Tag Archives: MD&A

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!

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!

Conflict Minerals Reporting Developments

By: George M. Wilson & Carol A. Stacey

 

As you may have heard, on April 3, 2017, the U.S. District Court for the District of Columbia entered final judgment in the on-going litigation over the Conflict Minerals Reporting Rule and remanded the case to the SEC.

 
This follows the action of the U.S. Court of Appeals for the District of Columbia Circuit, which in August of 2015 reaffirmed its prior holding that Section 13(p)(1) of the Securities Exchange Act and Rule 13p-1 “violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be “DRC conflict free”’. (Nat’l Ass’n of Mfrs., et al. v. SEC, No. 13-CF-000635 (D.D.C. Apr. 3, 2017))

 
Now that the decision has been remanded to the Commission, how this part of the statute and the related rule will be dealt with is uncertain. Since the requirement is part of the Dodd-Frank Act, the Commission is in a complex position. Even more uncertain is how companies should approach this part of the reporting process as they prepare to File Form SD by May 31 of this year.
To help companies deal with this situation the SEC has issued two Public Statements.

 
The first, a Public Statement by the Division of Corporation Finance, discusses how the SEC will approach the issue until further rule-making or other developments take place. CorpFin’s position is summarized in the following quote:

 
The court’s remand has now presented significant issues for the Commission to address. At the direction of the Acting Chairman, we have considered those issues. In light of the uncertainty regarding how the Commission will resolve those issues and related issues raised by commenters, the Division of Corporation Finance has determined that it will not recommend enforcement action to the Commission if companies, including those that are subject to paragraph (c) of Item 1.01 of Form SD, only file disclosure under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD. This statement is subject to any further action that may be taken by the Commission, expresses the Division’s position on enforcement action only, and does not express any legal conclusion on the rule.

 
In the Instructions to Form SD it is instruction (c) which requires “due diligence” if the “reasonable country of origin inquiry” determines that a company’s conflict minerals did or could have originated in the Democratic Republic of the Congo or one of the adjoining countries.

 
The second, a Public Statement by Acting Chairman Piwowar, discusses plans for future Commission action and expresses various thoughts about the cost and related enforcement aspects of the rule. In the Public Statement he says:

 
The Court of Appeals left open the question of whether this description is required by statute or, rather, is solely a product of the Commission’s rulemaking. The Commission will now be called upon to determine how to address the Court of Appeals decision – including whether Congress’s intent in Section 13(p)(1) can be achieved through a descriptor that avoids the constitutional defect identified by the court – and how that determination affects overall implementation of the Conflict Minerals rule.

 

I have accordingly instructed our staff to begin work on a recommendation for future Commission action. In preparing its recommendation, the staff will consider, among other things, the public comments received in response to the January 31, 2017 request for comment.

 

As always, your thoughts and comments are welcome!

The New Going Concern Disclosures – An Example

By: George M. Wilson & Carol A. Stacey

Sears, a storied retailer with a rich history, provides a perhaps not unexpected example of the new going concern disclosures in their recently filed 10-K. In their financial statements on page 66 of the 10-K you will find these disclosures:

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.

This, as the bolded sentence above illustrates, is an example of the situation where there is substantial doubt about the ability of Sears to continue as a going concern, but the substantial doubt is mitigated by the company’s plans. The new reporting requirement for going concern disclosures has a two path approach. The first is:

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):

  • 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)
  • Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  • Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

The second disclosure path is:

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:

  • Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
  • Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  • 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.

Sears provides us an interesting example and the delicate dance of the wording in their disclosure sheds light on how challenging this new requirement can be for companies.

And, to close the loop, here is the opinion paragraph from the auditor of Sear’s financial statements:

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.

As always, your thoughts and comments are welcome!

Communicate Consistently – It Really Does Matter

By: George M. Wilson & Carol A. Stacey

 
As we discuss in our workshops, it is crucial that companies communicate consistently across all the channels they use. Here are a couple of SEC comments that illustrate this point.

This first comment refers to articles in the news. Yes, the SEC staff does read the paper! This means that companies need to monitor news stories to assure that publically disseminated information is consistent with other disclosures.

General

  1. Recent articles indicate that Yahoo’s November 2014 agreement with Mozilla contains a change-in-control provision that provides Mozilla with the right to receive $375 million annually through 2019 if Yahoo is sold and Mozilla does not deem the new partner acceptable. As this provision appears to take the agreement out of the ordinary course of business, please provide us with your analysis of the materiality of this agreement for purposes of Item 601(b)(10) of Regulation S-K.

 

Here is another frequent theme, how the staff monitors earnings calls and other presentations.

Results of Operations, page II-7

 

  1. We note in your September 8, 2015 earnings call, your chief executive officer made reference to verbal commitments from customers to escalate contract prices when oil prices improve. Given the importance of the price of oil on your results, please tell us and consider disclosing in more detail whether such verbal commitments represent a known event. Refer to Item 303(a)(3)(ii) of Regulation S-K and SEC Release No. 33- 8350.

 

As a parting thought, have all the members of your disclosure committee, and in particular the persons involved in drafting and reviewing MD&A, reviewed your earnings calls as part of their process? (And yes, the second comment is one of our favorite MD&A topics!)

 

As always, your thoughts and comments are welcome!

When Disclosure Obligations Reach Beyond Financial Reporting

By: George M. Wilson & Carol A. Stacey

Good accounting requires good communication. Many times information that is well-removed from the financial reporting and accounting functions has impacts on the financial statements or other parts of the SEC reporting process, especially MD&A. The Sarbanes Oxley Act built on the internal accounting controls guidance in section 13(b) of the FCPA Act in expanding the evaluation, audit and reporting requirements for internal control over financial reporting, or ICFR, and creating the concept of disclosure controls and procedures, or DCP.

A recent enforcement action brings home, at this important year-end time, the importance of effective disclosure controls throughout the company, with perhaps redundant controls that search beyond traditional financial reporting functions for issues that may impact the financial statements or require disclosure in other parts of a periodic report. It reinforces the idea that responsibility for disclosure is a company-wide obligation, and that companies need to build reliable infrastructures to ensure that investors receive all of the information they are supposed to receive.

ICFR and its related requirements have been part of the reporting process for decades. ICFR is formally defined in Exchange Act Rule 13(a)-15 as:

a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

(1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

(2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and

(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

ICFR is all about the financial statements and that of course includes all of the relevant disclosures in the footnotes to the financial statements.

Here is how SOX expanded this process and formally defined disclosure controls in Exchange Act Rule 13(a)-15:

For purposes of this section, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

What is clear in this definition is that DCP relates to the entire report, not just the financial statements. And, both ICFR and DCP are relevant to the financial statements.

The terms “accumulate and communicate” are particularly relevant for this case. DCP clearly applies to the concept of a known trend in MD&A, which may not be relevant to the financial statements. It also applies to information that may be relevant to accounting for contingencies, even when that information is in an operational area.

In the enforcement case mentioned above the company paid “a $1 million penalty to settle charges that deficient internal accounting controls prevented the company from properly assessing the potential impact on its financial statements of a defective ignition switch found in some vehicles.” Further,

“[t]he SEC’s order finds that the company’s internal investigation involving the defective ignition switch wasn’t brought to the attention of its accountants until November 2013 even though other (company) personnel understood in the spring of 2012 that there was a safety issue at hand. Therefore, during at least an 18-month period, accountants at the (company) did not properly evaluate the likelihood of a recall occurring or the potential losses resulting from a recall of cars with the defective ignition switch.

This case clearly addressed accounting for contingencies and the related GAAP disclosures. In other situations there may not be a contingency disclosure, but there could be a known trend in MD&A. Both are relevant issues as we work through year-end. What this all builds to is that the disclosure process, including both ICFR and DCP, has to reach beyond the information required for financial statement reporting.

It is all about communication! And this might be a good time to communicate this issue to your disclosure committee and all the parts of your organization.

As always, your thoughts and comments are welcome!

Why, Oh Why, Is It Always Segments?

By: George M. Wilson & Carol A. Stacey

If you have been involved with SEC reporting for more than say, five minutes, you have heard about or discussed with someone the SEC’s focus on operating segments. Segment related disclosures are included in several Form 10-K Items, including:

Item 1 – Description of the business,

Item 2 – Properties,

Item 7 – MD&A, and of course

Item 8 – Financial Statements.

Almost every SEC conference or workshop addresses the importance of segment disclosures.

The latest segment “message” from the SEC is in the November 7, 2016 Accounting and Auditing Enforcement Release dealing with PowerSecure.

It is the same familiar message we heard in the Sony case in 1998 and the PACCAR case in 2013. When companies avoid making proper GAAP disclosures for operating segments to try and bury problems in one part of a business with profits from another part of their business, trouble will result.

In the “classic” Sony case the company used profits from its music business to mask problems in its movie business. This case also has a great known trend disclosure problem and becomes an almost scary “double trouble” example. To escalate this case to “triple trouble” the SEC also made it clear that Sony’s assignment of MD&A to the IR manager was not appropriate by naming that person in the case and forcing Sony to reassign this responsibility to the CFO. With all that was going on with Sony the SEC went so far as to require the company to engage its auditors to “examine” MD&A. Surprisingly, under the attest standards, auditors can issue a full opinion report on MD&A!

In the PACCAR case problems in new truck sales were hidden with profits from truck parts sales. This SEC Complaint includes a very detailed summary of the operating segment disclosure requirements, discussing in detail how PACCAR’s management viewed the business and how, in the SEC’s judgement, PACCAR was not following the GAAP requirements. It includes this language:

“However, in reporting its truck and parts results as a single segment, PACCAR did not provide investors with the same insight into the Company as PACCAR’s executives.”

This story line repeats in PowerSecure. For the periods in question PowerSecure reported one segment when that was not how management actually viewed the business:

“PowerSecure also misapplied ASC 280 by concluding that its CODM – who was determined to be the Chief Executive Officer (“CEO”) – did not regularly review operating results below the consolidated level to make decisions about resource allocations and to assess performance. This was inconsistent with the way in which the CEO regularly received, reviewed, and reported on the results of the business and how the company was structured. On a monthly basis, the CEO received financial results that reflected a measure of profitability on a more disaggregated level than the consolidated entity. Further, on a quarterly basis, the CEO met with each business unit some of the business unit leaders had business unit level budgets and forecasts and received incentive compensation based, at least in part, upon the results of their business unit.“

The message is clear, don’t use segments to try and hide problems! As a last reminder, don’t forget that these disclosure requirements may go to an even lower level than operating segments in MD&A. Regulation S-K Item 303 makes this clear:

“Where in the registrant’s judgment a discussion of segment information or of other subdivisions of the registrant’s business would be appropriate to an understanding of such business, the discussion shall focus on each relevant, reportable segment or other subdivision of the business and on the registrant as a whole.”

As always, your thoughts and comments are welcome!

 

Disclosure Effectiveness – The Saga Continues

By: George M. Wilson & Carol A. Stacey

A not so long, long time ago (OK, sorry Arlo Guthrie), and over a very reasonable period, the SEC began its Disclosure Effectiveness initiative. As you have likely heard (and can read about here), the Staff has sought comment and feedback about a variety of issues, including a lengthy release dealing with Regulation S-K and another dealing with various “financial statements of others” requirements in Regulation S-X.

The latest disclosure simplification development is a 26-page Staff report required by the FAST Act titled “Report on Modernization and Simplification of Regulation S-K”. It addresses a variety of areas ranging from properties to risk factors. Included are several interesting ideas such as requiring year-to-year comparisons in MD&A for only the current year and prior year and including hyperlinks to prior filings for prior comparisons.

The report is a thoughtful and interesting step in this challenging process.

As always, your thoughts and comments are welcome!

A Very Picky Reminder – ICFR and Accounting Standard Implementation Reporting

By: George M. Wilson & Carol A. Stacey

SAB 74 (SAB Codification 11-M) disclosures surrounding the new revenue recognition, leasing and financial instrument impairment standards have been receiving a lot of attention lately, especially with the SEC Staff announcement about them at the September EITF meeting.

This is not the only reporting that a new accounting standard might involve. Since these new standards could have an impact on ICFR, this is a good time to remember the requirements to report material changes in ICFR. These requirements apply to both Item 9A in Form 10-K and Part I Item 4 in Form 10-Q. They begin with 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. Is this the type of change 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:

  1. 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!

Three Years of Fun – Planning the “Big Three” New FASB Statement Transitions

by: George M. Wilson & Carol A. Stacey, SEC Institute

We have all heard about the major projects the FASB has completed in recent years. Together with their implementation dates for public companies and allowed transition methods they are:

Revenue recognition: January 1, 2018. (F/Y’s beginning after December 15, 2017)

Early adoption is allowed to the original effective date, F/Y’s beginning after 12/15/16). Either a retrospective or modified retrospective with a cumulative effect adjustment transition may be used.
Leases: January 1, 2019. (F/Y’s beginning after December 15, 2018)

Early adoption is allowed. A retrospective transition must be used. The retrospective approach includes several practical accommodations.

Financial Instrument Impairment: January 1, 2020 (F/Y’s beginning after December 15, 2019)

Early adoption to years beginning after December 15, 2018 is allowed. The transition method is essentially a “modified retrospective approach with a cumulative effect adjustment” with adjustments for certain types of financial instruments.
The revenue recognition and lease changes have been widely discussed, but the financial instruments impairment change has not been as “hot” a topic. It could be problematic for some companies as it will apply to all financial instruments, including accounts receivable. Many companies could face significant challenges gathering the information to move from the current incurred loss model to the new expected loss model.
While the impact of each new standard will vary from company to company, every company needs to think about how to manage these three transitions. Will it be best for your company to adopt all three at once, or will it be best to adopt them sequentially? Or perhaps mix and match a bit?
There are several considerations in these implementation date decisions. How they will affect investor relations is a major issue. The time and other resources required, systems issues and ICFR impact are among the other inputs to this decision. Each company has to evaluate these considerations based on their own circumstances.
Given the potential magnitude of these changes and their widespread discussion in the reporting environment, disclosures about these changes have become more and more important to users. With the recent SEC Staff Announcement at the September EITF meeting about SAB 74 (SAB Codification Topic 11-M) disclosures, disclosing where you are in this process has become almost required. The more or less simple “standard” disclosures about “we have not selected a transition method” and “we do not yet know the impact” may not be enough. Qualitative information about where you are in the process may be a required disclosure.

There are strong incentives to move diligently on these transitions and to tell investors where you are in the process. And, anyway, who really wants to look unprepared?
Three years of sequential fun or big change? Spread it out or rip off the Band-Aid? Slow burn or big bang? We all get to decide what will be best for our company and our investors, the key issue is to make this decision on a timely basis!

 

As always, your thoughts and comments are welcome!