Tag Archives: 10-K

How Prepared are you for SEC Annual Reporting Season or your next 10-Q?

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Have you stayed on top of recent developments at the SEC, FASB and PCAOB? Register for our live seminar and webcast, 32nd Annual SEC Reporting & FASB Forum being held November 14-15 in Dallas, December 12-13 in New York City and December 19-20 in San Francisco. Prepare for year-end reporting season and hear a discussion of current events, including disclosure effectiveness, juggling Rev. Rec., Leases and more.

http://www.pli.edu/Content/32nd_Annual_SEC_Reporting_FASB_Forum/_/N-1z11c8sZ4k?ID=262904

Disclosures About Risks and Uncertainties

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All the news about Apple’s international tax situation, a significant uncertainty that they and many other companies face, presents a great opportunity to review how uncertainties and the big questions they pose should be disclosed.

Developing disclosures about uncertainties is never simple. One reason for this complexity is how many areas they can affect in a 10-K or 10-Q. The key places to focus are:

Risk Factors

Financial statements – GAAP contingency disclosures

MD&A – possible known trend disclosures

The key disclosures will be in the three above items, and that is where we will focus for now. It is important to remember though that other areas could be involved. Disclosure might be included for example in legal proceedings in Item 3 (which would generally be similar to the financial statement disclosures but would likely include more details) and perhaps even the business description in Item 1 if the uncertainty was a significant general development.

Risk Factor Disclosure

S-K Item 503(c) contains this requirement:

(c) Risk factors. Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make the offering speculative or risky. This discussion must be concise and organized logically.

Clearly a material uncertainty could fall into this disclosure requirement. Apple talked about tax issues in their most recent Form 10-Q Part II Item 1A disclosure (emphasis added):

The Company could be subject to changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.

The Company is subject to taxes in the U.S. and numerous foreign jurisdictions, including Ireland, where a number of the Company’s subsidiaries are organized. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. The Company’s effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in tax laws or their interpretation, including in the U.S. and Ireland. For example, in June 2014, the European Commission opened a formal investigation of Ireland to examine whether decisions by the tax authorities with regard to the corporate income tax to be paid by two of the Company’s Irish subsidiaries comply with European Union rules on state aid. If the European Commission were to conclude against Ireland, it could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid, and such amount could be material.

The Company is also subject to the examination of its tax returns and other tax matters by the Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of these examinations. If the Company’s effective tax rates were to increase, particularly in the U.S. or Ireland, or if the ultimate determination of the Company’s taxes owed is for an amount in excess of amounts previously accrued, the Company’s financial condition, operating results and cash flows could be adversely affected.

 

Financial Statement Disclosures

After the risk factor, where perhaps we use an “everything including the kitchen sink” approach, Apple goes further. In the notes to the financial statements they included this disclosure. Note here that ASC 450 dealing with contingencies and the three levels of probability — probable, reasonably possible and remote — would apply, along with guidance about uncertain tax positions. Here, along with disclosure about other tax issues, Apple discloses the issue again (check out the last paragraph in particular).

Note 5 – Income Taxes

As of June 25, 2016, the Company recorded gross unrecognized tax benefits of $7.6 billion, of which $2.8 billion, if recognized, would affect the Company’s effective tax rate. As of September 26, 2015, the total amount of gross unrecognized tax benefits was $6.9 billion, of which $2.5 billion, if recognized, would have affected the Company’s effective tax rate. The Company’s total gross unrecognized tax benefits are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets. The Company had $1.5 billion and $1.3 billion of gross interest and penalties accrued as of June 25, 2016 and September 26, 2015, respectively, which are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets.

Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company believes it is reasonably possible that its gross unrecognized tax benefits could decrease (whether by payment, release or a combination of both) in the next 12 months by as much as $800 million.

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of June 25, 2016 the Company is unable to estimate the impact.

One of the areas the SEC focuses on in reviewing contingency disclosures is the “reasonably possible” probability level. In this situation disclosure is required and an amount must be disclosed if it can be estimated. If it can’t be estimated disclosure is still required.

 

MD&A

 

And, lastly MD&A requires disclosure of known trends and uncertainties. The language in S-K Item 303 includes this requirement:

 

 

(a)(3)(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

 

Here is an excerpt from Apple’s MD&A.

 

 

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of June 25, 2016 the Company is unable to estimate the impact.

 

 

Uncertainty disclosures are never easy, and with all the areas that can potentially be involved, a place to be very careful!

 

As always, your thoughts and comments are welcome!

Get the Skills Necessary to Succeed in the Current SEC Reporting Environment

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Financial Reporting professionals are constantly challenged to keep on top of changing SEC Reporting requirements. Accountants and Auditors need to know how to prepare and review SEC periodic and current reporting forms, including the 10-K Annual Report, the 10-Q Quarterly Report, and the 8-K Current Report, as well as an understanding of how to comply with the annual proxy requirements and how insider trading rules work. Register today for one of our upcoming live in-depth workshops, SEC Reporting Skills Workshop 2016 being offered October 13-14 in New York City, October 24-25 in Chicago and November 10-11 in San Diego. December dates and locations are also available and posted on our website. Attendees will learn to master Forms 10-K, 10-Q, and 8-K and the proxy statement, use all the important sources of SEC reporting rules and guidance, write an effective MD&A and deal with the SEC staff and understand their “hot buttons,” including frequent comment areas such as revenue recognition, the statement of cash flows, segments, non-GAAP measures, and contingencies.

http://www.pli.edu/Content/Seminar/SEC_Reporting_Skills_Workshop_2016/_/N-4kZ1z11c95?Ns=sort_date%7c0&ID=262877

Year-End Planning – Number Four – Recently Issued Accounting Standards and a Few Example Comments

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In recent weeks we have been posting about areas to deal with in advance of year-end. So far we have addressed:

Issues in the Statement of Cash Flows

Evaluating and Auditing ICFR

The New Item 16 Form 10-K Summary

 

The spirit and rationale behind these posts is that it is always a good idea to proactively anticipate problems that may arise and act to keep issues from becoming problems.

As we continue this series our next post is about SAB 74 (Topic 11-M in the SAB Codification), the requirement for disclosures about recently issued accounting standards.

 

With the major changes coming from the new revenue recognition standard, the new lease standard, and for financial companies the new financial instrument impairment standard, these disclosures become increasingly important. Users need to be forewarned about the expected impact of these new standards. This is essentially a known trend disclosure in your MD&A.

 

Here is an excerpt from Topic 11-M. You can read the entire SAB here.

 

Interpretive Response: The staff believes that the registrant should evaluate each new accounting standard to determine the appropriate disclosure and recognizes that the level of information available to the registrant will differ with respect to various standards and from one registrant to another. The objectives of the disclosure should be to (1) notify the reader of the disclosure documents that a standard has been issued which the registrant will be required to adopt in the future and (2) assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. The staff understands that the registrant will only be able to disclose information that is known.

 

The following disclosures should generally be considered by the registrant:

 

A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.

 

A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.

 

A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.

 

Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.

 

 

As a company gets closer to the adoption date for a new standard these disclosures should evolve. And although “[t]he staff understands that the registrant will only be able to disclose information that is known”, the other side of this disclosure is that when you know something, you should disclose it!

 

One last heads up – when you file your 10-K for the year before adoption, in other words you will adopt the day after that year-end, the staff will likely expect robust disclosure, including quantification of the impact of adoption.

 

When a company has decided which method it will use to adopt, it should disclose that information!

 

As a company researches and builds an understanding of how much a new standard will affect the financial statements, this impact should be disclosed.

 

Frequently we are concerned that there is uncertainty in this process, and that is never comfortable to discuss in an SEC report. Here are two excerpts that are examples of this disclosure from a June 30, 2016 Form 10-K. They deal with this uncertainty (emphasis added):

 

Leases

 

In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.

 

The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We currently anticipate early adoption of the new standard effective July 1, 2017 in conjunction with our adoption of the new revenue standard. Our ability to early adopt is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.

 

We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for office, retail, and datacenter operating leases.

 

Revenue from Contracts with Customers

 

In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.

 

The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We currently anticipate early adoption of the new standard effective July 1, 2017. Our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.

 

We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for software license revenue. We expect revenue related to hardware, cloud offerings, and professional services to remain substantially unchanged. Specifically, under the new standard we expect to recognize (Product A) revenue predominantly at the time of billing rather than ratably over the life of the related device. We also expect to recognize license revenue at the time of billing rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing.

 

We currently believe that the net change in (Product A) revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard.

 

Lastly, as we always like to do, here are two example comments to reinforce the issues in this disclosure:

 

Please revise your disclosures to fully comply with Question 2 of SAB Topic 11:M for each standard listed. Specifically, if early adoption is permitted, you should state the date that you plan to adopt the standard. You should also discuss the impact that adoption of each standard is expected to have on your financial statements or, if applicable, make a statement to the effect that you are still assessing the impact that adoption of each standard will have on your financial statements and the impact is not known or reasonably estimable at this time.

 

Please revise to include a discussion of the potential effects that recently issued accounting standards will have on your financial statements when adopted in a future period. Refer to SAB Topic 11.M. For example, please revise to disclose the potential effect of ASU No. 2014-09, Revenue from Contracts with Customers.

How Prepared are you for SEC Annual Reporting Season or your next 10-Q?

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It has been a very active time at the SEC, FASB and PCAOB. Have you stayed on top of recent developments, activities and proposals? For example, the Leases Standard is final and the FASB is awash in simplification and other projects. Register now for our upcoming live seminar and webcast, 32nd Annual SEC Reporting & FASB Forum being held November 14-15 in Dallas, December 12-13 in New York City and December 19-20 in San Francisco. Prepare for year-end and reporting season by attending this highly anticipated and popular annual seminar and hear a roundtable discussion of current events, including simplification overload, disclosure effectiveness, juggling Rev. Rec., Leases, CECL adoptions and more. Our expert faculty will also discuss the new CDIs on non-GAAP measures, the Regulation S-K Concept Release, frequent accounting and disclosure comments, Revenue Recognition and guidance on lease accounting, MD&A disclosure and much more.

http://www.pli.edu/Content/32nd_Annual_SEC_Reporting_FASB_Forum/_/N-1z11c8sZ4k?ID=262904

Year End Planning Topic 3 – The New Item 16 Form 10-K Summary (and Disclosure Philosophy!)

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Everyone who works with SEC periodic reports knows that making changes to disclosure is not a simple process. Reporting involves so many stakeholders and so many approval points that without an early start it is almost impossible to make improvements (or even simple changes such as formatting!).

This post is about one possible change that will need some time for consideration, adding the new Item 16 summary. With this reminder hopefully you will have enough time to consider whether this optional item makes sense for you.

This kind of summary has always been permitted, or at least never prohibited. However, in the process of making periodic reports more about communication than compliance, the FAST Act required the SEC to formally put a summary into Form 10-K, hence new Item 16. You can read the text of Item 16 in this post.

Your Communication Philosophy

If you read a lot of Form 10-K’s (and what is more fun than that?) you will see a variety of communication styles. We discuss different communication styles or “philosophies” in our workshops. We encourage companies to articulate their “philosophy” of disclosure.

To simplify a bit, some companies adopt a very “compliance” based philosophy for disclosure. In this model companies disclose what the SEC requires to be disclosed and essentially nothing more. This can be done in a fairly mechanical fashion and is usually very simple and direct, if not almost terse.

At the other end of a disclosure spectrum some companies adopt a more “communications” based philosophy where they disclose more than the bare bones requirements in an effort to tell a more complete “story” of how their company operates.

A simple example of this difference can be found in Form 10-K Item 1. This is the description of the business and the required disclosures are in Regulation S-K Item 101. Nowhere in Item 101 is there any requirement to disclose a company’s business strategy. And many companies do not say anything about the strategic orientation of their business. And yet, many companies discuss their strategy at length. Check out the differences in these two companies:

Here is a very well done example for an SRC (Golden Enterprises) of the compliance approach. Golden makes snack foods and does a simple, direct presentation. (Also, best potato chips ever!)

Here is another well-done example of a company (Square) that uses a more communications oriented approach. Square is a payment processor and supports businesses in many ways.

To be clear, there is no right or wrong way in this discussion; we are talking about a judgment you need to make. So, why do some companies disclose more than the S-K requirement?   These companies are considering disclosure as more than a compliance process. They are using the reporting process as a communications tool.

If you are going to focus more on communication the SEC’s Interim Final Rule about a Form 10-K summary could be a new element in your communication strategy. Almost every business writer will suggest that an executive level overview for a long document is a good communication strategy.

FR 72 suggested this for MD&A way back in 2003:

Many companies’ MD&A could benefit from adding an introductory section or overview that would facilitate a reader’s understanding. As with all disclosure, what companies would appropriately include in an introduction or overview will depend on the circumstances of the particular company. As a general matter, an introduction or overview should include the most important matters on which a company’s executives focus in evaluating financial condition and operating performance and provide the context for the discussion and analysis of the financial statements. Therefore, an introduction or overview should not be a duplicative layer of disclosure that merely repeats the more detailed discussion and analysis that follows.

In recent remarks the SEC staff has said they are seeing more companies using their filings as communication documents and this trend certainly fits into the SEC’s disclosure effectiveness program.

So, as you get into your annual reporting process, be sure you articulate this overall strategy for disclosure, and if you think it appropriate, put consideration of the new Item 16 summary into your thought process.

As always, your thoughts and comments are welcome!

A Busy Summer for the SEC!

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The SEC has been busy on many fronts this summer. If you review the summary of proposed rules here on their web site you will see they have proposed five rules so far this summer and the summary of final rules here has another six rules issued in final form.

 

That is a busy summer!

 

The proposed rules contain some of the first concrete, early steps in the SEC’s disclosure effectiveness project. The proposal will “clean-up” some areas where the SEC’s rules overlap or are redundant with GAAP, IFRS or other guidelines. They also include a proposal to change the threshold to use the Smaller Reporting Company system to $250,000,000 in public float.

 

You can see the details of each proposal below:

 

Disclosure Update and Simplification

 

Amendments to Smaller Reporting Company Definition

 

Modernization of Property Disclosures for Mining Registrants

 

 

The final rules range from the final resource extraction payment rules required by Dodd/Frank, which replace the earlier version overturned in the courts, to the FAST Act 10-K summary.

 

You can see the details of each final rule below:

 

Disclosure of Payments by Resource Extraction Issuers

 

Adoption of Updated EDGAR Filer Manual

 

Form 10-K Summary

 

 

As always, your thoughts and comments are welcome!

Leases and the Five-Year Selected Financial Data in Form 10-K

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Within the required retrospective transition method for the new lease accounting standard is a very familiar question:

Will we be required to revise all five years of the selected financial data presented in Item 6 of Form 10-K?

As you may already know the SEC formally granted relief in the five-year summary for companies that use a full retrospective implementation for the new revenue recognition standard. For leases, they have done exactly the same.

 

At the March SEC Regulations Committee meeting of the CAQ this issue was addressed and if you read the minutes of the meeting you will see the SEC Staff’s announcement that:

“The selected financial data table should follow the transition provisions of the ASU (i.e., the new leasing standard should be applied as of the beginning of the earliest comparative period presented in the financial statements).”

Thank you letters may be appropriate!

As always, your thoughts and comments are appreciated!

Comment of the Week – Be Consistent in All Communications

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One of the themes we discuss in our workshops is how the SEC does not limit their review process to information in a company’s SEC filings. Here is an example of a comment (which also deals with known trends and uncertainties, another favorite topic) that demonstrates how the Staff finds issues by looking in places such as earnings releases, conference call recordings and web pages:

 

Results of Operations, page 23

 

  1. Please expand your discussion to address any known trends or uncertainties that are reasonably expected to have a material impact on revenue, cost of revenue, or income from operations. For example, we note that during your 2015 fourth quarter and full year earnings call on February 11, 2016, your management quantitatively described the volume increase, as well as discussed your customer mix changes by segment and certain trends in 2016. In addition, disclosure appearing on page 11 of your filing on Form 10-K under your risk factors indicates that extended periods of low fuel prices can also have an adverse effect on your results of operations and overall profitability, as well as on the valuation of inventory to the extent your hedges are not effective at mitigating fluctuations in fuel prices. However, you have not provided a discussion in your filing with respect to an analysis of known material trends, demands and uncertainties.

 

Refer to Section III of Financial Reporting Release No. 72, codified in FRC §501.12 and Item 303 of Regulation S-K.

 

It is important to assure that all the vehicles you use to communicate with your shareholders and the rest of the public are consistent and that issues raised in one place are appropriately dealt with across all communication channels.

 

As always, your thoughts and comments are welcome!

Get the Message: SEC Enforcement Case Deals With Evaluating ICFR Weaknesses!

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By sending a clear message through the enforcement process, the SEC has come full circle in their concerns about whether ICFR audits are finding material weaknesses. The staff has said on numerous occasions that they see too many situations where a company identifies a control deficiency but the company’s analysis fails when assessing whether the control deficiency is in fact a material weakness.

Over the last few years the SEC Staff have emphasized their concerns in numerous speeches and other public settings. As they sometimes do when they don’t see companies listening, they have also emphasized this issue through enforcement.

This enforcement is dramatic, involving:

The company

Two company officers

The audit partner

The ICFR consulting firm partner (a surprise here!)

 

This excerpt from a December 2015 speech by Deputy Chief Accountant Brian Croteau summarizes the SEC’s concerns:

Still, given the frequency with which certain ICFR issues are identified in our consultations with registrants, I’d be remiss not to remind management and auditors of the importance of properly identifying and describing the nature of a control deficiency and understanding the complete population of transactions that a control is intended to address in advance of assessing the severity of any identified deficiencies.  Then, once ready to assess the severity of a deficiency, it’s important to remember that there are two components to the definition of a material weakness – likelihood and magnitude.  The evaluation of whether it is reasonably possible that a material misstatement could occur and not be prevented or detected on a timely basis requires careful analysis that contemplates both known errors, if any, as well as potential misstatements for which it is reasonably possible that the misstatements would not be prevented or detected in light of the control deficiency.  This latter part of the evaluation, also referred to as analysis of the so called “could factor,” often requires management to evaluate information that is incremental to that which would be necessary, for example, for a materiality assessment of known errors pursuant to SAB 99. The final conclusions on severity of deficiencies frequently rest on this “could factor” portion of the deficiency evaluation; however, too often this part of the evaluation appears to be an afterthought in a company’s analysis.  Yet consideration of the “could factor” is very important. 

The issue is clear; too often companies are finding a control deficiency but not appropriately evaluating the severity of the issue to determine if it is a material weakness.

In a “classic” example this SEC enforcement involves a company that performed its annual ICFR evaluation and stated in its form 10-K that ICFR was effective at year-end. Then, shortly after that report in their Form 10-K, the company restated its financial statements and disclosed the existence of a material weakness. It is very unlikely that the material weakness arose between the year-end of the Form 10-K and the date of the restatement.

You can read about the enforcement in this press release, which also has links to the SEC Enforcement Orders for the company and the individuals involved:

www.sec.gov/news/pressrelease/2016-48.html

 

The fact that the company and auditor were named is not surprising. What is surprising is that the firm the company retained to provide SOX 404 services, which included assisting “management with the documentation, testing, and evaluation of the company’s ICFR” and no external report, was included in the enforcement.

This is a loud and clear message to all participants in the process! Be thorough and complete in your evaluation of control deficiencies!

If you would like to delve a bit deeper into this issue one of our follow-up posts to this year’s Form 10-K Tune-Up One Hour Briefing focused on ICFR issues, including the issue raised in this enforcement case.

You can read our post at:

seciblog.pli.edu/?p=530

 

As always, your thoughts and comments are welcome and appreciated!