The New MD&A Rule: Part Six – Replacing the Contractual Obligations Table with a Principles-Based Requirement

This is the sixth in a series of blog posts in which we are diving into the details of the SEC’s Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information Final Rule. This rule was published in the Federal Register on January 11, 2021.  It is effective for filings on or after February 10, 2021.

The rule’s transition provisions include a mandatory transition date but also allow voluntary early compliance.  The mandatory transition date is each company’s first fiscal year that ends after August 9, 2021, 210 days after the effective date.  Companies may voluntarily apply the new rule, on an S-K item-by-item basis, in any filing made on or after the effective date of February 10, 2021.

This means a company that files a Form 10-K on or after February 10, 2021, has the option to early implement this new MD&A (S-K Item 303) guidance.  Even if a company does not implement the rule early, it is not too soon to start planning for any required changes.  And, hopefully, this exploration can be a possible stepping-off point for a process to review and possibly improve MD&A as a communication document.

In this post, we overviewed the MD&A changes.  The second, thirdfourth and fifth posts reviewed and discussed:

The addition of an objective to S-K Item 303,

New critical accounting estimate disclosures,

Changes to results of operations and known trend discussions, and

The elimination of a separate paragraph with disclosure requirements for off-balance sheet arrangements.

This sixth post addresses a change many preparers welcome, eliminating the Contractual Obligations Table.  As is frequently the case though, when a disclosure requirement is removed, a new requirement is put in place.  The Final Rule expands disclosures about liquidity requirements and capital resources in a new, principles-based requirement. (More about this in the last post in this series.) Thus, the rules-based table is replaced with a broad, principles-based requirement for disclosure about capital resources and related information.

Over the years since the Sarbanes-Oxley Act, when the table was introduced, a multitude of questions has arisen about how to handle situations that did not easily fit the table’s brief instructions.  Perhaps the best suggestion about the table was in the SEC’s 2010 Liquidity Release – FR 83:

The purpose of the contractual obligations table is to provide aggregated information about contractual obligations and contingent liabilities and commitments in a single location so as to improve transparency of a registrant’s short-term and long-term liquidity and capital resources needs and to provide context for investors to assess the relative role of off-balance sheet arrangements; registrants should prepare the disclosure consistent with that objective. …… Registrants should determine how best to present the information that is relevant to their own business in a manner that is clear, consistent with the purpose of the disclosure and not misleading, and should provide additional disclosure where necessary to explain what the tabular data includes and does not include.

This is a very rules-based disclosure and even this statement of an overall objective for the table did not eliminate questions.  In the MD&A Final Rule Release, the SEC made these comments about eliminating the table:

Our amendments are also intended to address commenters’ concerns about the challenges imposed by the current contractual obligations table. We recognize that, because the current contractual obligations table does not have a materiality threshold, the burdens imposed by the table on registrants can include identifying, evaluating, and aggregating contracts that are not material.

By eliminating the prescriptive requirement to prepare a contractual obligations table and refocusing instead on a principles-based approach that requires a robust discussion of liquidity and capital resources, including a discussion of contractual obligations, our intent is to relieve registrants of these burdens while continuing to provide investors with material information.

 In addition, the Final Rule Release makes these important points about the principles-based approach to the discussion of contractual obligations:

We are eliminating Item 303(a)(5) as proposed and, in consideration of comments received, we are also amending Item 303(b) to specifically require disclosure of material cash requirements from known contractual and other obligations as part of a liquidity and capital resources discussion. As discussed in the Proposing Release, the Commission believed that eliminating current Item 303(a)(5) should not result in the loss of material information.

This approach is now built into S-K Item 303 with this new instruction:

  1. For the liquidity and capital resources disclosure, discussion of material cash requirements from known contractual obligations may include, for example, lease obligations, purchase obligations, or other liabilities reflected on the registrant’s balance sheet. Except where it is otherwise clear from the discussion, the registrant must discuss those balance sheet conditions or income or cash flow items which the registrant believes may be indicators of its liquidity condition.

So, along with the elimination of the table we need to delve into the Final Rule’s principles-based expansion of the liquidity and capital resources discussion.  And with these changes, there is a real opportunity to improve MD&A.  The liquidity and capital resources discussion is, unfortunately, frequently poorly written.  Part of this goes back to the lack of clarity and the brevity of the old requirements, and part of it goes back to challenges in discussing what is presented in the statement of cash flows.  All in all, most companies have a chance to improve this section of their MD&A.  And that will be the focus of the last post in this series where we explore the changes for liquidity and capital resources.

As always, your thoughts and comments are welcome!

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