By: George M. Wilson, SEC Institute

It is almost impossible to attend an SEC workshop or conference and not hear the words “operating segments.” In the IPO process operating segment disclosures are almost always a time consuming and complex issue. The importance of this information to investors coupled with the subjective and complex nature of the related accounting guidance both contribute to this challenge. While this will likely always be a complex issue in our reporting, the FASB has started a project to review certain parts of the related GAAP.

As you can read in this Project Summary, the Board is planning to focus on aggregation criteria and the structure of disclosures by segment. From the Project Summary:

Segment Aggregation Criteria For segment aggregation criteria, the Board decided it could:

1. Move the reportable segment thresholds to form part of the aggregation guidance, that is, develop a brightline threshold for aggregation.
2. Remove the aggregation criteria, but retain the practical limit guidance.

Segment Disclosure Requirements  For segment disclosure requirements, three alternatives were considered. The Board could:

3. Add individual pieces of segment information to the list of requirement disclosures.
4. Require the disclosures in Topic 280, Segment Reporting, to be reported in a table.
5. Require a table of regularly reviewed information based on how it relates to the lines in the financial statements.

This plan to address the frequently misunderstood and complex aggregation criteria is particularly good news, as the SEC staff frequently challenges aggregation. Companies frequently aggregate segment information to avoid disclosing granular information that could be used by their competitors. This concern frequently directly conflicts with GAAP disclosure requirements. Here is an example of such a comment that a company that operates hotels received:

2. We note your disclosure that all of your operating segments meet the aggregation criteria to be grouped as a single reportable segment. Please tell us how you considered the need to aggregate your operating segments into reportable segments by brand or property type. In your response, please explain to us in sufficient detail how you determined all of your operating segments meet the aggregation criteria of ASC Topic 280-10-50-11.

This was the second of two comments in a letter dated April 19, 2017. As you might expect, this type of comment can take a lot of work to respond to and frequently is not resolved in the first round of comments.

The aggregation criteria the staff referred to are from ASC 280-10-50-11:

Aggregation Criteria

Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the objective and basic principles of this Subtopic, if the segments have similar economic characteristics, and if the segments are similar in all of the following areas (see paragraphs 280-10-55-7A through 55-7C and Example 2, Cases A and B [paragraphs 280-10-55-33 through 55-36]):

• The nature of the products and services
• The nature of the production processes
• The type or class of customer for their products and services
• The methods used to distribute their products or provide their services
• If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

A very common misapplication of these criteria is to review the five areas, but not start with the issue of “do these operating segments have similar economic characteristics”.

For the comment above, the company’s response was:

Response: 

We consider each one of our hotels to be an operating segment meeting the definition set forth in ASC Topic 280; however, no individual hotel is a reportable segment because none meets the quantitative threshold for reportable segments. For purposes of determining reportable segment(s), we aggregate all of the Company’s properties, regardless of brand or property type, because all of our hotels meet the criteria for aggregation set forth in ASC Topic 280-10-50-11.

Specifically, we believe that:

Aggregation is consistent with the objective and basic principles of this subtopic; and,

The properties have the following similar economic characteristics:

All but seven of the 96 hotels in the Company’s portfolio are classified by the lodging industry as upper-upscale and luxury properties and represent over 98% of revenues. Further, as disclosed in the 10-K, no single property represents more than 7% of total revenues. The remaining seven hotels are defined as upscale or midscale and represent less than 2% of revenues and as such do not either individually or in the aggregate approach the quantitative thresholds necessary to qualify as a reportable segment.

All of the properties in the portfolio, regardless of brand or property type, share very similar long-term financial performance and economic characteristics, including the nature of their products, services and production processes and the methods used to distribute their product. The hotels are designed and operated to appeal to similar individuals and group leisure and business customers that travel to upper-upscale and luxury properties. For example, while approximately 64% of total revenues are generated from room revenues, the individual hotels typically include meeting and banquet facilities, a variety of restaurants and lounges, swimming pools, exercise/spa facilities, gift shops, and parking facilities. Importantly, these amenities are either a brand(s) standard and/or customer expectation across all of the upper-upscale and luxury hotels in the portfolio. All of the properties in the portfolio react similarly to economic stimulus such as business investment, changes in GDP and changes in travel patterns. Capital allocation decisions to acquire, enhance, redevelop, or perform renewal and replacement expenditures are determined on a property-by-property basis to appropriately match each hotel within its specific market to seek to improve operating performance and include consideration of local market changes in supply and demand.

The staff asked for more information and you can find the company’s second response letter here. The depth of analysis in this second letter is significantly more than in the first response. And, both the comment and the response demonstrate the complexity of this issue in current GAAP.

As always, your thoughts and comments are welcome.

By: George M. Wilson, SEC Institute

We periodically post information from the FASB’s agenda to get a sense of the direction of accounting standard setting. When it comes to SEC rulemaking however it can be a bit harder to get a sense of what is in process. The SEC’s webpage does not have as straightforward a list of projects in process as the FASB’s agenda. The SEC’s agenda is compiled and included in the semiannual Unified Agenda of Federal Regulatory and Deregulatory Actions which is compiled by the Regulatory Information Service Center, a component of the U.S. General Services Administration along with the Office of Management and Budget’s Office of Information and Regulatory Affairs.

One issue in past SEC agenda setting is that the lists in the Unified Agenda were perhaps a bit of a “wish list” and might include more than could be done in the Unified Agenda’s regulatory one-year time horizon. The current leadership at the SEC has taken a different tack with this list and tried to build an agenda that can, hopefully, be accomplished in a one-year time horizon.

This agenda is maintained in the government’s Office of Information and Regulatory Affairs. As you can see the agenda is not encyclopedic, but does touch on a variety of areas. It is also worth noting how many of the areas on the agenda deal with disclosure effectiveness and modernization.

As always, your thoughts and comments are welcome!

By: George M. Wilson, SEC Institute

In a meeting on Wednesday, February 21, 2018, the SEC adopted an Interpretive Release titled “Commission Statement and Guidance on Public Company Cybersecurity Disclosures.” The release reinforces and expands upon the staff’s 2011 cybersecurity guidance in Corporation Finance Disclosure Guidance Topic Two. In this post from January 31, 2018, we briefly reviewed Disclosure Topic Two and the possibility of moving this guidance from a staff document to a commission release.

In addition, the new release addresses two issues that have been important in recent cybersecurity breaches, the importance of cybersecurity policies and procedures and the application of insider trading prohibitions in the cybersecurity context.

Disclosure Guidance Topic Two was a very principles-based disclosure model, and as you read the new Interpretation you will see it incorporates those principles. The release emphasizes the role of disclosure controls and procedures and the importance of board of directors involvement in cybersecurity disclosures. One significant change is that Disclosure Guidance Topic Two was staff guidance, and the Interpretive Release is formal guidance from the Commission, and in essence moves towards the authority of a rule.

In the release the Commission also states that they will continue to monitor company disclosures and cybersecurity developments to assess whether further guidance or rulemaking in necessary.

As always, your thoughts and comments are welcome!

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!

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!

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!

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!

By: George M. Wilson, SEC Institute

As prospects of a government shut-down loom, the SEC has published its “Operations Plan Under A Lapse In Appropriations And Government Shutdown”. Hopefully it will not have to be used, but just in case you can find some details of how certain operations will continue on page 12.

As always, your thoughts and comments are welcome!

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!