Financial Reporting professionals are constantly challenged to keep on top of changing SEC Reporting requirements. Accountants and Auditors need to know how to prepare and review SEC periodic and current reporting forms, including the 10-K Annual Report, the 10-Q Quarterly Report, and the 8-K Current Report, as well as an understanding of how to comply with the annual proxy requirements and how insider trading rules work. Register today for one of our upcoming live in-depth workshops, SEC Reporting Skills Workshop 2016 being offered October 13-14 in New York City, October 24-25 in Chicago and November 10-11 in San Diego. December dates and locations are also available and posted on our website. Attendees will learn to master Forms 10-K, 10-Q, and 8-K and the proxy statement, use all the important sources of SEC reporting rules and guidance, write an effective MD&A and deal with the SEC staff and understand their “hot buttons,” including frequent comment areas such as revenue recognition, the statement of cash flows, segments, non-GAAP measures, and contingencies.
In recent weeks we have been posting about areas to deal with in advance of year-end. So far we have addressed:
The spirit and rationale behind these posts is that it is always a good idea to proactively anticipate problems that may arise and act to keep issues from becoming problems.
As we continue this series our next post is about SAB 74 (Topic 11-M in the SAB Codification), the requirement for disclosures about recently issued accounting standards.
With the major changes coming from the new revenue recognition standard, the new lease standard, and for financial companies the new financial instrument impairment standard, these disclosures become increasingly important. Users need to be forewarned about the expected impact of these new standards. This is essentially a known trend disclosure in your MD&A.
Here is an excerpt from Topic 11-M. You can read the entire SAB here.
Interpretive Response: The staff believes that the registrant should evaluate each new accounting standard to determine the appropriate disclosure and recognizes that the level of information available to the registrant will differ with respect to various standards and from one registrant to another. The objectives of the disclosure should be to (1) notify the reader of the disclosure documents that a standard has been issued which the registrant will be required to adopt in the future and (2) assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. The staff understands that the registrant will only be able to disclose information that is known.
The following disclosures should generally be considered by the registrant:
A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.
A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.
A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.
Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.
As a company gets closer to the adoption date for a new standard these disclosures should evolve. And although “[t]he staff understands that the registrant will only be able to disclose information that is known”, the other side of this disclosure is that when you know something, you should disclose it!
One last heads up – when you file your 10-K for the year before adoption, in other words you will adopt the day after that year-end, the staff will likely expect robust disclosure, including quantification of the impact of adoption.
When a company has decided which method it will use to adopt, it should disclose that information!
As a company researches and builds an understanding of how much a new standard will affect the financial statements, this impact should be disclosed.
Frequently we are concerned that there is uncertainty in this process, and that is never comfortable to discuss in an SEC report. Here are two excerpts that are examples of this disclosure from a June 30, 2016 Form 10-K. They deal with this uncertainty (emphasis added):
In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.
The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We currently anticipate early adoption of the new standard effective July 1, 2017 in conjunction with our adoption of the new revenue standard. Our ability to early adopt is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.
We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for office, retail, and datacenter operating leases.
Revenue from Contracts with Customers
In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations.
The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.
The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We currently anticipate early adoption of the new standard effective July 1, 2017. Our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.
We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for software license revenue. We expect revenue related to hardware, cloud offerings, and professional services to remain substantially unchanged. Specifically, under the new standard we expect to recognize (Product A) revenue predominantly at the time of billing rather than ratably over the life of the related device. We also expect to recognize license revenue at the time of billing rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing.
We currently believe that the net change in (Product A) revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard.
Lastly, as we always like to do, here are two example comments to reinforce the issues in this disclosure:
Please revise your disclosures to fully comply with Question 2 of SAB Topic 11:M for each standard listed. Specifically, if early adoption is permitted, you should state the date that you plan to adopt the standard. You should also discuss the impact that adoption of each standard is expected to have on your financial statements or, if applicable, make a statement to the effect that you are still assessing the impact that adoption of each standard will have on your financial statements and the impact is not known or reasonably estimable at this time.
Please revise to include a discussion of the potential effects that recently issued accounting standards will have on your financial statements when adopted in a future period. Refer to SAB Topic 11.M. For example, please revise to disclose the potential effect of ASU No. 2014-09, Revenue from Contracts with Customers.
It has been a very active time at the SEC, FASB and PCAOB. Have you stayed on top of recent developments, activities and proposals? For example, the Leases Standard is final and the FASB is awash in simplification and other projects. Register now for our upcoming live seminar and webcast, 32nd Annual SEC Reporting & FASB Forum being held November 14-15 in Dallas, December 12-13 in New York City and December 19-20 in San Francisco. Prepare for year-end and reporting season by attending this highly anticipated and popular annual seminar and hear a roundtable discussion of current events, including simplification overload, disclosure effectiveness, juggling Rev. Rec., Leases, CECL adoptions and more. Our expert faculty will also discuss the new CDIs on non-GAAP measures, the Regulation S-K Concept Release, frequent accounting and disclosure comments, Revenue Recognition and guidance on lease accounting, MD&A disclosure and much more.
Cybersecurity Risk continues to be a huge and problematic issue. Processes and tools to respond to Cybersecurity incidents are constantly evolving. To help you keep up to date with these issues our “Cybersecurity 2016: Managing Cybersecurity Incidents” program will be offered on September 20 live in NY and via webcast.
Topics to be addressed will include:
Overview of the cyber insurance market and what to look for when purchasing
Cybersecurity provisions to include in vendor and business partner agreements
Managing a forensic investigation
Threat landscape: how can companies protect themselves?
Cybersecurity Act of 2015 and its ramifications for the private sector, plus SEC activity
EU developments on breach notification in the GDPR and NIS Directive
The program will also include these special features:
Hacker’s perspective: what are they seeking?
CISO and Regulators panel: strategies for global companies and guidance on sharing information with the government
You can learn more here.
As always, your thoughts and comments are welcome!
Everyone who works with SEC periodic reports knows that making changes to disclosure is not a simple process. Reporting involves so many stakeholders and so many approval points that without an early start it is almost impossible to make improvements (or even simple changes such as formatting!).
This post is about one possible change that will need some time for consideration, adding the new Item 16 summary. With this reminder hopefully you will have enough time to consider whether this optional item makes sense for you.
This kind of summary has always been permitted, or at least never prohibited. However, in the process of making periodic reports more about communication than compliance, the FAST Act required the SEC to formally put a summary into Form 10-K, hence new Item 16. You can read the text of Item 16 in this post.
Your Communication Philosophy
If you read a lot of Form 10-K’s (and what is more fun than that?) you will see a variety of communication styles. We discuss different communication styles or “philosophies” in our workshops. We encourage companies to articulate their “philosophy” of disclosure.
To simplify a bit, some companies adopt a very “compliance” based philosophy for disclosure. In this model companies disclose what the SEC requires to be disclosed and essentially nothing more. This can be done in a fairly mechanical fashion and is usually very simple and direct, if not almost terse.
At the other end of a disclosure spectrum some companies adopt a more “communications” based philosophy where they disclose more than the bare bones requirements in an effort to tell a more complete “story” of how their company operates.
A simple example of this difference can be found in Form 10-K Item 1. This is the description of the business and the required disclosures are in Regulation S-K Item 101. Nowhere in Item 101 is there any requirement to disclose a company’s business strategy. And many companies do not say anything about the strategic orientation of their business. And yet, many companies discuss their strategy at length. Check out the differences in these two companies:
Here is a very well done example for an SRC (Golden Enterprises) of the compliance approach. Golden makes snack foods and does a simple, direct presentation. (Also, best potato chips ever!)
Here is another well-done example of a company (Square) that uses a more communications oriented approach. Square is a payment processor and supports businesses in many ways.
To be clear, there is no right or wrong way in this discussion; we are talking about a judgment you need to make. So, why do some companies disclose more than the S-K requirement? These companies are considering disclosure as more than a compliance process. They are using the reporting process as a communications tool.
If you are going to focus more on communication the SEC’s Interim Final Rule about a Form 10-K summary could be a new element in your communication strategy. Almost every business writer will suggest that an executive level overview for a long document is a good communication strategy.
FR 72 suggested this for MD&A way back in 2003:
Many companies’ MD&A could benefit from adding an introductory section or overview that would facilitate a reader’s understanding. As with all disclosure, what companies would appropriately include in an introduction or overview will depend on the circumstances of the particular company. As a general matter, an introduction or overview should include the most important matters on which a company’s executives focus in evaluating financial condition and operating performance and provide the context for the discussion and analysis of the financial statements. Therefore, an introduction or overview should not be a duplicative layer of disclosure that merely repeats the more detailed discussion and analysis that follows.
In recent remarks the SEC staff has said they are seeing more companies using their filings as communication documents and this trend certainly fits into the SEC’s disclosure effectiveness program.
So, as you get into your annual reporting process, be sure you articulate this overall strategy for disclosure, and if you think it appropriate, put consideration of the new Item 16 summary into your thought process.
As always, your thoughts and comments are welcome!
In a recent post we explored a very complex securities registration issue within retrospective application of the new revenue recognition standard. (The issue arises with any retrospective application, so it will also arise in the new leasing standard.) In a nutshell the registration issue comes up when you:
(1) Adopt the new revenue recognition standard as of January 1, 2018 (assume a December 31 year-end), then
(2) File your March 31, 2018 10-Q and then
(3) File an S-3 to register to sell securities.
The S-3 incorporates your 2017 Form 10-K by reference which includes 2015 financial statements. The 2015 financial statements would not normally be retrospectively adjusted for the new revenue recognition standard. In this case though that could be necessary. You can read all the technical details here.
This first post led to a really interesting question from a reader. What happens if you file the S-3 before you file your March 31, 2018 10-Q? We explored the issue in this post.
This then led to a really great comment from another reader. In our workshops we always emphasize building research skills and using all the relevant SEC resources, especially the CorpFin Financial Reporting Manual (FRM). This really astute reader found this section in Topic 13 of the FRM:
13110.2 In the case of a registration statement on Form S-3, Item 11(b)(ii) of that form would specifically require retrospective revision of the pre-event audited financial statements that were incorporated by reference to reflect a subsequent change in accounting principle (or consistent with staff practice, discontinued operations and changes in segment presentation) if the Form S-3 also incorporates by reference post-event interim financial statements. If post-event financial statements have not been filed, the registrant would not revise the pre- event financial statements in connection with the Form S-3, however, pro forma financial statements in accordance with Article 11 of Regulation S-X may, in certain circumstances, be required. In contrast, a prospectus supplement used to update a delayed or continuous offering registered on Form S-3 (e.g., a shelf takedown) is not subject to the Item 11(b)(ii) updating requirements. Rather, registrants must update the prospectus in accordance with S-K 512(a) with respect to any fundamental change. It is the responsibility of management to determine what constitutes a fundamental change.
Here there is at least some relief for the S-3 filed after year-end but before the Form 10-Q is filed! As a reminder S-X Article 11 contains this requirement:
- 210.11-01 Presentation requirements.
(a) Pro forma financial information shall be furnished when any of the following conditions exist:
(Note: (1) to (7) omitted)
(8) Consummation of other events or transactions has occurred or is probable for which disclosure of pro forma financial information would be material to investors.
Some judgment will be required to make that decision! If the effect of the new revenue recognition standard is large enough, it could well be material to investors.
Similarly, for the S-3 shelf takedown S-K 512(a) includes this requirement (in bullet ii):
(ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement.
Again, some judgment will be required to make that decision!
Thanks to both the readers who contributed to this discussion, and as always your thoughts and comments are welcome!
In a recent post we discussed a potential complication in the registration process and Form S-3 in particular if you retrospectively implement the new revenue recognition standard. You can review the post here. The issue arises if you file an S-3 in 2018 after you adopt the new revenue recognition standard but before your 10-K for 2018 is filed. The 2018 Form 10-K will have annual financial statements for 2018, 2017 and 2016 retrospectively applying the new standard. However, if you file an S-3, or have an S-3 shelf registration in place, before you file the 2018 Form 10-K, your S-3 would be required to have three fiscal years, now 2017, 2016 and 2015 that apply the new standard.
Thus, you could be required to report an extra year, 2015, on the new revenue recognition standard if you want to access the capital markets with an S-3, or an S-3 shelf registration, during 2018.
Whether or not the SEC can or will have any relief from this issue is not finalized. So stay tuned!
In our post we set up the example with an S-3 filed after the first-quarter 2018 form 10-Q is filed.
This all lead to a really great question from a reader:
In the hypothetical, if an issuer were to file an S-3 in the first quarter of 2018 (before its 3Q financials go stale and before the 2018 10-Q is filed), does Item 11 of Form S-3 require the company to file an 8-K with its recast 2015 financials reflecting the full retrospective adoption of the new standard before the issuer may take-down securities?
The answer to this question? Well, there is not a detailed rule anywhere that deals with the issue.
We researched the question and the closest guidance we could find was in the CorpFin Financial Reporting Manual Topic 11:
“Companies may transition to ASU No. 2014-09 and IFRS 15 (collectively, the “new revenue standard”) using one of two methods:
Retrospectively to each prior period presented, subject to the election of certain practical expedients (“full retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. In its 2018 annual report, the company would revise its 2016 and 2017 financial statements and record the cumulative effect of the change recognized in opening retained earnings as of January 1, 2016.
Retrospectively with the cumulative effect of initially applying the new revenue standard recognized at the date of adoption (“modified retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. At that time, the company must record the cumulative effect of the change recognized in opening retained earnings and financial statements for 2016 and 2017 would remain unchanged. The standard also sets forth additional disclosures required by companies that adopt the new standard using this method.
That language sure sounds like if you file after January 1, 2018, you need three years, 2015, 2016 and 2017 based on the new standard.
That said, stay tuned, we will all continue our research! And what is more fun than a really deep SEC research question?
As always, and especially with this one, your thoughts and comments are welcome!
In the massive press coverage about “Brexit” one of the most frequently used words is “uncertainty”. While the impact of Brexit will differ from company to company it is important, as we come to the end of the June 30, 2016 quarter (or whenever your next quarter end will be), to think about whether the vote and the resulting uncertainty should be dealt with in your SEC reporting.
The two most straightforward issues are likely risk factors and MD&A known trends.
The risk factor disclosure in Part II Item 1A of 10-Q refers back to S-K 503(c) and requires disclosure of what makes owning your company’s securities “speculative or risky”. Companies should consider whether the uncertainties and already known impacts of Brexit increase risk and deserve mention in risk factors.
When a risk factor becomes more probable of having a material impact the risk factor should transmogrify into an MD&A “known trend” disclosure. This disclosure is required when there are “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.” (S-K Item 303). There are similar known trend disclosures for liquidity and capital resources. If you could be affected by market uncertainty, reasonably possible changes in exchange rates or other impacts of Brexit this disclosure may be necessary in MD&A. Lots of judgment here.
It is always important to remember that the “reasonably expects” probabilistic test in FR 36 requires disclosure if you cannot say the trend is “not reasonably likely” to come to fruition. (Sorry for the double negative, but it is in the test!). So if there is a 50/50 chance of a material impact, disclosure should likely be made.
Lastly, beyond these two issues there are a wealth of other possible accounting and disclosure ramifications, ranging from issues such as possible elevated risk of impairment to tax consequences, depending on your circumstances.
As always, your thoughts and comments are welcome.
One of the themes we discuss in our workshops is how the SEC does not limit their review process to information in a company’s SEC filings. Here is an example of a comment (which also deals with known trends and uncertainties, another favorite topic) that demonstrates how the Staff finds issues by looking in places such as earnings releases, conference call recordings and web pages:
Results of Operations, page 23
- Please expand your discussion to address any known trends or uncertainties that are reasonably expected to have a material impact on revenue, cost of revenue, or income from operations. For example, we note that during your 2015 fourth quarter and full year earnings call on February 11, 2016, your management quantitatively described the volume increase, as well as discussed your customer mix changes by segment and certain trends in 2016. In addition, disclosure appearing on page 11 of your filing on Form 10-K under your risk factors indicates that extended periods of low fuel prices can also have an adverse effect on your results of operations and overall profitability, as well as on the valuation of inventory to the extent your hedges are not effective at mitigating fluctuations in fuel prices. However, you have not provided a discussion in your filing with respect to an analysis of known material trends, demands and uncertainties.
Refer to Section III of Financial Reporting Release No. 72, codified in FRC §501.12 and Item 303 of Regulation S-K.
It is important to assure that all the vehicles you use to communicate with your shareholders and the rest of the public are consistent and that issues raised in one place are appropriately dealt with across all communication channels.
As always, your thoughts and comments are welcome!
As we all know, the new revenue recognition standard will be effective for public companies for periods beginning after December 15, 2017. This change will have challenges for everyone. Even if the new five-step, contract based model does not dramatically change the timing of your company’s revenue recognition, documenting how the new model applies in your case will require some time, and all of us will have to deal with the significant increase in disclosures, particularly the requirement to disaggregate revenues.
One place we see some confusion is about what these challenges will look like. This new standard is a complete departure from our old revenue recognition guidance and the detailed, rule based nature of the old standards. Some writers still talk about the “hundreds of pages” of guidance that must be dealt with. This makes it sound like the new standard is a large collection of detailed rules that simply replaces the large collection of detailed rules in the old revenue recognition GAAP.
This is not the case.
In the ASU the core of the new revenue model starts on page 14 and ends with the last of the disclosures on page 48. Seems pretty short!
It is very principles base guidance! In our workshops, the broad, principles based nature of the new standard creates some of the biggest challenges for companies.
The whole standard is based on this principle, from paragraph 606-10-10-2:
“the core principle of the guidance in this Topic is that an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”
Notice the lack of language about an earnings process being complete or revenue being “realized or realizable”.
Each of the five steps and the disclosure requirements also start with a broad principle. Here is an example from step three, determining the transaction price (606-10-32-2):
“An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.”
On interesting aspect of this principle is that if there is variable consideration in a contract, it must be estimated! That is a whole new principle and each company will have to assess how to apply it to their circumstances.
Because this new revenue recognition model establishes a whole new set of principles, the FASB knew we would all need some help in how to interpret these principles. So, the standard, after the disclosure requirements, includes a number of implementation guidance discussions to explain what the principles are intended to mean. Terms such as “satisfied over time” and “distinct within the context of the contract” are explored. But you won’t find any detailed rules.
After the implementation guidance are a number of examples, and here you can find some actual interpretations of the principles which are very helpful. There are not too many of them.
As a last source of support for your process of learning about these principles and how to interpret and apply them don’t forget about the TRG. While the TRG does not issue formal guidance, their discussions are rich with examples of how some very experienced professionals are interpreting the standard. And, as you may have heard, the SEC Chief Accountant has said if companies depart from TRG discussions, they should be prepared to support such positions to the SEC staff. (You can read more about that in this speech.)
So, our tip for today, as you move through your implementation be ready to build an understanding of the principles and how to apply them to your specific circumstances!
As always, your thoughts and comments are welcome!