in 70 years, according to PCAOB Chairman James Doty.”

http://www.journalofaccountancy.com/news/2017/jun/pcaob-expands-auditor-reporting-duties-201716790.html

 

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PLI will highlight this significant event at our upcoming live program next Monday (June 12th)   in New York City  “Audit Committees and Financial Reporting 2017”

Representatives from the PCAOB and SEC will be on hand to discuss the new standard.

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Audit Committees and Financial Reporting 2017: Recent Developments and Current Issues

Co-Chairs: Catherine L. Bromilow – Partner, Governance Insights Center, PwC Linda L. Griggs – Consultant John F. Olson – Gibson, Dunn & Crutcher LLP

Join PLI on June 12 for a look at the rapidly changing responsibilities of the audit committee. Our expert faculty of government regulators, public company directors, audit committee members, lawyers and CPAs will give you the information and tools you need to successfully perform and meet the many challenges facing audit committees and boards today. You will benefit from their practical advice and real-world experience.

 

New York City and Live Webcast – June 12, 2017

Groupcast Locations: Atlanta, Boston, Cleveland, Philadelphia, Pittsburgh and Mechanicsburg – June 12, 2017

Key Topics Will Include:

  • The most important developments in the past year for audit committees, including SEC and PCAOB developments
  • Implications of the Trump administration on regulations implementing Dodd-Frank
  • Key accounting developments: important changes and GAAP/IFRS convergence update
  • How to build and maintain strong compliance programs
  • Ethical issues arising when advising audit committees

Special Feature:

  • Up to one hour of Ethics CLE credit

Credit Information: CLE, CPE, CPD and CFE Credit

Register Now!