One Last Year-End Check – Frequent Problem and Restatement Areas

At this point in the year-end process most of us have numbers in place and are working on the final steps in reporting.  As you move toward final reviews, we share with you Audit Analytics’ list of high-risk financial reporting areas that can hopefully help you avoid reporting problems.

For the last 17 years Audit Analyticshas done an exhaustive review of public company restatements.  Their report “2017 Financial Restatements – A Seventeen Year Comparison” has an amazing wealth of information about numbers of restatements, types of restatements and trends over time.

For purposes of this post, the most meaningful information is the list of underlying areas that were involved in the 553 restatements made in 2017.  These are the areas that clearly present the highest risks of misstatement in financial reporting, and warrant a bit of extra review before issuance of financial statements.

Here are the top ten items on Audit Analytics’ list for 2017:

Number and Percentage of
Area                                                                                                                          Restatements

Debt, Quasi debt, Warrants & Equity (BCF) Security Issues               87        15.7%
Revenue Recognition Issues                                                                           77        13.9%
Tax Expense/Benefit/Deferral/Other Issues                                             77        13.9%
Cash Flow Statement Classification Errors                                               72        13.0%
Liabilities, Payables, Reserves and Accrual Estimate Failures         63        11.4%
Expense (payroll, SGA, other) Recording Issues                                     59        10.7%
Foreign, Related Party, Affiliated or Subsidiary Issues                        53          9.6%
Accounts/loans Receivable, Investments & Cash Issues                    47          8.5%
Acquisitions, Mergers, Disposals, re-org Acct Issues                           45         8.1%
Deferred, Stock-based and/or Executive Comp Issues                       40          7.2%


Note, the list goes on to include 14 other causes of restatements, but we are focusing on the top 10 here as the highest risk areas.

If you made tough calls in any of these areas, here is a reminder to be sure all the i’s are dotted, and t’s are crossed.  Hope this helps!

As always, your thoughts and comments are welcome!

A Year-End Reporting Question: Does a Material Weakness Mean the Financial Statements Are Misstated?

On December 11, 2018, the SEC announced settled chargesagainst a natural and organic food company, Hain Celestial Group.  The company’s problems began when members of the company’s finance group discovered that its sales organization had been offering unauthorized incentives to two major customers.  These incentives induced the customers to accept shipments near quarter-end that helped the sales department meet internal sales goals.

When the finance department discovered these unauthorized practices they began an investigation and appropriately involved the company’s audit committee.  In August 2016, when the company determined that the amount involved was likely material, they self-reported the problem to the SEC.  On the same day they announced the problem to the public and indicated they would not be able to file their SEC reports until an appropriate investigation could be completed.

The company did not file periodic reports until June 2017, at which time they filed their 10-K and also caught up their 10-Qs.  One very interesting aspect of the reports is that the company determined that there were no material misstatements in any prior periods.  The 10-K they filed had no restated financial statements.  That said, the company concluded that there was in fact a material weakness in internal control over financial reporting.

This clearly makes sense. The existence of a material weakness does not mean that a material error has occurred.  It means, as the definition of a material weakness states, that there “is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.”  The risk a misstatement will not be detected is different from the risk that a misstatement will occur.

You can read the Form 10-K with the related disclosures here.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Ten – A Quick Reminder About S-X Rule 3-13 Waivers

In November and December 2018, SEC Chair Clayton, Chief Accountant Bricker and several other staff members discussed the use of S-X Rule 3-13 waivers.  These waivers may be appropriate when a mechanical application of rules like the significant subsidiary test yield results that may require costly disclosures that might not be material to investors.  All of the SEC speakers emphasized that such waivers require thorough analysis and are not automatic.  The SEC staff has processes in place to respond to these requests in a timely manner.

If you want to review the details of this process you can check out this post from December 2017, and this update in April 2018.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Nine – FEI Insights About Changes in ICFR for New Accounting Standards

As companies worked through the implementation of the new revenue recognition standard they dealt with two issues surrounding ICFR:

What changes were required to ICFR for this new standard, and

Whether or not these changes to ICFR required reporting a material change in ICFR.

Reporting material changes in ICFR is a requirement in both Form 10-K and Form 10-Q and involves substantial amounts of judgment.  This postreviews the details of this requirement.

As we grapple with the new Lease and Credit Losses standards, to help us with the ICFR change process, FEI published two research studies in November 2018:

A Lessee’s Guide to Implementing Internal Control over Financial Reporting for contracts accounted for under Accounting Standards Codification (ASC) 842, Leases


A Guide to Implementing Internal Control over Financial Reporting for the Current Expected Credit Loss (CECL) Standard.

The reports were issued by FEI’s Committee on Corporate Reporting (CCR).  (Our workshop leader Reed Wilson is a member of CCR, and thanks to him for the heads-up about these reports).  Both are designed to help companies anticipate ICFR issues they may encounter as they implement these new standards and also provide examples for documentation and processes.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Eight – Recent Guidance from the Office of the Chief Accountant

The staff in the SEC’s Office of the Chief Accountant recently provided their insights on a number of issues based on recent consultations with companies, their auditors and other groups within the SEC.  They shared these observations in speeches which you can find on this section of the SEC’s webpage.

The issued discussed by the OCA staff included:

Internal control over financial reporting (“ICFR”) – evaluation of control deficiencies.

Internal control over financial reporting (“ICFR”) – preparation of material weakness disclosures.

Internal control over financial reporting (“ICFR”) – evaluation of operating effectiveness of controls

New revenue standard (Topic 606) – observations on the identification of performance obligations

New revenue standard (Topic 606) – evaluating the existence of a significant financing component.

New revenue standard (Topic 606) – application of the principal versus agent guidance

New revenue standard (Topic 606) – identification of performance obligations

New leases standard (“Topic 842”) – Lessee transition – minimum rental payment composition policies

New leases standard (“Topic 842”) – Lessee transition – minimum rental payment measurement policies

New leases standard (“Topic 842”) – Certain lessee and lessor costs

New credit losses standard (“Topic 326”) – Accounting policy for loan charge-offs upon the adoption of the new credit losses standard

New credit losses standard (“Topic 326”) – Application of subsequent events guidance following adoption of the new credit losses standard

The shift from the London Interbank Offered Rate (LIBOR)

If you are currently dealing with any of these issues you will find examples and the staff’s positions on these issues in the related speeches.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Seven – The Financial Reporting Big Picture and the Bricker Blueprint

At the AICPA’s December conference, Chief Accountant Wesley Bricker’s remarks included a suggestion that this Statement would be valuable reading for professionals involved in the reporting process.  The Statement includes a summary of recent OCA activities, reviews priorities such as fostering ICFR and exercising effective oversight over accounting and auditing standard setting, and also discusses the OCA consultation process.

In addition to providing the Statement, Mr. Bricker and Chair Clayton also displayed and emphasized the importance of what Chair Clayton named the “Bricker Blueprint.” This is the comprehensive summary of all the participants in the process of providing reliable financial information to our capital markets.  If you have not seen this document before, it is a great review of how our system works and the importance of each participant.  You can find a video overview of the process and the “Blueprint” here.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Six – An SEC Comment Challenging Materiality Judgments

Materiality is always one of the most complex judgments we make.  You can check out some background in these earlier posts about materiality considerations, SAB 99 and related issues.

As a year-end thought, here is a March 2018 comment about materiality judgments:

Note 1 – Organization and Summary of Significant Accounting Policies, page 43

  1. We note that in fiscal 2017 you revised your March 31, 2016 balance sheet for an error in the historical carrying value of inventory which you believe was not material to any previously issued consolidated financial statements. However, we note that this $1.5 million overstatement of inventory appears quantitatively significant in comparison to the $0.2 million pre-tax loss of fiscal 2016 and $2.2 million pre-tax tax loss of fiscal 2015.

In order to assist us in understanding your disclosure, please provide us with the following additional information:

  • tell us the specific nature of these errors, how long inventory balances were not accurately costed, when and how you discovered them.
  • provide the impact of the error on fiscal 2016 and 2015 and your analysis regarding how you determined these errors were both quantitatively and qualitatively immaterial to previously reported periods including quarterly financial statements. Please refer to SAB Topics 1.M. and 1.N.

The company’s response, which is detailed and lengthy, is here.

The next step was the SEC’s closing letter, with no further comments.

As always, your thoughts and comments are welcome!

Preparing for Year-End 2018: Number Five – Are Market Risk Disclosures Getting More Scrutiny?

One area where companies have not received many SEC comments – and, in all honesty, we don’t like to think about much – is market risk disclosures in Item 7A of Form 10-K and Part 1 – Item 3 in Form 10-Q.  In this time of more volatile markets this forward-looking disclosure about the extent of risk is becoming more important.

We have recently seen three comment letters with questions about market risk disclosures.  In a June 27, 2018 letter the only comment the company received was this market risk question:

Item 7A. Quantitative and Qualitative Disclosures about Market Risk, page 60

  1. Please tell us how you determined it was unnecessary to provide quantitative disclosures about foreign currency exchange risk. Please refer to Item 305 of Regulation S-K.

Another June 27, 2018 letter contained this comment:

Form 10-K for the Fiscal Year Ended December 31, 2017

Market Risks, page K-29

We note that you are exposed to market risk related to the fluctuations of interest rates on your fixed and floating-rate debt instruments, i.e. interest rate risk. Please revise your future filings to disclose the interest rate risk with respect to your fixed rate debt instruments using one of the three disclosure alternatives as prescribed under Item 305(a) of Regulation S-K.

In an August 29, 2018 letter a company received this market risk comment:

  1. We note that you are exposed to the following market risks: interest rate risk related to your debt instruments, foreign currency exchange rate risk related to your construction contracts denominated in euros, and fuel price risk related to your operations. Please revise your future filings to disclose for all market risks the quantitative information for the preceding fiscal year along with the reasons for material changes in amounts from the preceding year. Refer to 305(a)(3) and Instruction 3(F) to Item 305(a) of Regulation S-K.

Market risk disclosures as required by Regulation S-K Item 305 are one of the more complex and least understood disclosures required in periodic reports.  Part of the issue with these disclosures is that they are entirely forward looking and are designed to help investors understand how much a future price or rate change could affect the business.  This post from 2015walks though the objectives of the disclosure and breaks down the S-K Item 305 requirements.

While there is not a lot of public discussion about market risk, in this time of more volatile markets it is not unexpected that it should get more emphasis.  We would suggest taking a fresh look at your disclosures to be sure they are on-point.

As always, your thoughts and comments are welcome!

Non-GAAP Fines? Yes! Don’t Forget “Equal or Greater Prominence”!

On December 26, 2018, the SEC levied a fine on a company that failed to follow the Regulation S-K Item 10 (e) guidance concerning the use of non-GAAP measures.  Specifically, the company did not present the most directly comparable GAAP measure with equal or greater prominence in the headline and highlights in two of its earnings releases.

As you can read about here, the issue was aggravated because while the company touted increases in non-GAAP measures such as adjusted EBITDA, which showed “profitability” in the headline and highlights of its earnings releases, the comparable GAAP measure, net loss, had actually worsened.  It clearly raises concerns when a non-GAAP measure shows profitability and the comparable GAAP measure shows a loss and where the measures are moving in different directions.

The company agreed to pay a fine of $100,000.

As always, your thoughts and comments are welcome!