Tag Archives: SEC Reporting Skills Workshop

Form S-3 and the New Revenue Recognition Standard

The new revenue recognition standard allows for two transition methods. One is a kind of hybrid “retrospective with a cumulative effect” approach, where in the year of adoption a company records the cumulative effect and goes forward (with some significant “old GAAP” disclosures). The other is full retrospective implementation.

The full retrospective implementation comes with a lot of baggage beyond the amount of work it might require.

One question is what about the five-year summary? In Form 10-K is it necessary to retrospectively adjust the two earliest years in the five year summary along with the three years in S-X audited financial statements? The SEC staff has addressed this question and said this is not necessary. The CorpFin Financial Reporting Manual now states:

11100 REGISTRANT FINANCIAL INFORMATION

 

11100.1 Selected Financial Data

 

Question

A registrant elects to adopt the new revenue standard using the full retrospective approach. Must it apply the new revenue standard when reporting selected financial data (S-K Item 301)) for periods prior to those presented in its retroactively-adjusted financial statements?

 

Answer

No, but registrants must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented.

This second question is a lot more intricate. What if a company does an S-3 after the first quarter of implementation? To set this issue up, here is a fact set:

Company year-end: December 31

Revenue Recognition Standard adoption date: January 1, 2018

Full retrospective method of adoption is used. In this method, for the 2018 Form 10-K the years 2016, 2017 and 2018 would be presented using the new revenue recognition standard.

Now assume that in 2018 (thus before the December 2018 Form 10-K is filed), the company reports for the first quarter of 2018 and files Form 10-Q on April 30, 2018. If the company then files an S-3 to raise capital on May 31, 2018, the previous Form 10-K for the year ended December 31, 2017, would be incorporated into the Form S-3. That Form 10-K would have financial statements for 2017, 2016 and 2015. The financial statements for 2015 are the key issue here, as they would not be required in the December 31, 2018 Form 10-K. But, since they are incorporated into the S-3 and the company has adopted the new revenue recognition standard, Item 11(b) in Form S-3 will apply (emphasis added):

 

Item 11. Material Changes.

 

(a) Describe any and all material changes in the registrant’s affairs which have occurred since the end of the latest fiscal year for which certified financial statements were included in the latest annual report to security holders and which have not been described in a report on Form 10-Q (§249.308a of this chapter) or Form 8-K (§249.308 of this chapter) filed under the Exchange Act.

 

(b) Include in the prospectus, if not incorporated by reference therein from the reports filed under the Exchange Act specified in Item 12(a), a proxy or information statement filed pursuant to Section 14 of the Exchange Act, a prospectus previously filed pursuant to Rule 424(b) or (c) under the Securities Act (§230.424(b) or (c) of this chapter) or, where no prospectus is required to be filed pursuant to Rule 424(b), the prospectus included in the registration statement at effectiveness, or a Form 8-K filed during either of the two preceding years:

 

(i) information required by Rule 3-05 and Article 11 of Regulation S-X (17 CFR Part 210);

 

(ii) restated financial statements prepared in accordance with Regulation S-X if there has been a change in accounting principles or a correction in an error where such change or correction requires a material retroactive restatement of financial statements;

 

(iii) restated financial statements prepared in accordance with Regulation S-X where one or more business combinations accounted for by the pooling of interest method of accounting have been consummated subsequent to the most recent fiscal year and the acquired businesses, considered in the aggregate, are significant pursuant to Rule 11-01(b), or

 

(iv) any financial information required because of a material disposition of assets outside the normal course of business.

 

This would seem to require that the new revenue recognition standard be applied to the year ended December 31, 2015.

Not a happy outcome!

This question has come up in earlier accounting standard transitions, and the SEC Staff is clearly aware of this issue. Wes Bricker, Deputy Chief Accountant, said this in a recent speech:

“I am also aware that registrants have expressed concern about the requirement to provide restated financial statements when a Form S-3 registration statement is filed after the registrant has filed its first Form 10-Q reflecting adoption of the revenue standard. This requirement to restate the financial statements means that companies that adopt the revenue standard under a full-retrospective transition approach would be required to restate an additional year in its Form S-3 to show the effect of the new revenue standard on that earlier period.

While this issue is not specific to the new revenue standard, the pervasive impact of the new revenue standard amplifies the issue.

To this, I would observe the transition provisions in the new revenue standard reference existing GAAP, which provides for an impracticability exception to retrospective application if, for example, a company is unable to apply the requirement after making every reasonable effort to do so. OCA is available for consultation if a registrant believes that, based on its facts and circumstances, a retrospective application of the new revenue recognition standard to all periods required to be presented in a Form S-3 is impracticable.”

The actual language he refers to in the excerpt above is from ASC 250:

250 – 10 – 45 – 5

An entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.

And:

Impracticability

250 – 10 – 45 – 9

It shall be deemed impracticable to apply the effects of a change in accounting principle retrospectively only if any of the following conditions exist:

  1. After making every reasonable effort to do so, the entity is unable to apply the requirement.
  2. Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
  3. Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
  4. Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
  5. Would have been available when the financial statements for that prior period were issued.

That’s where this issue is for now, and this could well be a problematic issue for any company raising capital in the year of adoption of the new revenue recognition standard!

As always, your thoughts and comments are welcome!

SEC News – The FAST Act Form 10-K Summary

The SEC, on June 1, 2016, adopted an Interim Final Rule and Request for Comment to implement the Form 10-K summary provisions of The FAST Act. Passed earlier this year, the FAST Act contains a number of SEC reporting requirements, many of which the SEC has already implemented.

 

The Interim Final rule provides that a company may, at its option, include a summary in its Form 10-K. Each item in the summary must include a cross-reference by hyperlink to the material contained in the company’s Form 10-K to which the item relates.

 

The summary is a new Item 16 in Form 10-K:

 

Item 16. Form 10-K Summary.

 

Registrants may, at their option, include a summary of information required by this form, but only if each item in the summary is presented fairly and accurately and includes a hyperlink to the material contained in this form to which such item relates, including to materials contained in any exhibits filed with the form.

 

Instruction: The summary shall refer only to Form 10-K disclosure that is included in the form at the time it is filed. A registrant need not update the summary to reflect information required by Part III of Form 10-K that the registrant incorporates by reference from a proxy or information statement filed after the Form 10-K, but must state in the summary that the summary does not include Part III information because that information will be incorporated by reference from a later filed proxy or information statement involving the election of directors.

 

 

While perhaps not particularly dramatic, this is a nice step towards making Form 10-K a better communication tool, which is of course a big part of the disclosure effectiveness activities of the SEC. We could even debate whether such a rule is necessary as some companies, GE in particular, already provides such a summary.

 

You can read the Interim Final Rule and request for comment here.

 

And, if you have not read it recently, Carol and George, your bloggers, suggest taking a look here at the GE Form 10-K. You will find it interesting and the summary is on page 217.

 

As always, your thoughts and comments are welcome!

 

Ever Been to an SEC Event? Mark out April 13 for a webcast!

In our workshops we sometimes joke (a bit) about how fun it is to listen to a webcast of an SEC meeting. And yes, we do say the same thing about FASB meetings. (Total Geek-Out For Sure!)

These meetings are interesting in that you can observe the process the SEC Commissioners and the FASB follow. The depth of the discussions and their careful consideration of the issues is always fascinating to observe.

These meetings generally do not tell you what might happen in the short-term, but do provide a longer-term glimpse into the directions of policy-making and standard setting.

Disclosure effectiveness is a major longer-term initiative at the SEC right now. On April 13, 2016 the SEC is going to discuss “whether to issue a concept release seeking comment on modernizing certain business and financial disclosure requirements in Regulation S-K.”

As you know, this kind of change is something the SEC staff has wanted to do for years. In addition, provisions of both the JOBS Act and the FAST Act focused on disclosure effectiveness. And here is the logical next step – this meeting will likely help illuminate the future direction of disclosure effectiveness.

 

In addition, this meeting may offer ideas that you can implement now to help make your disclosure more direct and useful to investors.

 

So, perhaps this is the time to listen to one of the meetings? You could play it on your computer, have the sound coming out of your speakers, and think how many of your colleagues would join you and listen! SEC Party time perhaps? If you can’t make the live webcast, you can find all of the archived meetings at http://www.sec.gov/news/openmeetings.shtml

 

You can learn more at:

sec.gov/news/openmeetings/2016/ssamtg033016.htm

 

where the original meeting was announced and at:

www.sec.gov/news/openmeetings/2016/ssamtg041316.htm

where the date was changed from March 30 to April 13, 2016.

 

As always, your thoughts and comments are welcome!

Known Trends and Self-Fulfilling Prophecies

Forewarning disclosures, the “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” are one of the topics we discuss occasionally in our blog posts. This MD&A disclosure can be very problematic because the information disclosed may alarm investors or make management nervous about creating a “self-fulfilling prophecy”.

We are always watching how companies deal with these issues, and here are two examples from both ends of the potential disclosure spectrum.

The first example, dealing with goodwill impairment, is from a company that has been in the news a lot lately, Yahoo. Along with all the issues they have dealt with involving their investment in Alibaba, Yahoo continues to work on building their core business. As part of this process in June of 2013 they acquired Tumblr, the blog-hosting website. The purchase price was $990 million and in connection with the acquisition Yahoo recorded $749 million in goodwill. (See note 4 about acquisitions in the consolidated F/S in the 2015 10-K)

Fast forward the acquisition to December 31, 2015 and in note 5 to the consolidated F/S dealing with impairments Yahoo says:

As identified above, in step one, in 2015, the carrying value of the U.S. & Canada, Europe, Tumblr and Latin America reporting units exceeded the estimated fair value. The Company completed an assessment of the implied fair value of these reporting units, which resulted in an impairment of all goodwill for the U.S. & Canada, Europe, and Latin America reporting units and a partial impairment for the Tumblr reporting unit. The Company recorded goodwill impairment charges of $3,692 million, $531 million, $230 million and $8 million, associated with the U.S. & Canada, Europe, Tumblr, and Latin America reporting units, respectively, for the year ended December 31, 2015. The impairments were a result of a combination of factors, including a sustained decrease in our market capitalization in fourth quarter of 2015 and lower estimated projected revenue and profitability in the near term.

 

So, from June 2013 to December 31, 2015 the $749 million in Tumblr related goodwill was reduced by $230 million. In the tech world, these things happen.

But what about the future? In an interesting spot, Critical Accounting Estimates in their 2015 10-K MD&A Yahoo included this statement:

Given the partial impairment recorded in our Tumblr reporting unit in 2015, it is reasonably possible that changes in judgments, assumptions and estimates we made in assessing the fair value of goodwill could cause us to consider some portion or all of the remaining goodwill of the Tumblr reporting unit to become impaired, which comprised $519 million of our remaining $808 million goodwill balance as of December 31, 2015. In addition, a future decline in market conditions and/or changes in our market share could negatively impact the estimated future cash flows and discount rates used in the income approach to determine the fair value of the reporting unit and could result in an impairment charge in the foreseeable future.

 

This is a direct warning, using the S-K words “reasonably possible”.

 

Here is the second example. These comments are from a letter to a retailing company, and you can see the SEC is asking whether the company effectively dealt with an uncertainty in their future:

  1. Please expand this section to discuss any known material trends, events or uncertainties that have had or are reasonably expected to have a material impact on your liquidity or revenues or income from continuing operations. In this regard, we note (i) persistent comparable store sales decreases in fiscal year 2014 and through the first three quarterly periods of 2015 and (ii) that the company has scaled back its previously planned strategic retail expansion for fiscal year 2016 and beyond.

We also note management’s concern, as expressed in recent earnings calls, regarding the cannibalization effect from new retail stores, coupled with softer than expected new store performances. Please discuss whether you expect comparable store sales to continue to decrease, due to continued cannibalization or otherwise, and the short and long-term actions that you are taking to address any perceived trends. In this regard, your discussion should address your past and future financial condition and results of operation, with particular emphasis on the prospects for the future. See Item 303(a) of Regulation S-K and SEC Release No. 33- 8350.

 

One really interesting part of this comment is how the staff went well beyond the company’s filings to information disclosed in earnings calls.

 

 

As always, your thoughts and comments are appreciated!

The New Revenue Recognition Standard – When to Start Implementation?

Implementing the new revenue recognition standard is a major challenge that many of us face between now and January 1, 2018 (or whatever fiscal year you have that begins after that date of course.) Many professionals are happy to be close to retirement at this point in time!

With the magnitude of the change in this new standard, including the significantly expanded disclosures which apply to everyone, when is the appropriate time to begin implementation efforts? This is a very complex question. There are still some moving parts as the FASB and IASB continue to make changes to the final standard. The new standard can have varying impacts across companies depending on such issues as complexity of contracts, how product is delivered, do you have software licenses, and principal versus agent issues, to name a few. While the TRG has addressed many issues, there are only a few left to be resolved. While this may seem to be a good sign, the SEC staff has stated concerns that there are not more issues being raised, attributing the low number as a sign that perhaps implementation initiatives are not far enough along or are not being elevated to the TRG (see the September 17th speech by Wesley Bricker, Deputy Chief Accountant in the SEC’s Office of Chief Accountant at: http://www.sec.gov/news/speech/wesley-bricker-remarks-bloomberg-bna-conf-revenue-recognition.html)

There is much discussion about when to begin implementation discussions. To date there has not been much hard data about what companies are actually doing. The Financial Executives Research Foundation (FERF), which is an affiliate of FEI, and PwC have teamed up to survey companies about this issue.

As nearly as we can tell, this is the first really good data about where companies are in the implementation process. You can find the study at:

www.pwc.com/us/revrecsurvey

The survey deals with a number of issues surrounding the impact and implementation of the new standard. It is a good read, and worth spending some time digesting. Here are a couple of things to ponder while you read.

  1. Do you have a reasonable understanding of how the new standard will affect your accounting and disclosure?
  2. What resources will you need in this effort?
  3. What level of organizational involvement across functional areas will be necessary (e.g., sales, legal, etc.)?

As always, your comments and thoughts are welcome!