The FASB’s new lease accounting standard presents complex accounting, internal control, systems and implementation challenges. Attend SECI’s live interactive workshop, Implementing the FASB’s New Leases Accounting Standard Workshop being held May 17th in Dallas with additional dates and locations this fall. Attendees will learn the conceptual underpinnings, overall structure and details of this new standard as it applies to both lessees and lessors. Implementation considerations, system issues and related topics will be discussed in detail and concepts will be reinforced by use of examples and case studies.
Tag Archives: auditor independence
The New Going Concern Disclosures – An Example
By: George M. Wilson & Carol A. Stacey
Sears, a storied retailer with a rich history, provides a perhaps not unexpected example of the new going concern disclosures in their recently filed 10-K. In their financial statements on page 66 of the 10-K you will find these disclosures:
Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.
If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.
This, as the bolded sentence above illustrates, is an example of the situation where there is substantial doubt about the ability of Sears to continue as a going concern, but the substantial doubt is mitigated by the company’s plans. The new reporting requirement for going concern disclosures has a two path approach. The first is:
If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is alleviated as a result of consideration of management’s plans, an entity shall disclose in the notes to financial statements information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the notes):
- Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
- Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
- Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.
The second disclosure path is:
If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, the entity shall include a statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Additionally, the entity shall disclose information that enables users of the financial statements to understand all of the following:
- Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
- Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
- Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.
Sears provides us an interesting example and the delicate dance of the wording in their disclosure sheds light on how challenging this new requirement can be for companies.
And, to close the loop, here is the opinion paragraph from the auditor of Sear’s financial statements:
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As always, your thoughts and comments are welcome!
Non-GAAP Measures – The Saga Continues
By: George M. Wilson & Carol A. Stacey
The sometimes fuzzy distinction between non-GAAP liquidity measures and non-GAAP performance measures is a major concern of the SEC’s Non-GAAP Compliance and Disclosure Interpretations (C&DI’s) and the comment letters the Staff issues focused on this topic. In the middle of this grey question are EBITDA and “adjusted EBITDA”. Whether these measures are liquidity measures or performance measures can be a very complex, subjective question. To take some of the grey away the SEC included this C&DI in their May 2016 changes:
Question 103.02
Question: If EBIT or EBITDA is presented as a performance measure, to which GAAP financial measure should it be reconciled?
Answer: If a company presents EBIT or EBITDA as a performance measure, such measures should be reconciled to net income as presented in the statement of operations under GAAP. Operating income would not be considered the most directly comparable GAAP financial measure because EBIT and EBITDA make adjustments for items that are not included in operating income. In addition, these measures must not be presented on a per share basis. See Question 102.05. (emphasis added) [May 17, 2016]
The last sentence in this answer is all about the potential confusion between EBITDA and cash flow from operations. GAAP and the SEC guidance specifically prohibit presenting cash flow per share because of the potential confusion between earnings per share and cash flow per share. (This goes all the way back to ASR 142 and old SFAS 95!) EBITDA, even when intended by management as an operations measure, is so close to this line that it cannot be presented on a per share basis.
In an interesting sequence of comment letters and responses the SEC has pushed its concerns about these kinds of non-GAAP measures to a new level. After a number of back and forth letters with a registrant focusing on whether a “non-GAAP adjusted net income” was a performance or liquidity measure the staff included this language in a late round comment:
Finally, in light of our discussions about this matter, we will evaluate the industry practices you described to us and consider whether additional comprehensive non-GAAP staff guidance is appropriate.
It is extremely unusual, as was even reported in The Wall Street Journal on February 13, 2017, to see a statement like this in a comment letter.
Even more eyebrow-raising is this comment in the SEC’s closing letter:
Although we do not agree with your view, in light of the circumstances, 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. (emphasis added)
If you are presenting an EBITDA or similar measure it would be smart to review these letters.
You can find the first of the comment letter series here. The company’s responses (CORRESP documents) and the follow-up comment letters (UPLOAD documents) appear in this EDGAR list.
As always, your thoughts and comments are welcome.
More Change – Final – Resource Extraction Payment Rule Repealed
By: George M Wilson & Carol A. Stacey
On February 14, 2017 President Trump signed the law eliminating the resource extraction payment disclosure provisions of the Dodd Frank Act.
From:
www.whitehouse.gov/the-press-office/2017/02/14/president-trump-cutting-red-tape-american-businesses
GETTING GOVERNMENT OUT OF THE WAY: Today, President Donald J. Trump signed legislation (House Joint Resolution 41) eliminating a costly regulation that threatened to put domestic extraction companies and their employees at an unfair disadvantage.
H.J. Res. 41 blocks a misguided regulation from burdening American extraction companies.
By halting this regulation, the President has removed a costly impediment to American extraction companies helping their workers succeed.
This legislation could save American businesses as much as $600 million annually in regulatory compliance costs and spare them 200,000 hours of paperwork.
The regulation created an unfair advantage for foreign-owned extraction companies.
As always your comments and thoughts are welcome.
Communicate Consistently – It Really Does Matter
By: George M. Wilson & Carol A. Stacey
As we discuss in our workshops, it is crucial that companies communicate consistently across all the channels they use. Here are a couple of SEC comments that illustrate this point.
This first comment refers to articles in the news. Yes, the SEC staff does read the paper! This means that companies need to monitor news stories to assure that publically disseminated information is consistent with other disclosures.
General
- Recent articles indicate that Yahoo’s November 2014 agreement with Mozilla contains a change-in-control provision that provides Mozilla with the right to receive $375 million annually through 2019 if Yahoo is sold and Mozilla does not deem the new partner acceptable. As this provision appears to take the agreement out of the ordinary course of business, please provide us with your analysis of the materiality of this agreement for purposes of Item 601(b)(10) of Regulation S-K.
Here is another frequent theme, how the staff monitors earnings calls and other presentations.
Results of Operations, page II-7
- We note in your September 8, 2015 earnings call, your chief executive officer made reference to verbal commitments from customers to escalate contract prices when oil prices improve. Given the importance of the price of oil on your results, please tell us and consider disclosing in more detail whether such verbal commitments represent a known event. Refer to Item 303(a)(3)(ii) of Regulation S-K and SEC Release No. 33- 8350.
As a parting thought, have all the members of your disclosure committee, and in particular the persons involved in drafting and reviewing MD&A, reviewed your earnings calls as part of their process? (And yes, the second comment is one of our favorite MD&A topics!)
As always, your thoughts and comments are welcome!
Non-GAAP Measures – Rise of the Enforcement Message!
By: George M. Wilson & Carol A. Stacey
On January 18, 2017, the SEC ended the speculation about whether or when we would see enforcement actions focused on non-GAAP measures. MDC Partners, a New York marketing company, paid a fine and consented to an SEC cease-and-desist order without admitting or denying the findings. The case dealt with two issues, non-GAAP measures and failure to disclose certain perks properly. The non-GAAP measure issue related to amounts disclosed for “organic revenue growth” which the company did not calculate consistently from period to period. In addition the company did not present the comparable GAAP measure with equal or greater prominence, as Regulation S-K Item 10(e) requires in an earnings release.
Both issues are frequently discussed areas in the SEC’s May 2016 C&DI’s about non-GAAP measures.
You can read the related release here.
Third Annual Form 10-K Tune-Up
As you draft your annual Form 10-K it is always a challenge to be sure that you deal effectively with new and emerging issues and the ever-evolving focus areas of the SEC. Register for our January 23rd One Hour Briefing, Form 10-K Tune-Up. Review the key issues to address in this year’s Form 10-K, including the latest in SEC Staff comments about non-GAAP measures; new accounting standards, revenue recognition, leases and financial instruments.
More About S-3 and the Transition to the New Revenue Recognition Standard
In a recent post we explored a very complex securities registration issue within retrospective application of the new revenue recognition standard. (The issue arises with any retrospective application, so it will also arise in the new leasing standard.) In a nutshell the registration issue comes up when you:
(1) Adopt the new revenue recognition standard as of January 1, 2018 (assume a December 31 year-end), then
(2) File your March 31, 2018 10-Q and then
(3) File an S-3 to register to sell securities.
The S-3 incorporates your 2017 Form 10-K by reference which includes 2015 financial statements. The 2015 financial statements would not normally be retrospectively adjusted for the new revenue recognition standard. In this case though that could be necessary. You can read all the technical details here.
This first post led to a really interesting question from a reader. What happens if you file the S-3 before you file your March 31, 2018 10-Q? We explored the issue in this post.
This then led to a really great comment from another reader. In our workshops we always emphasize building research skills and using all the relevant SEC resources, especially the CorpFin Financial Reporting Manual (FRM). This really astute reader found this section in Topic 13 of the FRM:
13110.2 In the case of a registration statement on Form S-3, Item 11(b)(ii) of that form would specifically require retrospective revision of the pre-event audited financial statements that were incorporated by reference to reflect a subsequent change in accounting principle (or consistent with staff practice, discontinued operations and changes in segment presentation) if the Form S-3 also incorporates by reference post-event interim financial statements. If post-event financial statements have not been filed, the registrant would not revise the pre- event financial statements in connection with the Form S-3, however, pro forma financial statements in accordance with Article 11 of Regulation S-X may, in certain circumstances, be required. In contrast, a prospectus supplement used to update a delayed or continuous offering registered on Form S-3 (e.g., a shelf takedown) is not subject to the Item 11(b)(ii) updating requirements. Rather, registrants must update the prospectus in accordance with S-K 512(a) with respect to any fundamental change. It is the responsibility of management to determine what constitutes a fundamental change.
Here there is at least some relief for the S-3 filed after year-end but before the Form 10-Q is filed! As a reminder S-X Article 11 contains this requirement:
- 210.11-01 Presentation requirements.
(a) Pro forma financial information shall be furnished when any of the following conditions exist:
………………….
(Note: (1) to (7) omitted)
(8) Consummation of other events or transactions has occurred or is probable for which disclosure of pro forma financial information would be material to investors.
Some judgment will be required to make that decision! If the effect of the new revenue recognition standard is large enough, it could well be material to investors.
Similarly, for the S-3 shelf takedown S-K 512(a) includes this requirement (in bullet ii):
(ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement.
Again, some judgment will be required to make that decision!
Thanks to both the readers who contributed to this discussion, and as always your thoughts and comments are welcome!
A Really Good Question – Form S-3 and the New Revenue Recognition Standard
In a recent post we discussed a potential complication in the registration process and Form S-3 in particular if you retrospectively implement the new revenue recognition standard. You can review the post here. The issue arises if you file an S-3 in 2018 after you adopt the new revenue recognition standard but before your 10-K for 2018 is filed. The 2018 Form 10-K will have annual financial statements for 2018, 2017 and 2016 retrospectively applying the new standard. However, if you file an S-3, or have an S-3 shelf registration in place, before you file the 2018 Form 10-K, your S-3 would be required to have three fiscal years, now 2017, 2016 and 2015 that apply the new standard.
Thus, you could be required to report an extra year, 2015, on the new revenue recognition standard if you want to access the capital markets with an S-3, or an S-3 shelf registration, during 2018.
Whether or not the SEC can or will have any relief from this issue is not finalized. So stay tuned!
In our post we set up the example with an S-3 filed after the first-quarter 2018 form 10-Q is filed.
This all lead to a really great question from a reader:
In the hypothetical, if an issuer were to file an S-3 in the first quarter of 2018 (before its 3Q financials go stale and before the 2018 10-Q is filed), does Item 11 of Form S-3 require the company to file an 8-K with its recast 2015 financials reflecting the full retrospective adoption of the new standard before the issuer may take-down securities?
The answer to this question? Well, there is not a detailed rule anywhere that deals with the issue.
We researched the question and the closest guidance we could find was in the CorpFin Financial Reporting Manual Topic 11:
“Companies may transition to ASU No. 2014-09 and IFRS 15 (collectively, the “new revenue standard”) using one of two methods:
Retrospectively to each prior period presented, subject to the election of certain practical expedients (“full retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. In its 2018 annual report, the company would revise its 2016 and 2017 financial statements and record the cumulative effect of the change recognized in opening retained earnings as of January 1, 2016.
Retrospectively with the cumulative effect of initially applying the new revenue standard recognized at the date of adoption (“modified retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. At that time, the company must record the cumulative effect of the change recognized in opening retained earnings and financial statements for 2016 and 2017 would remain unchanged. The standard also sets forth additional disclosures required by companies that adopt the new standard using this method.
That language sure sounds like if you file after January 1, 2018, you need three years, 2015, 2016 and 2017 based on the new standard.
That said, stay tuned, we will all continue our research! And what is more fun than a really deep SEC research question?
As always, and especially with this one, your thoughts and comments are welcome!
Brexit and your Second Quarter 10-Q
In the massive press coverage about “Brexit” one of the most frequently used words is “uncertainty”. While the impact of Brexit will differ from company to company it is important, as we come to the end of the June 30, 2016 quarter (or whenever your next quarter end will be), to think about whether the vote and the resulting uncertainty should be dealt with in your SEC reporting.
The two most straightforward issues are likely risk factors and MD&A known trends.
The risk factor disclosure in Part II Item 1A of 10-Q refers back to S-K 503(c) and requires disclosure of what makes owning your company’s securities “speculative or risky”. Companies should consider whether the uncertainties and already known impacts of Brexit increase risk and deserve mention in risk factors.
When a risk factor becomes more probable of having a material impact the risk factor should transmogrify into an MD&A “known trend” disclosure. This disclosure is required when there are “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.” (S-K Item 303). There are similar known trend disclosures for liquidity and capital resources. If you could be affected by market uncertainty, reasonably possible changes in exchange rates or other impacts of Brexit this disclosure may be necessary in MD&A. Lots of judgment here.
It is always important to remember that the “reasonably expects” probabilistic test in FR 36 requires disclosure if you cannot say the trend is “not reasonably likely” to come to fruition. (Sorry for the double negative, but it is in the test!). So if there is a 50/50 chance of a material impact, disclosure should likely be made.
Lastly, beyond these two issues there are a wealth of other possible accounting and disclosure ramifications, ranging from issues such as possible elevated risk of impairment to tax consequences, depending on your circumstances.
As always, your thoughts and comments are welcome.