At the AICPA’s December conference, Chief Accountant Wesley Bricker’s remarks included a suggestion that this Statement would be valuable reading for professionals involved in the reporting process.  The Statement includes a summary of recent OCA activities, reviews priorities such as fostering ICFR and exercising effective oversight over accounting and auditing standard setting, and also discusses the OCA consultation process.

In addition to providing the Statement, Mr. Bricker and Chair Clayton also displayed and emphasized the importance of what Chair Clayton named the “Bricker Blueprint.” This is the comprehensive summary of all the participants in the process of providing reliable financial information to our capital markets.  If you have not seen this document before, it is a great review of how our system works and the importance of each participant.  You can find a video overview of the process and the “Blueprint” here.

As always, your thoughts and comments are welcome!

Materiality is always one of the most complex judgments we make.  You can check out some background in these earlier posts about materiality considerations, SAB 99 and related issues.

As a year-end thought, here is a March 2018 comment about materiality judgments:

Note 1 – Organization and Summary of Significant Accounting Policies, page 43

1. We note that in fiscal 2017 you revised your March 31, 2016 balance sheet for an error in the historical carrying value of inventory which you believe was not material to any previously issued consolidated financial statements. However, we note that this $1.5 million overstatement of inventory appears quantitatively significant in comparison to the $0.2 million pre-tax loss of fiscal 2016 and $2.2 million pre-tax tax loss of fiscal 2015.

In order to assist us in understanding your disclosure, please provide us with the following additional information:

• tell us the specific nature of these errors, how long inventory balances were not accurately costed, when and how you discovered them.

• provide the impact of the error on fiscal 2016 and 2015 and your analysis regarding how you determined these errors were both quantitatively and qualitatively immaterial to previously reported periods including quarterly financial statements. Please refer to SAB Topics 1.M. and 1.N.

The company’s response, which is detailed and lengthy, is here.

The next step was the SEC’s closing letter, with no further comments.

As always, your thoughts and comments are welcome!

One area where companies have not received many SEC comments – and, in all honesty, we don’t like to think about much – is market risk disclosures in Item 7A of Form 10-K and Part 1 – Item 3 in Form 10-Q.  In this time of more volatile markets this forward-looking disclosure about the extent of risk is becoming more important.

We have recently seen three comment letters with questions about market risk disclosures.  In a June 27, 2018 letter the only comment the company received was this market risk question:

Item 7A. Quantitative and Qualitative Disclosures about Market Risk, page 60

1. Please tell us how you determined it was unnecessary to provide quantitative disclosures about foreign currency exchange risk. Please refer to Item 305 of Regulation S-K.

Another June 27, 2018 letter contained this comment:

Form 10-K for the Fiscal Year Ended December 31, 2017

Market Risks, page K-29

We note that you are exposed to market risk related to the fluctuations of interest rates on your fixed and floating-rate debt instruments, i.e. interest rate risk. Please revise your future filings to disclose the interest rate risk with respect to your fixed rate debt instruments using one of the three disclosure alternatives as prescribed under Item 305(a) of Regulation S-K.

In an August 29, 2018 letter a company received this market risk comment:

1. We note that you are exposed to the following market risks: interest rate risk related to your debt instruments, foreign currency exchange rate risk related to your construction contracts denominated in euros, and fuel price risk related to your operations. Please revise your future filings to disclose for all market risks the quantitative information for the preceding fiscal year along with the reasons for material changes in amounts from the preceding year. Refer to 305(a)(3) and Instruction 3(F) to Item 305(a) of Regulation S-K.

Market risk disclosures as required by Regulation S-K Item 305 are one of the more complex and least understood disclosures required in periodic reports.  Part of the issue with these disclosures is that they are entirely forward looking and are designed to help investors understand how much a future price or rate change could affect the business.  This post from 2015walks though the objectives of the disclosure and breaks down the S-K Item 305 requirements.

While there is not a lot of public discussion about market risk, in this time of more volatile markets it is not unexpected that it should get more emphasis.  We would suggest taking a fresh look at your disclosures to be sure they are on-point.

As always, your thoughts and comments are welcome!

On December 26, 2018, the SEC levied a fine on a company that failed to follow the Regulation S-K Item 10 (e) guidance concerning the use of non-GAAP measures.  Specifically, the company did not present the most directly comparable GAAP measure with equal or greater prominence in the headline and highlights in two of its earnings releases.

As you can read about here, the issue was aggravated because while the company touted increases in non-GAAP measures such as adjusted EBITDA, which showed “profitability” in the headline and highlights of its earnings releases, the comparable GAAP measure, net loss, had actually worsened.  It clearly raises concerns when a non-GAAP measure shows profitability and the comparable GAAP measure shows a loss and where the measures are moving in different directions.

The company agreed to pay a fine of $100,000.

As always, your thoughts and comments are welcome!

In this fourth post of our series discussing issues for year-end planning consideration, we are suggesting an area where you can start now to begin creating momentum for change. In his speech at the annual SEC/FASB/PCAOB conference, AICPA Chair Barry Melancon highlighted integrated reporting. Sustainability and integrated reporting were also the focus of a disclosure panel at the conference.

You can find some background about integrated reporting on the AICPA’s webpage and on the International Integrated Reporting Council’s webpage.  In addition, this blog post by Bob Laux at the IIRC, who is also a Director here at SEC Institute, provides a valuable perspective.

The SEC raised the issue of disclosures about ESG matters in its 2016 Regulation S-K Concept Releaseand many companies have begun to make disclosures in the move towards the goal of communicating information to present a more complete and transparent picture of performance, utilization of resources, and ability to create value over the long term. This 2017 posthas some real company example disclosures.

Research shows that almost all of the Fortune 500 companies are making some level of sustainability disclosures.  A report from the Governance and Accountability Institute states that 85% of the Fortune 500 companies make a sustainability report.

With all this activity surrounding integrated Reporting our suggestion is to put this topic on your disclosure agenda, and as you work through year-end begin to think of areas where it would be appropriate for your company and your financial statement users to begin providing incremental information.

As always, your thoughts and comments are welcome!

In this third post of our year-end preparation series we are highlighting a planning area to incorporate in year-end now to hopefully avoid last-minute challenges next year.  Critical Audit Matters, or CAMs, will be discussed by your auditors in their reports for years ended on or after June 30, 2019 for Large Accelerated Filers and for years ended after December 15, 2020 for others.

There has been significant discussion about the advantages of doing a “dry-run” of CAMs well in advance of the date the disclosure is required in audit reports.  There are a number of good reasons to do this, including helping to understand if any original information could potentially be disclosed in the auditor’s report and to help assure that there are no glaring inconsistencies between Critical Accounting Estimate disclosure in MD&A and CAM disclosure in the auditor’s report.

To help companies in this process the Center for Audit Quality has issued a very helpful report titled “Critical Audit Matters: Lessons Learned, Questions to Consider, and an Illustrative Example.”  Along with an interesting example of CAM disclosure, the report also includes a helpful list of questions for audit committees to consider as auditors prepare to report CAMs.

As always, your thoughts and comments are welcome!

Thanks to Pat Finnegan, who works with Fitch and has helped us as a workshop leader, for letting us know that CVS is another company that uses the direct method for their statement of cash flows in their Form 10-K.

It is pretty neat and more understandable when we see line items such as “Cash receipts from customers” and “Cash paid for inventory and prescriptions dispensed by retail pharmacies” on the statement of cash flow.

Perhaps more interesting and useful, in CVS’s 10-Kcheck out their MD&A liquidity and capital resources discussion.  The presentation is much more understandable when based on direct method information such as changes in cash receipts from customers rather than items like changes in accounts receivable.  Small wonder that FR 72suggests that even companies using the indirect method would benefit if they developed direct method information for MD&A.  From Section IV.B.1:

1. Operations

The discussion and analysis of operating cash flows should not be limited by the manner of presentation in the statement of cash flows.  Alternate accounting methods of deriving and presenting cash flows exist, and while they generally yield the same numeric result in the major captions, they involve the disclosure of different types of information. When preparing the discussion and analysis of operating cash flows, companies should address material changes in the underlying drivers (e.g. cash receipts from the sale of goods and services and cash payments to acquire materials for manufacture or goods for resale), rather than merely describe items identified on the face of the statement of cash flows, such as the reconciling items used in the indirect method of presenting cash flows

Thanks again to Pat, and as always, your thoughts and comments are welcome!

In this second post of our series discussing areas to consider as we navigate our way through the year-end reporting process, we are focusing on the latest news from the PCAOB concerning the inspection process.

As the new PCAOB Board continues to implement their strategic plan (you can read more about the plan here), how they will guide the inspection process has been addressed in an “Inspections Outlook” document issued on December 6, 2018.

The Inspection Outlook begins with a discussion of “transformation” of the inspection process.  In this section the Board says:

“We are considering topics such as the procedures we perform on the review of specific engagements and systems of quality control, our approach to selecting engagements for inspection and areas of focus, and how and what we communicate about our inspections. We are also considering how to make our process forward-looking and how to more effectively consider evolving risks, environmental factors, and the changing needs of our stakeholders.”

Areas addressed in the Inspection Outlook include:

System of quality control

Independence

Recurring inspection deficiencies

External considerations

Cybersecurity risks

Software audit tools

Digital assets

Audit quality indicators

Changes in the auditor’s report

Implementation of new accounting standards

You can read the details of each area in the Inspection Outlook document.

As always, your thoughts and comments are welcome!

As we move through the calendar towards year-end or quarter-end, we are presenting a series of posts focusing on issues to consider as we navigate through the reporting process. This first post is a reminder to make sure to update your Form 10-K or Form 10-Q for the SEC’s Disclosure Update and Simplification Rule. The major areas to update include:

Form 10-K changes:

1. Item 1 – Changes to S-K Item 101
2. Item 5 – Changes to S-K Item 201
3. The impact of the Rule on the Annual Report to Shareholders
4. The elimination of the earnings to fixed charges ratio

Form 10-Q changes:

5. Item 1 – Changes to S-X Article 10 – Addition of changes in shareholders’ equity information
6. Item 1 – Changes to S-X Article 10 – Removal of contingency disclosure language

As overviewed in this previous post, our “cookbook” to help you through the mechanics of each of the above changes can be found here.

Post Number Two in this series will have the news of the latest Inspection Outlook from the PCAOB.

As always, your thoughts and comments are welcome!

The ASC 230 guidance for the statement of cash flows includes the following language in paragraph 230-10-45-25:

In reporting cash flows from operating activities, entities are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum—the net cash flow from operating activities (the direct method). (Paragraphs 230-10-55-1 through 55-4 and paragraph 230-10-55-21, respectively, discuss and illustrate a method by which those major classes of gross operating cash receipts and payments generally may be determined indirectly.)

Although the direct method is the “preferred” method, very few companies present the direct method. The reasons behind use of the indirect method, where net income is reconciled to cash from operating activities, generally go back to system issues and information availability.  (And, if a company uses the direct method they are still required to present indirect method information.)

Erie Indemnity, a very unique company that provides service to an “insurance exchange” has a robust approach to reporting and a 10-K filled with good examples.  One of the most interesting examples is that they use the direct method when presenting their statement of cash flows, one of very few companies that use this method.

You can find their annual report here, and the statement of cash flows is on page 45.

As always, your thoughts and comments are welcome!