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Board’s November 8, 2017 meeting they decided not to make changes and instead use the existing definition from old, now superseded, Concept Statement 2: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!

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!

By: George M. Wilson, SEC Institute

Amidst all the activity and uncertainty about tax reform is the additional, potentially complex question: “How will this affect financial reporting?”

It is not too early to begin preparing to answer this question!

The starting point in this assessment is this part of ASC 740-10:

Changes in Laws or Rates

25-47     The effect of a change in tax laws or rates shall be recognized at the date of enactment.

25-48     The tax effect of a retroactive change in enacted tax rates on current and deferred tax assets and liabilities shall be determined at the date of enactment using temporary differences and currently taxable income existing as of the date of enactment.

For existing deferred tax assets and liabilities this change may have a significant impact because of this requirement in ASC 740-10-30-2:

30-2

The following basic requirements are applied to the measurement of current and deferred income taxes at the date of the financial statements:

1. The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated.

In other words, what this means is that at the date of enactment of the new tax law all deferred tax accounts will be remeasured to the new rates. The impact of this remeasurement will flow through current period tax expense. This impact on current period tax expense will even include remeasurment of deferred taxes related to items classified on OCI. As a result, it is likely that deferred tax assets will be reduced, resulting in higher tax expense, and deferred tax liabilities will also be reduced, resulting in lower tax expense.

Other areas that could be affected include:

How much disclosure will be appropriate at year end, especially in this uncertain environment?

How will the potential movement to a territorial system affect existing tax accounts and valuation allowances?

Will these changes result in repatriation of cash and if so what should be disclosed?

The legal profession is also focusing on this issue. In this post from TheCorporateCounsel.net there is mention of the potential write down of deferred tax assets and even discussion about whether this event may trigger in Item 2.05 Impairment 8-K.

We should all stay tuned to how the legislative process proceeds, and be ready with appropriate disclosures when it concludes.

As always, your thoughts and comments are welcome!

By: George M. Wilson, SEC Institute

On December 12, 2017, the SEC appointed a new Chair and four new members to the PCAOB. The new appointees are:

William D. Duhnke III – Chair

Robert Brown – Board member

Kathleen M. Hamm – Board member

James G. Kaiser – Board member

Duane M. DesParte – Board member

These appointments bring the board to its full complement of five members. Following the SOX requirements two of the appointees, Mr. Kaiser and Mr. DesParte, are accountants. Mr. Duhnke, Dr. Brown and Ms. Hamm have background as lawyers. All of the new Board members bring a variety of deep and relevant experience to the Board.

You can read about the appointments and find out more about the new members in this press release and in this statement from SEC Chair Clayton.

Meanwhile, the two nominations for the open commissioner positions at the SEC are still awaiting confirmation by the full senate.

As always, your thoughts and comments are welcome!

By: George M. Wilson & Carol A. Stacey

On October 23, 2017, the SEC formally approved the PCAOB’s new Auditor’s Reporting Standard, now AS 3101. The final PCAOB standard was submitted to the SEC for approval on July 19 and published in the Federal Register on July 28.

The new standard takes effect in two phases:

The first phase adds information to and modifies the format of the auditor’s report and is effective for audits of periods ending after December 15, 2017, this calendar year end. This change applies to all reporting companies.

The second phase, which adds information about critical audit matters (CAMs) to the auditor’s report, does not apply to EGC’s, and is effective:

For audits of large accelerated filer for fiscal years ending on or after June 30, 2019

For audits of all other companies to which the requirements apply for fiscal years ending on or after December 15, 2020.

The new Auditor’s Report requirements that will be effective this year, for periods ending after December 15, 2017, include these modifications:

• Auditor tenure – a statement disclosing the year in which the auditor began serving consecutively as the company’s auditor;
• Independence – a statement regarding the requirement for the auditor to be independent;
• Addressee – the auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted);
• Amendments to basic elements – certain standardized language in the auditor’s report has been changed, including adding the phrase “whether due to error or fraud,” when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatement; and
• Standardized form of the auditor’s report – the opinion will appear in the first section of the auditor’s report, and section titles have been added to guide the reader.

The second phase, with the later effective date, requires the auditor’s report to discuss critical audit matters, which are defined as:

“A matter that was communicated or required to be communicated to the audit committee and that:

(1) relates to accounts or disclosures that are material to the financial statements and

(2) involved especially challenging, subjective, or complex auditor judgment.”

Chair Clayton, in a statement about the new standard, said:

I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships — with Main Street investors ending up in a worse position than they were before.

I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release

As a thought question, it will be interesting to see how a company’s disclosures of Critical Accounting Estimates will relate to the auditor’s discussion of Critical Audit Matters. More about this in our next post!

As always, your thoughts and comments are welcome!