Auditors and Financial Officers of companies who raise capital with complex financial instruments often find themselves drowning in convoluted accounting issues and restatements. Avoid the confusion by attending the live workshop, Debt vs. Equity Accounting for Complex Financial Instruments being held May 25th in New York City and June 23rd in San Francisco. Through a detailed review of the accounting literature and numerous examples and case studies this Workshop will help you build the knowledge and experience to appropriately recognize, initially record and subsequently account for these complex financing tools
Category Archives: Hot Topic
Challenging Accounting Judgments, Principles Based Standards and ICFR
By: George M. Wilson & Carol A. Stacey
As you have undoubtedly heard from a variety of sources (including this post we made last December), the new revenue recognition, financial instruments impairment and lease standards all involve many new and sometimes complex accounting judgments and estimates.
Issues ranging from how to estimate current expected credit losses to what is stand-alone selling price confront us with new, difficult, and subjective judgment calls.
Even the Chief Accountant has discussed this issue in a recent speech, which we discussed in our blog. In his remarks, the Chief Accountant focused on ICFR, specifically mentioning:
“Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and
Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.”
To help us all deal with these challenges the Anti-Fraud Collaboration, a group made up of the Center For Audit Quality, FEI, NACD and IIA, has issued a report titled “Addressing Challenges for Highly Subjective and Complex Accounting Areas”.
This report is built on a foundation of detailed analysis of several SEC and PCAOB enforcement cases, a webcast and two workshops. The report has a robust discussion of several of the issues underlying these enforcement cases. One important conclusion drawn from this work is that a lack of controls surrounding subjective and complex accounting judgments is frequently a root cause underlying reporting problems. Based on this conclusion, the report includes a discussion of ways to help establish appropriate controls for such estimates and judgments. In fact, one of the enumerated objectives of the report is to:
“Facilitate a robust discussion about accounting policy, centering on highly subjective and complex accounting areas, and the design and operating effectiveness of ICFR”
In the report, there are several insights into ICFR issues surrounding complex judgments. For example:
Difficult Accounting Issues
Three accounting issues were problematic for companies under investigation: revenue recognition, loan impairment, and valuation. Both highly subjective and complex, these three areas were under stress during the financial crisis and therefore more prone to manipulation or error. The analysis of the AAERs also highlighted issues with the accounting policies pertaining to these areas. In the enforcement actions studied, the SEC cited that the companies either did not have an adequate accounting policy or procedure for the issue being investigated; the company was non-compliant with their existing policy or procedure; or that management acted to override the company’s accounting policy.
The report goes on to state:
For all members of the financial reporting supply chain, the importance of tone at the top cannot be overstated. In most cases of alleged financial fraud, the SEC names the CEO and/or the CFO in the complaint. Commission staff noted that the driver of earnings management—the catalyst for most fraud cases—is often top management, such that the focus on the CEO and CFO is not surprising. In cases the PCAOB has brought against individual auditors, it is usually the lead audit engagement partner or other senior members of an audit engagement team who are disciplined.
Hopefully, as you think about the design of ICFR over the new estimates and judgments required to implement the revenue recognition, lease and financial instrument impairment standards, you will find some helpful ideas in this report.
As always, your thoughts and comments are welcome!
Broker – Dealer Regulation Update
By: George M. Wilson & Carol A. Stacey
The pace of change challenged many broker-dealers and their auditors when the PCAOB became the standard setter for audits of broker-dealers. This is illustrated by the topics addressed in this PCAOB “Annual Report on the Interim Inspection Program”. Problems were found in areas including independence rules, auditing revenue recognition and auditing the Net Capital Rule.
To help broker-dealers and their auditors and attorneys keep up to date with this complex regulatory landscape we are offering our Fundamentals of Broker-Dealer Regulation program on July 17, 2017. The program will be presented in New York at our PLI Center. It will be webcast and groupcasts are available in several locations.
This program will help you build a solid foundation in the regulatory regime applying to broker-dealers, including what to expect next regarding broker-dealer regulation. You will learn how the Securities Exchange Act of 1934, FINRA rules and state securities laws interact in governing the brokerage industry.
Significant focus will also be placed on recent exam and regulatory enforcement activity by the SEC, FINRA, and the states and about how broker-dealers are responding to these developments and the challenges ahead for the industry.
As always, your thoughts and comments are welcome!
New SEC Chair Sworn-In!
New SEC Chairman Jay Clayton officially started in his new role with his swearing-in on Tuesday May 4, 2017. You can see his comments and get details of his background in this press release.
As always, your thoughts and comments are welcome!
Learn About Recent Whistleblower Developments
By: George M. Wilson & Carol A. Stacey
We have done several posts about whistleblowing and the related SOX and Dodd-Frank whistle blower regimens. It is hard to overstate the importance of whistleblowers in the SEC’s enforcement efforts.
On April 25, 2017, the SEC announced a $4 million payout to a whistleblower who provided industry-specific experience and expertise to the staff as they conducted their investigation. In that release they also announced that whistleblower payouts now total approximately $153 million!
Keeping abreast of whistleblowing developments is an important part of governance and compliance. To help in this process we are offering our Corporate Whistleblowing program on June 28. This program will provide in-depth perspectives on recent regulatory and legal developments, including:
- What direction the federal whistleblower protection programs will likely take under the new administration
- What to expect in case law and regulatory enforcement developments in the coming year
- Best practices in responding to whistleblower reports
- Key ethical considerations in conducting internal investigations of issues raised by whistleblowers.
As always, your thoughts and comments are welcome!
Conflict Minerals Reporting Developments
By: George M. Wilson & Carol A. Stacey
As you may have heard, on April 3, 2017, the U.S. District Court for the District of Columbia entered final judgment in the on-going litigation over the Conflict Minerals Reporting Rule and remanded the case to the SEC.
This follows the action of the U.S. Court of Appeals for the District of Columbia Circuit, which in August of 2015 reaffirmed its prior holding that Section 13(p)(1) of the Securities Exchange Act and Rule 13p-1 “violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be “DRC conflict free”’. (Nat’l Ass’n of Mfrs., et al. v. SEC, No. 13-CF-000635 (D.D.C. Apr. 3, 2017))
Now that the decision has been remanded to the Commission, how this part of the statute and the related rule will be dealt with is uncertain. Since the requirement is part of the Dodd-Frank Act, the Commission is in a complex position. Even more uncertain is how companies should approach this part of the reporting process as they prepare to File Form SD by May 31 of this year.
To help companies deal with this situation the SEC has issued two Public Statements.
The first, a Public Statement by the Division of Corporation Finance, discusses how the SEC will approach the issue until further rule-making or other developments take place. CorpFin’s position is summarized in the following quote:
The court’s remand has now presented significant issues for the Commission to address. At the direction of the Acting Chairman, we have considered those issues. In light of the uncertainty regarding how the Commission will resolve those issues and related issues raised by commenters, the Division of Corporation Finance has determined that it will not recommend enforcement action to the Commission if companies, including those that are subject to paragraph (c) of Item 1.01 of Form SD, only file disclosure under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD. This statement is subject to any further action that may be taken by the Commission, expresses the Division’s position on enforcement action only, and does not express any legal conclusion on the rule.
In the Instructions to Form SD it is instruction (c) which requires “due diligence” if the “reasonable country of origin inquiry” determines that a company’s conflict minerals did or could have originated in the Democratic Republic of the Congo or one of the adjoining countries.
The second, a Public Statement by Acting Chairman Piwowar, discusses plans for future Commission action and expresses various thoughts about the cost and related enforcement aspects of the rule. In the Public Statement he says:
The Court of Appeals left open the question of whether this description is required by statute or, rather, is solely a product of the Commission’s rulemaking. The Commission will now be called upon to determine how to address the Court of Appeals decision – including whether Congress’s intent in Section 13(p)(1) can be achieved through a descriptor that avoids the constitutional defect identified by the court – and how that determination affects overall implementation of the Conflict Minerals rule.
I have accordingly instructed our staff to begin work on a recommendation for future Commission action. In preparing its recommendation, the staff will consider, among other things, the public comments received in response to the January 31, 2017 request for comment.
As always, your thoughts and comments are welcome!
A JOB’s Act Update
By: George M. Wilson & Carol A. Stacey
When Congress passed the JOBS Act in 2012 they built it to last. When financial laws last a long time they frequently need a bit of periodic updating. With all credit to Congress and the drafters who designed the JOBS Act, they included provisions for the SEC to make periodic updates in the Act.
On April 5, the SEC made several updates, which include an increase in the revenue threshold to qualify as an Emerging Growth Company to $1,070,000,000, an increase from $1,000,000,000. You can read about all the other updates, most of which relate to Regulation Crowdfunding here.
As always, your thoughts and comments are welcome!
The Move to The New Revenue Recognition Standard – Is the Pressure On?
By: George M. Wilson & Carol A. Stacey
Now that year-end is over for most calendar-year companies the transition to the new revenue recognition standard is a major focus area. In recent weeks there have been two interesting sources of comment and information about this transition.
First, on March 21, 2017 Chief Accountant Wesley Bricker spoke before the Annual Life Sciences Accounting & Reporting Congress in Philadelphia. (If you are thinking “that sounds familiar”, it was at this same conference a year ago that former Chief Accountant Jim Schnurr made some serious comments about the use of non-GAAP measures that previewed the May C&DI’s!).
In his remarks, Mr. Bricker focused on the transition to the new revenue recognition standard, saying:
“Let me now turn to implementation of the new revenue standard. This area deserves close attention, both to make sure that the standard is implemented appropriately and timely and to ask whether the appropriate transition disclosures are being made so that investors and other market participants have sufficient time to absorb the anticipated effects of the new standard.
…………………………..
In the worrisome column, however, some companies need to make significant progress this year in their implementations. In a survey of public companies released in October 2016, eight percent of respondents at that time had not started an initial assessment of the new revenue recognition standard, while an overwhelming majority of the others were still assessing the impact.
Particularly for companies where implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why and provide informative disclosures to investors about the status so that investors can assess the implications of the information. Successful implementation requires companies to allocate sufficient resources and develop or engage appropriate financial reporting competencies.”
The second recent development is the release by Deloitte in a “Heads Up” newsletter in April 2017 of their most recent updated survey “Adopting the New Revenue Standard — Where Do Companies Stand?”
In the survey, Deloitte found that many companies that had originally contemplated using a full retrospective have moved more towards the modified retrospective method. And, along with the worries of the Chief Accountant above, they also found:
“Slightly more than half of respondents had started to implement the new standard, but most were in the very early phases of adoption.”
As always, your thoughts and comments are welcome!
SEC Direction, Politics and Would You Like a Bit More Uncertainty?
By: George M. Wilson & Carol A. Stacey
As reported by Reuters, the Senate Banking Committee will vote next week, April 4, 2017, on Jay Clayton’s nomination to be Chairman of the SEC. The next step, not scheduled yet, would be a full Senate vote.
In the meantime, there is still plenty of excitement! Several democratic Senators have sent a letter to the SEC’s Inspector General asking the IG to review recent actions at the SEC. In one part of the letter the Senators say:
There is no evidence that any of these changes in the SEC’s course are desired, or have been sought, by the person nominated to be the next SEC Chair. At his confirmation hearing, SEC Chair-nominee Jay Clayton testified that he had not been consulted about Acting Chairman Piwowar’s change to enforcement policy, did not know enough to know whether it was appropriate to reopen the pay ratio rule, and had no specific plans to revisit any Dodd-Frank- mandated rules. Regardless of whether the SEC’s work on Acting Chairman Piwowar’s order results in a final action, agency staff will expend time and energy on these matters. As former Chair Mary Jo White has said, “[m]uch of [the SEC staff’s work] is behind the scenes, much of it out of the headlines. Should Mr. Clayton be confirmed, and should he disagree with the policy changes being pursued by Commissioner Piwowar, significant SEC staff work will have gone to waste.
Don’t you love the suspense…….
As always, your thoughts and comments are welcome!
The New Going Concern Disclosures – An Example
By: George M. Wilson & Carol A. Stacey
Sears, a storied retailer with a rich history, provides a perhaps not unexpected example of the new going concern disclosures in their recently filed 10-K. In their financial statements on page 66 of the 10-K you will find these disclosures:
Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.
If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.
This, as the bolded sentence above illustrates, is an example of the situation where there is substantial doubt about the ability of Sears to continue as a going concern, but the substantial doubt is mitigated by the company’s plans. The new reporting requirement for going concern disclosures has a two path approach. The first is:
If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is alleviated as a result of consideration of management’s plans, an entity shall disclose in the notes to financial statements information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the notes):
- Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
- Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
- Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.
The second disclosure path is:
If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, the entity shall include a statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Additionally, the entity shall disclose information that enables users of the financial statements to understand all of the following:
- Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
- Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
- Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.
Sears provides us an interesting example and the delicate dance of the wording in their disclosure sheds light on how challenging this new requirement can be for companies.
And, to close the loop, here is the opinion paragraph from the auditor of Sear’s financial statements:
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As always, your thoughts and comments are welcome!