Category Archives: Reporting

CorpFin to Increase Focus on Climate-Related Disclosures

Hot Topic, Reporting

On February 24, 2021, Acting Chair Allison Herren Lee issued this “Statement on the Review of Climate-Related Disclosure.”  In the statement she directs CorpFin to “enhance its focus on climate-related disclosure in public company filings.”  She also refers to the SEC’s 2010 Release FR 82 – Commission Guidance Regarding Disclosure Related to Climate Change.  Acting Chair Herren Lee indicates that experience gathered in the staff’s review of climate-related disclosures will be used to update this guidance.

As always, your thoughts and comments are welcome!

Contingent Consideration and an SEC Comment

Comment of the Week, Reporting

One of the more challenging estimates accounting for business combinations requires us to make is the fair value of contingent consideration.  This seems like a particularly challenging process because one of the reasons contingent consideration may be part of a deal is that the buyer and seller of the business could not agree on a price!  Nevertheless, in a transaction that involves contingent consideration ASC 805 states:

Contingent Consideration

805-30-25-5

The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. The acquirer shall recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree.

So, despite the fact that the buyer and seller of the business did not agree on a price, we accountants estimate the fair value of the contingent consideration.

As time passes and circumstances evolve or become clearer this estimate is bound to change.  Hence this subsequent measurement guidance:

Contingent Consideration

805-30-35-1

Some changes in the fair value of contingent consideration that the acquirer recognizes after the acquisition date may be the result of additional information about facts and circumstances that existed at the acquisition date that the acquirer obtained after that date. Such changes are measurement period adjustments in accordance with paragraphs 805-10-25-13 through 25-18 and Section 805-10-30. However, changes resulting from events after the acquisition date, such as meeting an earnings target, reaching a specified share price, or reaching a milestone on a research and development project, are not measurement period adjustments. The acquirer shall account for changes in the fair value of contingent consideration that are not measurement period adjustments as follows:

a.  Contingent consideration classified as equity shall not be remeasured and its subsequent settlement shall be accounted for within equity.

b.  Contingent consideration classified as an asset or a liability shall be remeasured to fair value at each reporting date until the contingency is resolved. The changes in fair value shall be recognized in earnings unless the arrangement is a hedging instrument for which Topic 815requires the changes to be initially recognized in other comprehensive income.

Changes to estimates of contingent consideration, except in extremely simple cases, are inevitable.  And, the opportunity to use such estimates for earnings management or other manipulative purposes is clear.  As you would expect, the SEC CorpFin staff asks questions when they see unusual fluctuations.  Here is one example comment:

  1. We note a significant gain of $31 million recorded during 2017 relating to a reduction in the contingent consideration of an acquisition in 2015. Please tell us, and revise to disclose, the nature of the events that lead to the reduction in the contingent consideration and how the reduced amount was calculated or determined.

The issue in the company’s financial statements underlying this comment was a decrease in SG&A from $151,353,000 in 2016 to $133,314,000 in 2017.  Net income for 2017 increased over net income for 2016 by $2,500,000.  The company’s disclosures surrounding this challenging contingent consideration estimate included the following: (note that the amounts in this footnote are in 000’s)

Note 1 –    GENERAL (Cont.)

ACQUISITIONS AND INVESTMENTS

In July 2015, the Company acquired a division from an Israeli-based company (the “Seller”), for a total consideration of approximately $154,000, of which approximately $40,000 is contingent consideration, which may become payable on the occurrence of certain future events.

In December 2016, following certain claims and allegations demanding indemnification pursuant to the asset purchase agreement, the Company signed a settlement agreement with the Seller, in which the parties agreed on certain cash payments and a reduction of up to $4,000 from any contingent consideration payment to Seller. During 2017, the Company recognized a reduction of approximately $31,200 in its contingent consideration related to the acquisition of the division from the Seller (the reductions in the contingent consideration offset general and administrative expenses).

With all that as prelude, here is the company’s response to the SEC’s comment:

 Response:

The asset purchase agreement (“APA”) applicable to the 2015 acquisition provided for contingent consideration to be paid to the seller if the acquired division met certain post-acquisition performance targets.  Such performance targets were based on accumulated revenues during, and surplus backlog (based on actual orders received) at the end of, an earn-out period starting January 1, 2015 and ending December 31, 2017 (the “earn-out period”).

It should be noted that due to orders that could have been booked up to the last day of the earn-out period, the surplus backlog could be finally determined only at the end of 2017, based on order bookings and revenues up to that date.

The APA provided that any contingent consideration was to be determined following the end of 2017, with the Company delivering its calculation thereof to the seller by March 31, 2018, whereupon the seller would have a period of 45 days to review and notify the Company of any dispute with Company’s computation of the earn-out.

Following the end of the earn-out period, on December 31, 2017, the Company considered the facts and circumstances at that date and performed a detailed analysis involving the sales & marketing, finance and corporate management departments, to conclude whether the acquired division’s performance achieved the targets set forth in the APA. The Company’s analysis included a review of the acquired division’s actual revenues during the earn-out period as well as a review of the actual backlog as of December 31, 2017, the earn-out period expiration date.

Additionally, because of a possible commercial dispute with the seller due to the possible subjective judgment involved in determining the surplus backlog, and since the seller’s review and dispute period had not commenced, the Company assessed the likelihood of whether the seller might object to such a determination and retained contingent consideration of $4.5 million, which represented the Company’s best estimate for a potential settlement after the seller’s review of the calculations. Accordingly, the Company recognized a net gain of approximately $31 million resulting from the adjustment of the carrying amount of the earn-out contingent liability at December 31, 2017, which was recognized in general and administrative expenses on the consolidated statements of income.

During the first quarter of 2018, the Company delivered to the seller a schedule setting forth a computation of the earn-out amount, informing the seller that the performance targets under the APA were not met and no earn-out payment was required. During the second quarter of 2018, the seller’s review period expired without any claims made by the seller. Therefore, the Company decreased the earn-out contingent liability to $0.

In view of the circumstances described above regarding the contingent earn-out obligation and its resolution and finalization during 2018, we propose the following additional disclosure in our future filings, commencing with our 2018 Form 20-F, which will be filed in March 2019 (revisions are marked in underlined italics for the convenience of the Staff):

“During 2018 and 2017, the Company recognized reductions of approximately $4,500 and $31,200, respectively, in its earn-out contingent liability related to the acquisition of a division, since the Company concluded that the acquired division had not achieved the performance requirements necessary for making contingent earn-out payments. Further, in May 2018, the period in which the Seller could have filed a dispute over the earn-out computation expired without any claim or demand from the Seller. The income resulting from the reductions in the contingent consideration liability was recognized in general and administrative expenses.”

The next letter from the SEC?  The one we like to see:

We have completed our review of your filing. We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff.

 Yes, it is an estimate.  And yes, it is challenging.  And yes, a reasonable, well documented approach to such estimates is crucial!  This will become even more important when the PCAOB’s new standard about auditing accounting estimates becomes effective.  More about this in a future post.

As always, your thoughts and comments are welcome!

 

A New Role at the SEC – ESG Senior Policy Advisor

Hot Topic, Reporting

On February 1, 2021, Satyam Khanna was named Senior Policy Advisor for Climate and ESG in the office of Acting Chair Allison Herren Lee.

As noted in this Press Release, in this new role, Mr. Khanna will “advise the agency on environmental, social, and governance matters and advance related new initiatives across its offices and divisions.”

You can read more about the role and Mr. Khanna’s background in the Press Release.

A New “Dear CFO” Letter – Securities Offerings and Price Volatility

Hot Topic, Reporting

It has been a while since CorpFin issued a “Dear CFO” letter.  These sample comment letters, which historically started with the salutation “Dear CFO,” advise companies about rapidly emerging disclosure and accounting concerns.  On February 8, 2021, with an update in the salutation to “Dear Issuer,” the staff issued this “Sample Letter to Companies Regarding Securities Offerings During Times of Extreme Price Volatility.”

Among the issues the sample letter addresses are:

  • Providing an appropriate description of the volatility of the company’s stock price,
  • Including risk factors addressing price volatility, and
  • Explaining the effects of a potential “short squeeze” on investors.

In these times of volatility and change it will be interesting to see how many “Dear Issuer” letters the SEC promulgates.

As always, your thoughts and comments are welcome!

Where to Place the Performance Graph? A Filed Versus Furnished Example

10-K Tips, Reporting, Uncategorized

A frequent question in our SEC Reporting Skills Workshop is “What the heck is going on with the performance graph required by S-K Item 201(e)?”  This question stems from a bit of history about the performance graph, an obscure instruction, and the distinction between furnished and filed documents.

(Spoiler alert:  The graph is not required in Form 10-K and can be furnished in the annual report to shareholders.)

S-K 201(e) requires a five-year line graph comparing the annual percentage change in the registrant’s cumulative total shareholder return on a class of common stock with the cumulative total return of a broad equity market index and a published industry, line-of-business or peer index.  You can read all the details of the requirement here.

Here is an example of the graph from Coca Cola’s 2019 Form 10-K.

Picture1

 

Where to place the graph turns out to be a murky question.  Originally, this graph was a required proxy disclosure.  Several years ago, when the SEC expanded the proxy executive compensation disclosures, they proposed to remove the graph.  Several commenters on the proposal asked the SEC to retain the requirement, stating that it provided valuable information.  The SEC did not want to include the graph in the proxy for a variety of reasons.  As a compromise, the Final Rule added the graph to S-K Item 201.  What the Final Rule did not do was require the graph in Form 10-K.

This is where the filed versus furnished question arises.  Historically, the graph was not filed information.  It was simply furnished in the proxy.  If the SEC had required the graph in Form 10-K it would have become filed information and subject to the 1934 Act’s liability provisions for filed information.  To keep this from happening, the SEC added the following instruction to S-K Item 201(e):

  1. The information required by paragraph (e) of this Item need not be provided in any filings other than an annual report to security holders required by Exchange Act Rule 14a-3 (17 CFR 240.14a-3) or Exchange Act Rule 14c-3 (17 CFR 240.14c-3) that precedes or accompanies a registrant’s proxy or information statement relating to an annual meeting of security holders at which directors are to be elected (or special meeting or written consents in lieu of such meeting). Such information will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

Unfortunately, this instruction was kind of hidden after an instruction for smaller reporting companies.

The bottom line is that the graph does not have to be in Form 10-K and does not have to be filed information.  It can be included in the annual report to shareholders, which is furnished, not filed. Companies that put the graph in the part of the annual report to shareholders that is not included in Form 10-K do not subject the disclosure to the 1934 Act’s liability provisions.

This annual report from Cracker Barrel Old Country Store provides an example of how the graph can be placed in the “wrap” pages of a “10-K wrap” annual report to shareholders.  This means the graph is not included in the filed Form 10-K.  You will find the graph on the back cover of the Cracker Barrel Old Country Store annual report to shareholders.

Lastly, to further illustrate the confusion about this graph, here is an SEC comment letter and company response about the placement of the graph.

The SEC Comment Letter

Re: Monro Muffler Brake, Inc.

Form 10-K for the Fiscal Year Ended March 28, 2015

Dear Ms. D’Amico:

We have limited our review of your filing to the financial statements and related disclosures and have the following comments. In some of our comments, we may ask you to provide us with information so we may better understand your disclosure.

Please respond to these comments within ten business days by providing the requested information or advise us as soon as possible when you will respond. If you do not believe our comments apply to your facts and circumstances, please tell us why in your response.

After reviewing your response to these comments, we may have additional comments.

Form 10-K for the Fiscal Year Ended March 28, 2015

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters, page 16

  1. Please tell us your consideration for including the performance graph as required by Item 201(e) of Regulation S-K.

 

The Company’s Response

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters

  1. Please tell us your consideration for including the performance graph as required by Item 201(e) of Regulation S-K.

Response: It is our understanding that the performance graph is required to be included in the Company’s annual report to stockholders, but not in its Form 10-K. This understanding is based on Instruction 7 to Item 201(e) of Regulation S-K, which states that “the information required by paragraph (e) of Item 201 need not be provided in any filings other than an annual report to security holders required by Exchange Act Rule 14a-3 or Exchange Act Rule 14c-3 that precedes or accompanies a registrant’s proxy or information statement relating to an annual meeting of security holders at which directors are to be elected (or special meeting or written consents in lieu of such meeting).” Further the staff of the Division of Corporation Finance has indicated in Regulation S-K Compliance and Disclosure Interpretations Question 106.10 that the performance graph is not required to be included under Item 5 of Form 10-K and need only be provided in the issuer’s annual report to stockholders.

The performance graph as required by Item 201(e) of Regulation S-K is included in the Company’s 2015 Annual Report under the Financial Highlights section on page 5.

 

SEC Response

Dear Ms. D’Amico

We have completed our review of your filing. We remind you that our comments or changes to disclosure in response to our comments do not foreclose the Commission from taking any action with respect to the company or the filing and the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. We urge all persons who are responsible for the accuracy and adequacy of the disclosure in the filing to be certain that the filing includes the information the Securities Exchange Act of 1934 and all applicable rules require.

As always, your thoughts and comments are welcome!

About That Selected Financial Data and Quarterly Information Change??

Reporting, SEC Hot Topic

In an earlier post, we suggested eliminating Selected Financial Data and quarterly information disclosures in Form 10-K.  This was based on the early transition option in the SEC’s Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information Final Rule.

The change in administrations in Washington, D.C. has created the possibility of a change in the effective date of the new rule.  In a January 20, 2021, Presidential Action titled “Regulatory Freeze Pending Review,” the new administration provides this guidance:

  1. With respect to rules that have been published in the Federal Register, or rules that have been issued in any manner, but have not taken effect, consider postponing the rules’ effective dates for 60 days from the date of this memorandum, consistent with applicable law and subject to the exceptions described in paragraph 1, for the purpose of reviewing any questions of fact, law, and policy the rules may raise.  For rules postponed in this manner, during the 60-day period, where appropriate and consistent with applicable law, consider opening a 30-day comment period to allow interested parties to provide comments about issues of fact, law, and policy raised by those rules, and consider pending petitions for reconsideration involving such rules.  As appropriate and consistent with applicable law, and where necessary to continue to review these questions of fact, law, and policy, consider further delaying, or publishing for notice and comment proposed rules further delaying, such rules beyond the 60-day period.  Following the 60-day delay in effective date:

a.  for those rules that raise no substantial questions of fact, law, or policy, no further action needs to be taken; and

b.  for those rules that raise substantial questions of fact, law, or policy, agencies should notify the OMB Director and take further appropriate action in consultation with the OMB Director.

A deferral of the effective date is not automatic.  And there are some questions about whether this action applies to independent agencies such as the SEC.  Whatever the case, the SEC would have to take action to defer the effective date.  With these uncertainties it is likely not prudent to make these changes now.

As always, your thoughts and comments are welcome!

An Overview of the New MD&A Rule

Hot Topic, Reporting

As we discussed in this post, the SEC’s Final Rule, “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” was published in the Federal Register on January 11, 2021.

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

This means a company that files a Form 10-K on or after February 10, 2021, has the option to selectively early implement the changes to each individual S-K item:

  • Selected financial data (S-K Item 301)
  • Quarterly information (S-K Item 302)
  • MD&A (S-K Item 303).

In this post, we reviewed the details and pros and cons of early implementation for selected financial data (S-K Item 301) and quarterly information (S-K Item 302).

Here is an overview of the MD&A changes in S-K Item 303.  In future posts we will explore each change in detail.

The Final Rule:

  • Adds a new Item 303(a), Objective, to make the principal writing objectives in FR 36 and FR 72 part of the core MD&A guidance;
  • Amends Item 303(a)(1) and (2) (amended Item 303(b)(1)) to modernize, enhance and clarify disclosure requirements for liquidity and capital resources, including an emphasis on a company’s ability to generate and obtain adequate amounts of cash and providing more details about future cash requirements;
  • Amends current Item 303(a)(3) (amended Item 303(b)(2)) to clarify, modernize and streamline disclosure requirements for results of operations, including a focus on describing causal factors and underlying reasons in both quantitative and qualitative terms;
  • Adds a new Item 303(b)(3), Critical accounting estimates, to clarify and codify previous Commission guidance in FR 72 on critical accounting estimates;
  • Replaces current Item 303(a)(4), Off-balance sheet arrangements, with a more principles-based requirement to disclose their impact, if material;
  • Eliminates current Item 303(a)(5), Tabular disclosure of contractual obligations., replacing it with a new, more principles-based, liquidity and capital disclosure requirements that include this information to the extent material;
  • Amends current Item 303(b), Interim periods (amended Item 303(c)) to allow for sequential-quarter analysis in Form 10-Q; and
  • Removes old paragraph (a)(3)(iv) about inflation disclosures as this requirement is essentially embedded in the principles-based MD&A requirements.

We will explore the details of these changes in upcoming posts.

As always, your thoughts and comments are welcome!

CorpFin Hot Disclosure Topic – Special Purpose Acquisition Companies

Hot Topic, Reporting

Special Purpose Acquisition Companies, or SPACs, have become a go-to vehicle for raising capital and becoming publicly traded.  This exponential growth has created a multitude of disclosure issues.  The 1933 Securities Act transaction disclosure requirements do not generally apply when a SPAC acquires an operating company.  Disclosure requirements for unique SPAC issues, including the economic stake that sponsors have in the SPAC and the process the SPAC uses to set the subsequent acquisition price, are frequently unclear.

On December 22, 2020, CorpFin issued Disclosure Guidance Topic 11, Special Purpose Acquisition Companies, to present their views about disclosure considerations for SPAC IPO and business combination transactions.

Disclosure considerations discussed for a SPAC IPO include:

  • Possible conflicts of interest for the SPAC sponsors,
  • Incentives that exist or may arise for sponsors to complete a business combination,
  • Compensation arrangements with underwriters, and
  • How the terms of securities held by sponsors may differ from those of the public shareholders.

Disclosure considerations surrounding SPAC subsequent business combination transactions include:

  • Terms of any additional financing,
  • How the target company was identified and evaluated, and
  • Services and fees related to underwriters.

The Disclosure Guidance Topic provides more details in each of these areas.  Additionally, this is clearly not an all-inclusive list.  It provides the core principles that SPACs should consider as they provide disclosures to investors.

As always, your thoughts and comments are welcome!

PS -If you want to learn more about SPACs on April 20 we will have a new conference:

The SPAC Life Cycle: Business, Legal and Accounting Considerations Forum 2021

Time to Remove Selected Financial Data and Quarterly Information?

Hot Topic, Reporting

As we discussed in this post, on January 11, 2021,  the SEC’s November 19, 2020 Final Rule, “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” was published in the Federal Register.

The Final Rule will be effective on February 10, 2021.  The transition provisions provide a mandatory transition date but also allow voluntary early compliance.  Companies must apply the rule for their first fiscal year that ends after August 9, 2021.  They may voluntarily apply the new rule, on an S-K item-by-item basis, in any filing made on or after the effective date of February 10, 2021.

This means that a company that will file its Form 10-K on or after February 10, 2021, has the option to implement some or all of the changes to MD&A (S-K Item 303), selected financial data (S-K Item 301), and quarterly information (S-K Item 302).

This post explores the relatively simple choices for S-K Item 301 and 302.  In coming posts we will explore the MD&A changes in S-K Item 303.

Selected Financial Data

The change for selected financial data is very simple.

On page 162, the Final Rule removes the selected financial data requirement from Regulation S-K:

  1. Remove and reserve § 229.301.

On page 182, the Final Rule makes a corresponding change to the instructions for Form 10-K:

  1. Amend Form 10-K (referenced in § 249.310) by:
    ……..
  2. Removing and reserving Item 6 (“Selected Financial Data”) of Part II.

Companies have the option to implement this change and omit Item 6 from a Form 10-K filed on or after February 10, 2021.  This is independent of the period end of the financial statements in the Form 10-K.

The rationale for removing this disclosure is fairly straightforward.  In the Final Rule the SEC states:

The Commission proposed to eliminate Item 301 in part because of advances in technology since the item’s adoption in 1970 that allow for easy access to the information required by this item on the Commission’s Electronic Data Gathering, Analysis, and Retrieval system (“EDGAR”).  The Commission also noted that Item 301 was originally intended to elicit disclosure of material trends and that requiring five years of selected financial data is not necessary to achieve this because of the requirement for discussion and analysis of trends in Item 303.

With this information readily available from several other sources and the existing requirement to disclose material trends in MD&A, this seems a good time to eliminate this disclosure!

Additionally, since Item 6 will no longer exist in Form 10-K after a company’s mandatory transition date, this item will have to be removed after that date.

Quarterly Information

The change for quarterly information on page 162 of the Final Rule is not as simple.  The Final Rule provides the following revised language for S-K Item 302:

            229.302 (Item 302) Supplementary financial information.

(a) Disclosure of material quarterly changes. When there are one or more retrospective changes to the statements of comprehensive income for any of the quarters within the two most recent fiscal years or any subsequent interim period for which financial statements are included or are required to be included by § 210.3-01 through 210.3-20 (Article 3 of Regulation S-X) that individually or in the aggregate are material, provide an explanation of the reasons for such material changes and disclose, for each affected quarterly period and the fourth quarter in the affected year, summarized financial information related to the statements of comprehensive income as specified in Rule 1-02(bb)(ii) of Regulation S-X and earnings per share reflecting such changes.

Again, companies have the option to implement this change and omit the quarterly information from a Form 10-K as long as it has not been materially, retrospectively changed.  As with the change for selected financial data, this applies to Form 10-Ks filed on or after February 10, 2021, and is independent of the period end of the financial statements in the Form 10-K.  Companies may make this change in a Form 10-K for December 31, 2020, as long as the report is filed on or after February 10, 2021.

The rationale for this change is discussed in the Final Rule:

We continue to believe that requiring quarterly financial data when there have not been one or more retrospective changes that are material, either individually or in the aggregate, would duplicate disclosures provided elsewhere, such as in Forms 10-Q or, in the case of fourth quarter results, can be derived from annual results disclosed in the Form 10-K. Our amendments eliminate these duplicative disclosures. We do, however, agree with commenters that timely disclosure of the effects of material retrospective changes may be important to investors, and lack of such disclosure could impact the ability to derive fourth quarter information when there have been such changes.

Again, this seems like the right time to implement this change.

More about the changes to MD&A in coming posts, and as always, your thoughts and comments are welcome!

MD&A, Selected Financial Data, and Quarterly Information Final Rule Published in Federal Register

Hot Topic, Reporting

On January 11, 2021, the SEC’s Disclosure Modernization Final Rule, “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” was published in the Federal Register.

The rule will be effective on February 10, 2021.  The rule provides for a mandatory compliance date 210 days after the publication date.  This mandatory compliance date is August 9, 2021.

This means that a company must apply the new rule for its fiscal year that ends after August 9, 2021.

The rule’s transition provisions provide for voluntary implementation earlier than a company’s mandatory compliance date.  This early implementation may be on an S-K item-by-item basis.  The Compliance Date section on page 104 of the Final Rule states that registrants:

“may provide disclosure consistent with the final amendments any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety. For example, upon effectiveness of the final amendments, a registrant may immediately cease providing disclosure pursuant to former Item 301, and may voluntarily provide disclosure pursuant to amended Item 303 before its mandatory compliance date. In this case, the registrant must provide disclosure pursuant to each provision of amended Item 303 in its entirety, and must begin providing such disclosure in any applicable filings going forward.”

We will dive into the details of each of the provisions in upcoming posts.

As always, your thoughts and comments are welcome!