SEC Chief Accountant Addresses Accounting Standard Setting

Hot Topic, Reporting

On February 14, 2023, SEC Chief Accountant Paul Munter again addressed the FASB’s standard-setting process in a Statement titled “Accounting Standard Setting in a Rapidly Evolving Business Environment: A Focus on the Timely Delivery of Investor Priorities.”  This Statement continues discussion of several issues mentioned in Mr. Munter’s February 22, 2022, “Statement on the FASB’s Agenda Consultation: Engagement with Investors and Other Stakeholders Vital to Development of High Quality Accounting Standards.”

In the 2022 Statement, Mr. Munter discussed several aspects of the FASB’s agenda consultation project, particularly the importance of investor and other stakeholder input.  He also highlighted the importance to investors of several standard-setting areas including disaggregating financial statement information, accounting for digital assets, and climate-related transactions and disclosures.

Mr. Munter’s 2023 Statement continues this focus on the FASB’s standard-setting process.  In the introduction to his Statement, he acknowledges that the FASB’s standard-setting project agenda has been reprioritized, “largely to focus on investor and other stakeholder priorities identified through the agenda consultation process.”  He also mentions the Board’s focus on various projects, including:

Disaggregation – Income Statement Expenses;

Accounting for and Disclosure of Crypto Assets;

Improvements to Income Tax Disclosures; and

Segment Reporting.

He then writes:

“Completion of these and other reprioritized projects in a timely manner is critical to the quality of accounting standards and the resulting quality of financial reporting. As FASB standard-setting projects move forward, we believe there are continued opportunities for improvement to the standard-setting process, and that constructive collaboration by preparers, investors, auditors, and other stakeholders, with a focus on timely solutions that meet investor financial reporting needs, is key to the development of high-quality accounting standards for the benefit of the financial reporting system, investors, and issuers.”

The next section in the Statement, titled “Enhancing the Accounting Standard-Setting Process,” includes this observation:

“The rapid pace of change in today’s business and economic environment requires a thoughtful, yet timely, response by standard setters to improve the quality of financial accounting and reporting standards, thereby enhancing the usefulness of the financial information provided to investors. The FASB’s recent agenda reprioritization, however, is just one step in addressing such needs in a rapidly changing environment. Consistent with many projects on its reprioritized agenda, the FASB should continue to scope its standard-setting projects to allow for achievable standards updates to be finalized in the near term on topics that are of the highest priority to investors. The FASB, with the support of its stakeholders, should act with a renewed sense of focus and urgency in order to enhance its standard-setting process and produce timely, meaningful improvements to its standards.”

 In this section Mr. Munter also states:

“However, more work remains to be done—including improved collaboration across the FAF and the FASB regarding additional process improvements needed to accomplish more timely standard setting in response to investor needs. To accomplish its mission of establishing and improving standards that foster decision-useful financial reporting for investors, it is critically important that the FASB, and the FAF Trustees in their oversight role, continue to enhance its process to improve standard-setting efficiency, effectiveness, and transparency.”

The Statement then discusses projects which are top priorities for investors and how the FASB’s agenda “now better reflects a focus on investor and other stakeholder priorities in meaningful and achievable standard-setting projects.”  Mr. Munter then notes:

“However, the proof is in the doing. The FASB should now execute on those stated priorities in an effective, efficient manner to produce timely, high-quality standards updates. As noted above, this will require the FASB to carefully design and execute on the scope of its projects. It is also of critical importance that preparers, auditors, and other stakeholders focus on providing collaborative feedback to the FASB on cost-effective solutions that meet investors’ needs for improved financial information.”

As always, your thoughts and comments are welcome!

Getting Ahead of the MD&A Update Curve – Meaningfully Addressing Liquidity and Capital Resources Disclosures

Hot Topic, Reporting, Uncategorized

As we discussed in a prior post, three parts of the SEC’s 2020 MD&A modernization have become focus areas in the comment process:

    • Critical accounting estimate disclosures
    • Quantitative and qualitative disclosures about material changes
    • Meaningfully addressing liquidity and capital resources disclosures

We also explored how one of the reasons behind this increase in MD&A comments could be that companies are reluctant to change MD&A, even when the change is to comply with a new rule or to improve MD&A!

In earlier posts we explored comment letter exchanges focused on critical accounting estimate disclosures and quantitative and qualitative disclosures about material changes.

Today’s post examines an example comment and company response for the third of these three areas, meaningfully addressing liquidity and capital resources disclosures.

The Regulation S-K Item 303 guidance for this disclosure is very big picture:

Analyze the registrant’s ability to generate and obtain adequate amounts of cash to meet its requirements and its plans for cash in the short-term (i.e., the next 12 months from the most recent fiscal period end required to be presented) and separately in the long-term (i.e., beyond the next 12 months). The discussion should analyze material cash requirements from known contractual and other obligations.

……..

Describe the registrant’s material cash requirements, including commitments for capital expenditures, as of the end of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements and the general purpose of such requirements.

It is important to note that the language “cash requirements” does not limit the disclosure to contractual obligations, but all reasonably likely cash requirements.  This in essences is a discussion of how the business is funded in both the long- and short-term.  An important part of this analysis is clear and understandable disclosure about sources of cash and how they have varied in the past and how they could vary in the future.

Here is an example disclosure from a company’s Form 10-Q MD&A that generated a comment to provide more meaningful disclosure about how cash is generated:

Net cash provided by operations was $19.8 million for the twenty-six weeks ended June 24, 2022 consisting of a net income of $18.3 million and $37.1 million of non-cash charges, partially offset by investments in working capital growth of $35.6 million. Non-cash charges increased $20.4 million primarily due to a $12.8 million change in deferred tax expenses and a $5.0 million increase in changes in the fair value of earn-out liabilities. The cash used for working capital growth of $11.8 million is primarily driven by the Company’s reinvestment in working capital to support sales growth.

The SEC’s comment focuses on more robust explanations for the causal factors behind changes in cash from operating activities:

Liquidity and Capital Resources Cash Flows, page 2

    1. Your analysis of changes in operating cash flows references net results, noncash charges and working capital. Note that references to these items may not provide a sufficient basis to understand how operating cash actually was affected between periods. Your analysis should discuss factors that actually affected operating cash and reasons underlying these factors.  In connection with this, discuss more fully what the cash used for working capital growth primarily driven by the Company’s reinvestment in working capital to support sales growth represents and the potential for this to be a continuing trend.  Refer to the introductory paragraph of section IV.B and paragraph B.1 of Release No. 33-8350 for guidance, and section 501.04 of the staff’s Codification of Financial Reporting Releases regarding quantification of variance factors.  Please revise your disclosure as appropriate.

In its response, the company provided more detailed discussion about the causal factors behind the change in operating cash flows:

In response to the Staff’s comment the Company will expand its disclosure of the factors impacting operating cash flows in future filings. The following is an example of the future disclosure related to operating cash flows:

Net cash provided by operations was $19.8 million for the twenty-six weeks ended June 24, 2022, compared to net cash used in operating activities of $23.9 million for the twenty-six weeks ended June 26, 2021. The increase in cash provided by operating activities is primarily due to the increased net income, net of non-cash charges, in the current year of $55.4 million versus a loss of $0.1 million in the prior year period. This improvement in cash-based profitability is primarily due to a 65% increase in sales compared to the prior year period. The sales growth also resulted in higher working capital (increased accounts receivable and inventory partially offset by higher accounts payable). The working capital growth of $11.8 million versus the prior year period partially offset the favorable impact of increased profitability. The Company’s increased working capital investment in the current year is the result of rapid sales growth driven by the Company’s recovery from the pandemic. The Company expects working capital growth to moderate in the future as sales growth normalizes.

Each of the three MD&A areas addressed in our “Getting Ahead of the MD&A Update Curve” series was changed in the SEC’s 2020 modernization rule, which has been in effect for two years.  SEC comments, like those discussed in this series, can be easily avoided by assuring your MD&A appropriately addresses each area.

As always, your thoughts and comments are welcome!

CorpFin Addresses Pay Versus Performance Questions with Compliance and Disclosure Interpretations

Hot Topic, Reporting

On February 10, 2023, CorpFin issued 15 Compliance and Disclosure Interpretations (C&DIs) to address issues arising in preparing the Pay Versus Performance disclosures adopted in August 2022.  Given that the new disclosures are required in proxy and information statements that include Regulation S-K Item 402 disclosures for fiscal years ending on or after December 16, 2022, the C&DIs are very timely!

In addition to other topics, the new C&DIs

    • Answer questions about the computation of tabular information required in pay versus performance disclosures;
    • Clarify that pay versus performance information is not required in Form 10-K;
    • Provide guidance for disclosing details of the adjustments to arrive at compensation actually paid; and
    • Discuss considerations in selecting financial performance measures.

As a reminder, in this post, you can find a template for preparation of pay versus performance disclosures from Gary Brown of Nelson Mullins.

As always, your thoughts and comments are welcome!

The SEC’s  “Recovery of Erroneously Awarded Compensation” a/k/a “Clawback” Rules – A Policy Template and Timing and Implementation Details

Hot Topic, Reporting, Uncategorized

The SEC’s October 2022 “Listing Standards for Recovery of Erroneously Awarded Compensation” Final Rulewill require companies whose securities are listed on national securities exchanges to develop and adopt  policies for the recovery or “clawback” of incentive compensation that has been “erroneously awarded” when a company restates its financial statements. Because the SEC generally cannot directly regulate corporate governance matters, the new requirements are being implemented through listing standards that national securities exchanges will soon be required to adopt.

Based on the Final Rule, clawback policies will be required to:

    • Apply to all current and former executive officers,
    • Require clawback of incentive compensation that was based on a financial measure that is changed when a company restates its financial statements, and
    • Apply to the three years before the date on which the company restates its financial statements.

Gary Brown, Partner at Nelson Mullins Riley & Scarborough LLP, and SEC Institute workshop leader and PLI author, has drafted an “Incentive Compensation Recoupment Policy” template to help companies get a head start in this process.  You can find the policy template here.

If you would like to learn more about the provisions of and timing for the new requirements, some highlights are provided below.  You can also learn more in this Fact Sheet and the Final Rule.

The Final Rule became effective on January 27, 2023.  Based on this effective date, the timing requirements of the Final Rule are:

    • February 26, 2023 – last day by which national securities exchanges are to file proposed clawback listing standards;
    • November 28, 2023 – last day by which clawback listing standards must become effective; and
    • January 27, 2024 – last day by which listed companies must adopt and comply with an appropriate clawback policy.

Of course, if the exchanges enact listing standards earlier than the deadlines outlined above, companies will have to adopt policies before January 27, 2024.

Three important notes:

    • These new rules apply to all listed companies – including SRCs, emerging growth companies and foreign private issuers,
    • The clawback provisions will apply to both “Big R” and “little r” restatements, and
    • The requirement to pursue clawback recoveries will be subject to very limited “impracticability” exceptions.

In our next post we will review the related new disclosure requirements and form changes.

As always, your thoughts and comments are welcome!

Inflation – An MD&A Reminder

Hot Topic, Reporting

It its 2020 MD&A Modernization Rule, the SEC eliminated this separate paragraph addressing the impact of inflation:

(iv)  For the three most recent fiscal years of the registrant or for those fiscal years in which the registrant has been engaged in business, whichever period is shortest, discuss the impact of inflation and changing prices on the registrant’s net sales and revenues and on income from continuing operations.

This disclosure dated back to earlier periods when inflation had been a material issue for many companies.  In 2020, when the rule was adopted, inflation had not been a significant issue for most companies since the 1980s.  The rationale for this change in the Final Rule is based on the assumption that inflation may not be material to “most registrants”:

The purpose of the elimination is to streamline Item 303 by eliminating the specific reference to these topics, which may not be material to most registrants. This change is consistent with the principles-based disclosure framework of Item 303

That said, the principles-based nature of MD&A means that if inflation is a material issue for a company in any period, it should be addressed in MD&A.  This principle is clearly articulated in the Final Rule:

We do not believe that these changes will result in a loss of material information for market participants.   Registrants will still be required to discuss in their MD&A the impact of inflation and changing prices, if material, as is currently required.

In the current environment, the staff has been reminding companies of this requirement in the comment letter process.  Here are two examples.

Results of Operations, page 42

    1. Please expand your disclosure to address any known trends, events or uncertainties that have had, or that are reasonably likely to have, a material impact on your cash flows, liquidity, capital resources, cash requirements, financial position, or results of operations, as may be attributable to the inflation risk that you discuss on page 19.

Please clarify the extent to which your revenues and cost of product sales have been or are expected to be impacted by inflation, and discuss any plans that you have to respond to or counter any adverse circumstances.

Guess?, Inc., August 8, 2022

Management’s Discussion and Analysis of Financial Condition and Results of Operations, page 44

    1. We note you disclosed that your operating results for 2022 were negatively affected by inflationary cost pressures. Please revise to address the following:
        • Disclose any known trends or uncertainties that have had or are reasonably likely to have a material impact on your cash flows, liquidity, capital resources, cash requirements, financial position, or results of operations arising from, related to, or caused by the inflation;
        • Expand to identify the principal factors contributing to the inflationary pressures you have experienced and clarify the resulting impact to the company; and
        • Expand your disclosure to identify specific actions planned or taken, if any, to mitigate inflationary pressures.

FedEx Corporation, September 1, 2022

As always, your thoughts and comments are welcome!

Getting Ahead of the MD&A Update Curve – Quantitative and Qualitative Disclosures About Material Changes

Hot Topic, Reporting

As we discussed in a prior post, three parts of the SEC’s 2020 MD&A modernization have become focus areas in the comment process:

    • Critical accounting estimate disclosures
    • Quantitative and qualitative disclosures about material changes
    • Meaningfully addressing liquidity and capital resources

We also explored how one of the reasons behind this increase in MD&A comments could be that companies are reluctant to change MD&A, even when the change is to comply with a new rule or to improve MD&A!

In an earlier post we explored a comment letter exchange focused on critical accounting estimate disclosures.

Today’s post presents an example comment and company response for the second of these three areas, providing quantitative and qualitative disclosures about material financial statement changes.

The Regulation S-K Item 303 guidance for this disclosure is very direct:

Where the financial statements reflect material changes from period-to-period in one or more line items, including where material changes within a line item offset one another, describe the underlying reasons for these material changes in quantitative and qualitative terms.

Companies frequently describe qualitative factors behind changes without quantitative information to explain their relative magnitude.  While this has been a frequent comment area before the 2020 change, it has become the source of even more comments now that there is an objective requirement in S-K Item 303.  This is clearly an easily avoided comment.

Here is an example disclosure from a company’s Form 10-K that generated a comment to provide both quantitative and qualitative information.

Voyage expenses

To the extent that we employ our vessels on voyage charters, we incur expenses that include but are not limited to bunkers, port charges and canal tolls, as these expenses are borne by the vessel owner on voyage charters. Bunkers, port charges, and canal toll expenses primarily increase in periods during which more vessels are employed on voyage charters.

Voyage expenses for the year ended December 31, 2021 were $104.6 million, compared with $89.5 million for the year ended December 31, 2020. Voyage expenses have primarily increased due to an increase in bunker consumption expense, an increase in broker commission expense and an increase in port expenses.

The SEC’s comment is simple and direct:

Results of Operations for Years Ended December 31, 2021 and 2020, page 78

    1. We note that you list multiple factors that contribute to changes in your results. For example, you disclose several factors contributing to the increase in voyage expense. Revise your disclosure to quantify each material factor that contributes to a change in your revenues or expenses. Refer to Item 303(b) of Regulation S-K.

The company’s response is also simple and direct, as well as detailed:

The Company acknowledges the Staff’s comment and undertakes in future filings to include additional information to quantify material factors that contribute to a change in our revenues or expenses. To illustrate the Company’s intention with respect to such disclosure, we have provided below the relevant portions of the 2021 Form 10-K, revised to include such additional information (with underlined and strikethrough text indicating additions and deletions, respectively):

Voyage expenses

To the extent that we employ our vessels on voyage charters, we incur expenses that include but are not limited to bunkers, port charges and canal tolls, as these expenses are borne by the vessel owner on voyage charters. Bunkers, port charges, and canal toll expenses primarily increase in periods during which more vessels are employed on voyage charters.

Voyage expenses for the year ended December 31, 2021 were $104.6 million, compared with $89.5 million for the year ended December 31, 2020. Voyage expenses have primarily increased primarily due to an increase in bunker consumption expense of $8.0 million, which was driven by an increase in bunker fuel prices, an increase in broker commission expense of $4.6 million, which was driven by an increase in related revenues, and an increase in port expenses of $2.0 million, which was driven by an increase in the number of voyage days.

Our next post will explore the third of these frequent comment areas, liquidity and capital resources discussions.

As always, your thoughts and comments are welcome!

CorpFin Updates the Financial Reporting Manual

Reporting

On January 30, 2023, CorpFin announced an update to the Financial Reporting Manual (FRM).  Updated information includes:

    • The phone number for contacting CorpFin Office of the Chief Accountant staff;
    • A link to a new online submission for financial statement waiver or substitution requests;
    • Guidance for financial disclosures about guarantors and related matters – S-X Rules 3-10 and 3-16, as amended; and
    • Guidance related to the implementation of ASU 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts.

The update also removed information that is no longer applicable.

Still awaiting updates are sections addressing:

    • Disclosures about acquired and disposed businesses,
    • Qualifications of accountants, and
    • Management’s discussion and analysis.

You can read more about this update and find the FRM here.

As always, your thoughts and comments are welcome!

Getting Ahead of the MD&A Update Curve – Critical Accounting Estimates

Reporting, SEC Hot Topic, Uncategorized

As we discussed in this post, three parts of the SEC’s 2020 MD&A modernization have become focus areas in the comment process:

    • Critical accounting estimate disclosures
    • Quantitative and qualitative disclosures about material changes
    • Meaningfully addressing liquidity and capital resources

We also explored how one of the reasons behind this increase in MD&A comments could be that companies are reluctant to change MD&A, even when the change is to comply with a new rule or to improve MD&A!

This post presents an example comment and company response for the first of these three areas, critical accounting estimate disclosures.  While the example, particularly the revised disclosure, is lengthy, the lesson is simple.  Critical accounting estimates are not the same thing as accounting policies.  This is a very simple comment to avoid.

The Regulation S-K Item 303 guidance for critical accounting estimate disclosures, which was in FR 72 prior to the 2020 rule modernization, requires companies to go beyond accounting policy disclosure in the financial statements:

Critical accounting estimates. Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant. Provide qualitative and quantitative information necessary to understand the estimation uncertainty and the impact the critical accounting estimate has had or is reasonably likely to have on financial condition or results of operations to the extent the information is material and reasonably available. This information should include why each critical accounting estimate is subject to uncertainty and, to the extent the information is material and reasonably available, how much each estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.

Here is an example disclosure from a company’s Form 10-K that became the source of a critical accounting estimate comment. (Note that the title in this example is out of date.  It should, as stated in S-K Item 303, be Critical Accounting Estimates.)

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities at the date of the financial statements. We believe our estimates and assumptions are reasonable; however, actual results could differ from those estimates.

Our most significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments, or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria:

(1) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and

(2) different estimates reasonably could have been used, or changes in the estimate that are reasonably

We have identified the following critical accounting policies:

      • Revenue Recognition
      • Loyalty Program Accounting
      • Asset Impairment Analysis
      • Valuation of the TRA Liability

(Note: For the sake of illustration only the Loyalty Program Accounting disclosure is included here.  You can find the entire disclosure by the company here.)

Loyalty Program Accounting – The Company records a liability for loyalty points earned by passengers under its Sun Country Rewards program using two methods: (1) a liability for points that are earned by passengers on purchases of the Company’s services is established by deferring revenue based on the redemption value net of breakage; and (2) a liability for points attributed to loyalty points issued to the Company’s Visa card holders is established by deferring a portion of payments received from the Company’s co-branded agreement. The Company’s Sun Country Rewards program allows for the redemption of points to include payment towards air travel, land travel, taxes, and other ancillary purchases. The Company estimates breakage for loyalty points that are not likely to be redeemed. These estimates are based on historical experience of loyalty point redemption activity and other factors, such as program changes and modifications that could affect the ultimate usage pattern of loyalty points.

While this seems like a fairly robust accounting policy disclosure, as a critical accounting estimate disclosure it generated this comment:

Management’s Discussion and of Financial Condition and Results of Operations Critical Accounting Policies and Estimates, page 4

    1. The disclosures of your critical accounting policies and estimates appear to be a
      repetition of certain of your significant accounting policies. Please revise your disclosures to address the material implications of the uncertainties that are associated with the methods, assumptions and estimates underlying your critical accounting estimates. Your expanded disclosure should address the risk related to using different assumptions and analyze their sensitivity to change based on outcomes that are deemed reasonably likely to occur. For additional guidance, refer to Item 303(b)(3) of Regulation S-K and the related Instruction 3 to paragraph (b) of Item 303.

The essence of this comment is a frequent theme, that simply repeating an accounting policy is not a critical accounting estimate disclosure.  Here is the company’s response, which, as you can read, significantly expands the disclosure (note, it’s ok to skim this lengthy disclosure!):

The Company respectfully acknowledges the Staff’s comment and will revise future filings in response to the Staff’s comment. Utilizing the disclosure from the most recent annual report on Form 10-K, the following reflects our proposed updated disclosures to be included in future filings. The Company notes there have been no changes to the selection and application of its critical accounting policies and estimates. The Company will continue to evaluate any reasonably likely changes that could impact its critical accounting estimates and provide updated disclosure in future filings as necessary. All numbers below are presented in thousands consistent with the disclosure approach used in the Company’s most recent annual report on Form 10-K.

Critical Accounting Policies and Estimates

……..

Loyalty Program Accounting

The Sun Country Rewards program provides loyalty awards to program members based on accumulated loyalty points. The Company records a liability for loyalty points earned by passengers under the Sun Country Rewards program using two methods: (1) a liability for points that are earned by passengers on purchases of the Company’s services is established by deferring revenue based on the redemption value, net of breakage; and (2) a liability for points attributed to loyalty points issued to the Company’s Visa card holders is established by deferring a portion of payments received from the Company’s co-branded agreement. The Company’s Sun Country Rewards program allows for the redemption of points to include payment towards air travel, land travel, taxes, and other ancillary purchases. The balance of the Loyalty Program Liabilities fluctuates based on seasonal patterns, which impact the volume of loyalty points awarded through travel or issued to co-branded credit card and other partners (deferral of revenue) and loyalty points redeemed (recognition of revenue). The Company records an estimate for loyalty points breakage in Passenger Revenue upon issuance of the loyalty points. Loyalty points held by co-branded credit card members do not expire. All other loyalty points expire if unused after three years.

Points Earned Through Travel Purchases. Passenger sales that earn Sun Country Rewards provide customers with travel services and loyalty points, which are each considered distinct performance obligations. The Company values each performance obligation on a standalone basis. The Company determines the standalone selling price of loyalty points issued using a redemption value approach which considers the value a passenger will receive upon redemption of the loyalty points. Consideration allocated to loyalty points is deferred, net of estimated breakage, and recognized as Passenger Revenue when both the loyalty points have been redeemed and the passenger travel occurs.

Points Earned through the Co-Branded Credit Card Program. Under the Company’s co-branded credit card program, funds received for the marketing of a co-branded credit card and delivery of loyalty points are accounted for as a multiple-deliverable arrangement. The Company determined the arrangement has two distinct performance obligations: loyalty points to be awarded; and use of our brand and access to our customer lists, and certain other advertising and marketing elements (collectively, the marketing performance obligation). Funds received from the co-branded credit card program are allocated to the two performance obligations based on relative standalone selling price. The assumptions used to allocate the funds received are not considered critical to the application of the accounting model for the Company’s loyalty program. Consideration allocated to loyalty points is deferred, net of estimated breakage, and recognized as Passenger Revenue when both the loyalty points have been redeemed and the passenger travel occurs. Consideration allocated to the marketing performance obligation is recognized as revenue as the spend occurs and is recorded in Other Revenue.

The Company estimates breakage for loyalty points that are not likely to be redeemed. Loyalty points are combined in one homogenous pool, that includes both air and non-air travel awards, and are not separately identifiable. The estimated breakage rate is primarily based on historical experience of loyalty point redemption activity and other factors that may not be indicative of future trends, such as the COVID-19 pandemic, program changes or modifications that could affect the ultimate usage pattern of loyalty points. The Company continuously monitors its breakage rate assumptions and may adjust its estimated breakage rate for loyalty points in the future. Changes in the Company’s estimated breakage rate assumptions impact revenue recognition prospectively.

During the year ended 2021, the Company recognized $852 of loyalty points breakage within Passenger Revenue. A 10% change in the Company’s loyalty point estimated breakage rate would have resulted in a change to Passenger Revenue of approximately $170.

Our next post will explore another frequent comment area, providing both quantitative and qualitative explanations for material changes.

As always, your thoughts and comments are welcome!

Are You Behind the MD&A Update Curve?

Hot Topic, Reporting

In November 2020 the SEC made several changes to the MD&A requirements in Regulation S-K Item 303. While many of the changes dealt with “modernization” clarifications and related details, others were more substantive in nature.  Unfortunately, many companies did not implement the required changes to MD&A the year the rule became effective.  As a result, the SEC has been issuing more and more comments focused on the rule’s substantive requirements.  What has become clear, now is the time to be sure your MD&A appropriately deals with these requirements.

From recent SEC comments, we can observe that the SEC staff is currently focused on the following three areas of MD&A:

Critical accounting estimate disclosures

Quantitative and qualitative disclosures about material changes

Meaningfully addressing liquidity and capital resources

Here are example comments that demonstrate the staff’s concerns in each of these areas:

Critical accounting estimate disclosures

  1. In accordance with Item 303(b)(3), please provide a discussion and analysis
    of critical accounting estimates and assumptions that:
      • identifies your critical accounting estimates or assumptions;
        • supplements, but does not duplicate, the description of accounting policies in the notes to the financial statements; and
      • provides greater insight into the quality and variability of information regarding financial condition and operating performance.

Quantitative and qualitative disclosures about material changes

  1. We note that you list multiple factors that contribute to changes in your results. For example, you disclose several factors contributing to the increase in voyage expense. Revise your disclosure to quantify each material factor that contributes to a change in your revenues or expenses. Refer to Item 303(b) of Regulation S-K.

Meaningfully addressing liquidity and capital resources

  1. Please discuss your material cash requirements from known contractual and other obligations as of December 31, 2021, the anticipated source of funds needed to satisfy such cash requirements and the relevant time period for the related cash requirements in accordance with Item 303(b)(1) of Regulation S-K. In this regard, we note you have purchase obligations relating to take-or pay contracts of approximately $283 million as of December 31, 2021. For further guidance refer to Instruction 4 to Item 303(b) of Regulation S-K.

All too often companies are reluctant or slow to change MD&A.  The fear of SEC comments or other questions frequently impedes improving MD&A disclosure. However, in the current environment, exactly the opposite is true.  Not making appropriate updates to MD&A may well result in SEC comments.  These comments could easily be avoided by making appropriate updates.

In the next few posts, we will explore each area in detail, reviewing example disclosures and the comments they generated.

As always, your thoughts and comments are welcome.

CorpFin Issues Sample Letter to Companies Addressing Crypto Asset Markets

Hot Topic, Reporting

With the current disruption and distress in crypto asset markets, on December 8, 2022, the SEC Division of Corporation Finance issued a Sample Letter to Companies highlighting frequent crypto asset market comments.  The first example comment in the letter focuses on the overall impact of crypto asset market disruption on a business:

Provide disclosure of any significant crypto asset market developments material to understanding or assessing your business, financial condition and results of operations, or share price since your last reporting period, including any material impact from the price volatility of crypto assets.

The letter also provides example crypto asset market comments for the description of the business, MD&A and risk factors.

As always, your thoughts and comments are welcome!