Materiality – A Refresher and Reminder

 

By: George M. Wilson, SEC Institute

Materiality is one of the most challenging judgments we have to make in our period-end reporting. Few areas in our financial reporting world are as subjective and difficult to interpret. An issue that makes materiality judgments even more complex is that if, in a later period, someone (the SEC for example!), wants to evaluate or second guess our judgment, it is always with 20-20 hindsight.

 

We need to be thoughtful and complete in our analysis and documentation for every materiality judgment we make.

 

Where is the official guidance we should cite in our white paper to document materiality decisions?

 

From a US GAAP perspective you may remember that as part of its Conceptual Framework project the FASB was considering making some changes to the definition of materiality in the GAAP literature. At the Board’s November 8, 2017 meeting they decided not to make changes and instead use the existing definition from old, now superseded, Concept Statement 2:

 

Materiality

 

Materiality is a pervasive concept that relates to the qualitative characteristics, especially relevance and reliability. Materiality and relevance are both defined in terms of what influences or makes a difference to a decision maker, but the two terms can be distinguished. A decision not to disclose certain information may be made, say, because investors have no need for that kind of information (it is not relevant) or because the amounts involved are too small to make a difference (they are not material). Magnitude by itself, without regard to the nature of the item and the circumstances in which the judgment has to be made, will not generally be a sufficient basis for a materiality judgment. The Board’s present position is that no general standards of materiality can be formulated to take into account all the considerations that enter into an experienced human judgment. Quantitative materiality criteria may be given by the Board in specific standards in the future, as in the past, as appropriate.

 

So, the Board’s new Concept Statement 8 will have a definition close to the words above.

 

As a next reference point, Regulation S-X, Rule 1.02(o) provides this definition of material:

 

(o) Material. The term material, when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters about which an average prudent investor ought reasonably to be informed.

 

Obviously, this is not a simple definition to interpret and apply. It emphasizes the need for thoughtful, careful judgment when evaluating materiality. The SEC issued SAB 99, codified as SAB Topic 1-M, to provide more guidance as we make materiality judgments. SAB 99 quotes a Supreme Court Decision that held that a fact is material if there is:

 

a substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available

 

This SAB also clearly articulates that materiality is not simply a quantitative concept:

 

“In the context of a misstatement of a financial statement item, while the “total mix” includes the size in numerical or percentage terms of the misstatement, it also includes the factual context in which the user of financial statements would view the financial statement item. The shorthand in the accounting and auditing literature for this analysis is that financial management and the auditor must consider both “quantitative” and “qualitative” factors in assessing an item’s materiality”

 

Not surprisingly, the CorpFin Staff writes comments about materiality. As you can see in this comment, the Staff will actually ask for your SAB 99 white paper:

 

We have the following comments on your use of incorrect translation rates for reporting U.S. Dollar value of goodwill held by foreign subsidiaries:

 

Please tell us the date you determined this error, clarify how this error arose, and identify the periods affected by this error;

Please clarify impact, if any, the correction of this error had on your reported $(287,524) foreign currency translation adjustment for the three months ended December 30, 2016;

Provide us with your sufficiently detailed SAB 99 materiality analysis to support how you determined that effected accounts were not quantitatively or qualitatively material to any of the affected periods; and

Tell us how the errors impacted the previous conclusions regarding disclosure controls and procedures and internal control over financial reporting.

 

Just in case you were wondering how far a materiality issue can go, check out this enforcement case involving Gemstar and its auditors. (Yes, it is a classic!) Here is a quote from the release:

 

The auditors’ materiality determinations were unreasonable in that they were based on a quantitative analysis and failed to consider whether the revenues at issue were qualitatively material.

 

When we make difficult decisions the 20-20 hindsight factor is always in our minds. The best way to deal with this hindsight factor is to make a thoughtful judgment using all the facts available to us in the moment, and then to document all our considerations. We need to clearly and completely articulate all the relevant facts and information, enumerate quantitative issues, describe qualitative issues, and come to an overall conclusion that is consistent with all the above guidance.

 

As always, your thoughts and comments are welcome!

 

A Big Day Coming Up for the FASB

By: George M. Wilson, SEC Institute

The FASB has a meeting scheduled for Wednesday, February 7 at 9 am (EST) that will deal with a broad array of topics and will be of interest to many of us. The agenda includes:

 

  1. Collaborative arrangements—targeted improvements
  2. Segment reporting
  3. Ratification of an EITF consensus-for-exposure (cloud computing costs)
  4. Reclassification of certain tax effects from accumulated other comprehensive income
  5. Disclosure framework: disclosure review—fair value measurement
  6. Open discussion

 

You can find more details about the meeting agenda here. And, in case you are looking for a super fun way to spend Wednesday morning (be sure to have coffee and donuts for the crowd you will attract), you can learn about how to watch the webcast of the meeting here!

 

As always, your thoughts and comments are welcome!

An SEC MD&A Comment Example

By: George M. Wilson, SEC Institute

Many of us are finalizing disclosures in our Form 10-K (or perhaps a 10-Q) for December 31, 2017. Here is a reminder and issue to consider as you review your MD&A.

In our workshops when we discuss the SEC review process for MD&A we always mention the Staff’s focus on deeper analysis of causal factors and drivers in MD&A. Here is an SEC comment that highlights both issues. It presents a nicely balanced approach based on the nature of the company’s business to the issues raised by the Staff.

The Staff’s Comment:

 

  1. We note that your discussion of results of operations identifies certain events and trends affecting revenues and expenses. However, your current discussion lacks sufficient analysis and quantification of the underlying reasons for changes in your results of operations. For example, you state that for the year ended February 2, 2014, revenue increased $54.9 million from the net addition of 53 stores and Blue Tomato sales during fiscal 2013 that were not comparable to the prior year, partially offset by the effect of the 53rd week included in fiscal 2012 results and comparable store sale decrease of 0.3% for fiscal 2013. Please provide expanded discussion of the underlying reasons of your revenue growth, including quantified information with respect to key drivers such as price, volume and other key variables that management uses to manage the business. Also, please expand the discussion of results of operations for all periods discussed to quantify the effect of the events disclosed and to describe their underlying causes. For additional guidance, please refer to SEC Release 33-8350, available on the SEC website at www.sec.gov./rules/interp/33-8350.htm. Please provide a draft of your proposed disclosure.

 

The Company’s Response

We believe that our discussion of the results of operations identifies and discloses the key performance indicators used to manage our business and that we believe are material to our investors. In particular, as a retailer that offers a diversity of merchandise, including men’s and women’s apparel, footwear, accessories and hardgoods, the sales results of any one product category are not material to understanding our results of operations. Rather, we believe that due to our diversification model, comparable sales is a key performance indicator. Accordingly, in response to the Staff’s comment, we will provide additional disclosures on the quantification of our net sales results by comparable sales, geographic region, new stores and other relevant categories (such as the presence of an additional week during a fiscal period) in future filings. As an example, please refer below for our expanded quantification of the reasons for our revenue growth related to fiscal 2013 compared with fiscal 2012 (emphasis on modifications added):

Fiscal 2013 had 52 weeks versus 53 weeks in fiscal 2012. Net sales numbers for fiscal 2012 include an additional week and fiscal 2013 comparable sales are compared to the comparable sales for the 52 weeks ended February 2, 2013. Net sales were $724.3 million for fiscal 2013 compared to $669.4 million for fiscal 2012, an increase of $54.9 million or 8.2%. The increase reflected a $65.9 million increase due to the net addition of 53 stores (made up of 53 new stores in North America and six new stores in Europe offset by six store closures in North America) and Blue Tomato sales during fiscal 2013 that were not comparable to the prior year, partially offset by a $9.3 million decrease due to the impact of the 53rd week included in fiscal 2012 results and a $1.7 million decrease due to comparable sales for fiscal 2013. By region, North American sales increased $35.2 million and European sales increased $19.7 million during fiscal 2013 compared to fiscal 2012.

The 0.3% decrease in comparable sales was a result of a 1.0% decrease for our comparable in-store sales, partially offset by a 5.4% increase for our comparable ecommerce sales. Total ecommerce sales represented 12.3% of sales for fiscal 2013, compared to 11.2% of sales for fiscal 2012, increasing due to Blue Tomato ecommerce sales that were not comparable to the prior year and the growth in comparable ecommerce sales mentioned above. The decrease in comparable sales was primarily driven by a decline in comparable transactions, partially offset by an increase in dollars per transaction. Dollars per transaction increased due to an increase in units per transaction, partially offset by a decrease in average unit retail due to changes in sales product mix. Comparable sales decreases in men’s apparel, footwear and boy’s apparel were partially offset by comparable sales increases in junior’s apparel, hardgoods and accessories. For information as to how we define comparable sales, see “General” above.

Furthermore, we will continue to review our discussion on results of operations and enhance the disclosure to provide analysis and quantification, as appropriate, in accordance with SEC Release 33-8350.

 

 

As always, your thoughts and comments are welcome!

 

Cybersecurity – The SEC’s Official Guidance

By: George M. Wilson, SEC Institute

Cybersecurity risk is an important “hot topic” in period-end reporting. In our workshops we sometimes find that many people are not aware that the SEC has issued guidance about cybersecurity disclosures.

 

As a period-end reporting reminder, don’t forget to review CorpFin Disclosure Guidance Topic 2 as you address cybersecurity risk. The SEC, both at the staff and Commission level, have recently reiterated that they believe this guidance from 2011 is on-point for disclosure in the current environment. There have been some discussions about whether to move this from a CorpFin document to a more official Commission Release, but there has been no formal activity to date.

 

As you read the Disclosure Guidance Topic you will see it suggests that you should tailor information to your circumstances. Disclosure in Risk Factors (likely applicable for almost all companies!) is one issue, but disclosure may also be relevant in the Description of the Business, Legal Proceedings, MD&A and the Financials Statements.

 

Another reminder, Chairman Clayton’s remarks about cybersecurity risk also provide valuable insight into making appropriate disclosures in this complex area.

 

And, as a last thought, PLI is presenting a One-Hour Briefing titled “Integrating Enterprise Risk Management, Cybersecurity and Compliance in an Era of Big Data Breaches and Vulnerability” on February 13, 2018.

 

As always, your thoughts and comments are welcome!

 

To Cross Reference or not to Cross Reference, that is the Question!

By: George M. Wilson, SEC Institute

Here is a thought to incorporate as you draft your year-end Form 10-K or next 10-Q. It involves a topic that arises in almost all our workshops. We all know how frustrating it is to find parts of a 10-K that are simply duplicates of other parts. The idea of simply cutting and pasting information from one section to another really serves no disclosure purpose and makes documents less readable for investors.

 

At SECI’s New York Annual Forum in December 2017, a speaker from the Division of Corporation Finance commented that “cross references are wonderful!”.

 

Now, as a reminder, when the staff speaks they only provide their opinion, not an official SEC position. That said, cross references really are wonderful!

 

As always, your thoughts and comments are welcome!

The FASB and the Tax Act – The Process is Underway!

By: George M. Wilson, SEC Institute

On January 10, 2018, the FASB met to begin addressing several of the more complex accounting implications of the Tax Act. Their first formal meeting in this area addressed accounting for tax issues stranded in AOCI and five other accounting challenges in the ACT.

Tax Effects “Stranded” in AOCI

The FASB decided to start a narrow-scope project for tax effects “stranded” in AOCI. For example, if a company has available-for-sale securities the change in fair value and the related tax effect both are recorded in AOCI. Existing GAAP requires that revaluation of these tax effects should go through tax expense in the period of enactment. This can seem a bit “out-of-period.” The Board’s project is expected to move very quickly, with a 15-day comment period and provisions for early adoption for this year.

 

Other Issues

The FASB Staff presented position papers dealing with five other issues to the Board. Based on discussions in the meeting an FAQ document will be prepared and presented at the January 18, 2018, EITF meeting for the first four issues below. The last issue, dealing with private companies and not-for-profits, will be addressed in an FAQ document expected to be posted on the FASB’s webpage.

 

Issue One – Should a company discount the tax liability on a deemed repatriation?

The tax liability on deemed repatriations may be paid over an eight-year period. The staff’s position, briefly summarized, was that since under current GAAP deferred tax assets and liabilities are not discounted this liability should not be discounted.

 

Issue Two – Should a company discount alternative minimum tax credits that become refundable?

The staff’s position here was similar to issue one (i.e., that the amounts should not be discounted).

 

Issue Three – Is the new base erosion anti-abuse tax (BEAT) a separate tax

The staff analogized to the old AMT and suggested accounting for GILTI as we did for the AMT.

 

Issue Four – How should companies account for global intangible low-taxed income (GILTI);

This new tax provision presents a very complex issue about whether it should be accounted for in future periods or as a deferred tax item. The staff presented views that both positions could be supported and that perhaps a policy election with appropriate disclosure would be an appropriate path forward. The need for future standard setting will also be considered.

 

Issue Five – Should private companies and not-for-profit entities be allowed to use the guidance in SEC Staff Accounting Bulletin 118 if they cannot complete their accounting for the new tax law before relevant financial reporting deadlines?

The staff’s position, with which the board agreed, was that use of SAB 118 by these entities would “not be objected to.”

 

All of the above discussions have next steps, particularly the narrow-scope project for stranded tax effects and the actual drafting of the FAQs, so stay tuned!

 

As always, your thoughts and comments are welcome!

 

FASB Lease Relief Moves Along!

By: George M. Wilson, SEC Institute

As we posted back in early December the FASB, after significant constituent feedback, developed plans to make changes to their new lease accounting standard to ease the transition and reduce the impact of the new standard, particularly for lessors.

The board issued the planned exposure draft on January 5, 2018. You can read about the exposure draft in this press release and find the actual exposure draft here. The main provisions of the exposure draft are:
Adding a transition option that would permit application of the new standard at its adoption date instead of at the earliest comparative period presented in its financial statements.
Adding an optional practical expedient, by class of asset, for lessors to not separate nonlease components from the associated lease components if certain conditions are met. Election of the practical expedient would require disclosures.

 

The comment period for the proposed ASU ends on February 5, 2018.

 

Land Easements Final ASU Still in Process

 

The FASB also decided back in December to proceed with the issuance of a final ASU that provides an optional transition practical expedient for land easements that are not currently accounted for using existing lease guidance under ASC 840. Companies would not have to reconsider accounting for these land easements. This new standard will also clarify that after its effective date companies would use the new standard to evaluate new and modified land easements. This Final ASU is still in process with an estimated completion date in the first quarter of 2018.

 

As always, your thoughts and comments are welcome!

Tax Reform – Get the Details and Begin Dealing with the Changes!

By: George M. Wilson, SEC Institute

The new Tax Cuts and Jobs Act creates massive changes in taxation with deep, complex accounting and reporting ramifications. PLI is offering two programs to help you begin dealing with these changes.

 

First, on January 22, 2018 we will offer “The Tax Cuts and Jobs Act of 2017: Navigating the New Landscape”. This half-day program will be offered live in our New York training center and also via webcast.

 

For this program PLI has invited representatives from the Internal Revenue Service, the Department of the Treasury, the Senate Finance Committee and the House Ways and Means Committee to join our panel of tax experts and share their thoughts on the international and domestic implications of the tax reform package.

 

Topics discussed will include:

  • Transitions tax on deferred foreign income
  • New inclusion and deduction rules for “GILTI”
  • New deduction for foreign-derived intangible income (“FDII”)
  • New limitation on the deductibility of business interest
  • New deduction for individuals owning qualified businesses, REITs and MLPs
  • Other changes to the U.S. taxation of business income

 

 

As a follow-on to this program we will also offer a one-hour briefing on February 26, 2018 – “Tax Reform – Getting the Accounting and Disclosure Right!

 

This One-Hour Briefing will help you effectively deal with the accounting and SEC reporting implications of the new Tax Act. Our panel will review the detailed requirements of the FASB’s Accounting Standards Codification to determine the timing and process for recording the effect of the new Act as well as the related new SEC guidance about recording provisional amounts with appropriate disclosures. They will also discuss in-depth the SEC reporting issues involved in making complex judgments about appropriate disclosures in Forms 10-K and 10-Q for all aspects of the Act.

 

Jay Hanson, former PCAOB Board Member and George M. Wilson, a Director at SEC Institute, will address topics including:

 

  • SEC reporting and other disclosure considerations, including MD&A, risk factors and business-related disclosures
  • The “enactment date” provisions of Accounting Standards Codification 740
  • The provisions of Staff Accounting Bulletin No. 118 and the related new C&DI’s
  • How the new law affects deferred tax assets and liabilities at the date of enactment
  • How the new tax law affects income in the year of enactment
  • Other possible financial statement impacts of the Act

 

As always, your thoughts and comments are welcome!

 

SEC Help with Tax Act Accounting

By: George M. Wilson, SEC Institute

One of the major challenges in 2017 year-end accounting arose late last year when President Trump signed the new Tax Act. In this post, we began outlining some of the accounting challenges created by this new Act.

 

To help us all along this path, on December 22, 2017, the SEC staff issued guidance after previewing it at various public forums and conferences. The guidance has two pieces:

 

Staff Accounting Bulletin (SAB) No. 118

 

Compliance and Disclosure Interpretation 110.02 – Item 2.06 of Form 8-K

 

SAB 118 discusses the staff’s views about applying the provisions of U.S. GAAP in initial accounting for the income tax effects of the Act. If a company’s accounting for the Act is not complete when issuing financial statements, the SAB provides for the use of “provisional amounts” with an appropriate “limited” measurement period to complete the accounting. Supplemental disclosures would also be required.

 

The new C&DI provides the following guidance clarifying that an adjustment to deferred tax assets as a result of the Act does not require an Item 2.06 Impairment Form 8-K. The C&DI does have some incremental guidance if companies use the measurement period approach in SAB 118.

 

Question 110.02

 

Question: Does the re-measurement of a deferred tax asset (“DTA”) to incorporate the effects of newly enacted tax rates or other provisions of the Tax Cuts and Jobs Act (“Act”) trigger an obligation to file under Item 2.06 of Form 8-K?

 

Answer: No, the re-measurement of a DTA to reflect the impact of a change in tax rate or tax laws is not an impairment under ASC Topic 740.  However, the enactment of new tax rates or tax laws could have implications for a registrant’s financial statements, including whether it is more likely than not that the DTA will be realized.  As discussed in Staff Accounting Bulletin No. 118 (Dec. 22, 2017), a registrant that has not yet completed its accounting for certain income tax effects of the Act by the time the registrant issues its financial statements for the period that includes December 22, 2017 (the date of the Act’s enactment) may apply a “measurement period” approach to complying with ASC Topic 740.  Registrants employing the “measurement period” approach as contemplated by SAB 118 that conclude that an impairment has occurred due to changes resulting from the enactment of the Act may rely on the Instruction to Item 2.06 and disclose the impairment, or a provisional amount with respect to that possible impairment, in its next periodic report. [December 22, 2017]

 

To learn more about the accounting and SEC reporting implications of the new Tax Act, join us on January 26 as we present a One-Hour Briefing titled, “Tax Reform – Getting the Accounting and Disclosure Right!”

 

As always, your thoughts and comments are welcome!