Tag Archives: financial accounting

The New Going Concern Disclosures – An Example

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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!

Solid Knowledge and Tips Needed to Successfully Navigate SEC Reporting

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Financial reporting professionals that are armed with the foundational knowledge and practical experience are better prepared to complete and review the SEC’s periodic and current reporting forms, including the 10-K Annual Report, the 10-Q Quarterly Report and the 8-K Current Report. Attend an upcoming SECI live workshop, SEC Reporting Skills, being held in March in San Francisco, New York and San Diego with additional dates and locations.

http://www.pli.edu/Content/SEC_Reporting_Skills_Workshop_2017/_/N-1z10od0Z4k?ID=290554

Non-GAAP Measures – The Saga Continues

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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.

Things Are Changing!

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By: George M. Wilson & Carol A. Stacey

Two of the provisions of the Dodd Frank Act relating to disclosures by public companies are being considered for change in Washington, DC.

 
Conflict Minerals Disclosures
Acting Chairman Piwowar has directed the Staff to reconsider whether the 2014 guidance on the conflict minerals rule is still appropriate and whether any additional relief is appropriate. You can read his announcement including his formal statement and information he gathered on a trip to Africa here.

 
Resource Extraction Payment Rule
Congress has begun the process of revoking the Resource Extraction Payments provisions of the Act. The House passed this provision earlier and the Senate voted to revoke the provision Friday, February 3, 2017. You can read about the Senate vote here.

 

As always your thoughts and comments are welcome!

When Disclosure Obligations Reach Beyond Financial Reporting

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By: George M. Wilson & Carol A. Stacey

Good accounting requires good communication. Many times information that is well-removed from the financial reporting and accounting functions has impacts on the financial statements or other parts of the SEC reporting process, especially MD&A. The Sarbanes Oxley Act built on the internal accounting controls guidance in section 13(b) of the FCPA Act in expanding the evaluation, audit and reporting requirements for internal control over financial reporting, or ICFR, and creating the concept of disclosure controls and procedures, or DCP.

A recent enforcement action brings home, at this important year-end time, the importance of effective disclosure controls throughout the company, with perhaps redundant controls that search beyond traditional financial reporting functions for issues that may impact the financial statements or require disclosure in other parts of a periodic report. It reinforces the idea that responsibility for disclosure is a company-wide obligation, and that companies need to build reliable infrastructures to ensure that investors receive all of the information they are supposed to receive.

ICFR and its related requirements have been part of the reporting process for decades. ICFR is formally defined in Exchange Act Rule 13(a)-15 as:

a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

(1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

(2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and

(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

ICFR is all about the financial statements and that of course includes all of the relevant disclosures in the footnotes to the financial statements.

Here is how SOX expanded this process and formally defined disclosure controls in Exchange Act Rule 13(a)-15:

For purposes of this section, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

What is clear in this definition is that DCP relates to the entire report, not just the financial statements. And, both ICFR and DCP are relevant to the financial statements.

The terms “accumulate and communicate” are particularly relevant for this case. DCP clearly applies to the concept of a known trend in MD&A, which may not be relevant to the financial statements. It also applies to information that may be relevant to accounting for contingencies, even when that information is in an operational area.

In the enforcement case mentioned above the company paid “a $1 million penalty to settle charges that deficient internal accounting controls prevented the company from properly assessing the potential impact on its financial statements of a defective ignition switch found in some vehicles.” Further,

“[t]he SEC’s order finds that the company’s internal investigation involving the defective ignition switch wasn’t brought to the attention of its accountants until November 2013 even though other (company) personnel understood in the spring of 2012 that there was a safety issue at hand. Therefore, during at least an 18-month period, accountants at the (company) did not properly evaluate the likelihood of a recall occurring or the potential losses resulting from a recall of cars with the defective ignition switch.

This case clearly addressed accounting for contingencies and the related GAAP disclosures. In other situations there may not be a contingency disclosure, but there could be a known trend in MD&A. Both are relevant issues as we work through year-end. What this all builds to is that the disclosure process, including both ICFR and DCP, has to reach beyond the information required for financial statement reporting.

It is all about communication! And this might be a good time to communicate this issue to your disclosure committee and all the parts of your organization.

As always, your thoughts and comments are welcome!

Whistleblower Reminders

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By: George M. Wilson & Carol A. Stacey

 

On December 19 and 20, 2016, as a year-end reminder, the SEC’s Enforcement Division announced two more cases to emphasize that companies MUST NOT do anything to impede employees from blowing the whistle.

You can find a lot more background about this issue in this post.

In the first case NeuStar Inc. paid a fine of $180,000 for putting restrictive language in severance agreements.

The SEC found that NeuStar was “routinely entering into severance agreements that contained a broad non-disparagement clause forbidding former employees from engaging with the SEC and other regulators ‘in any communication that disparages, denigrates, maligns or impugns’ the company.” The agreements were structured harshly. Departed employees would lose all but $100 of their severance pay if they violated the agreement. This language impeded at least one former employee from contacting the SEC.

In the second case Oklahoma City-based SandRidge Energy Inc. agreed to pay a fine of $1.4 million. Even though the company reviewed their severance arrangements several times after new Dodd/Frank rules were put in place, they continued to include language “restricting” former employees from blowing the whistle to regulators.

The SEC found that “SandRidge fired an internal whistleblower who kept raising concerns about the process used by SandRidge to calculate its publicly reported oil-and-gas reserves.”

The message is clear – Don’t try to limit a former employee’s ability to blow the whistle! Instead, take steps to investigate the matter!

As always, your thoughts and comments are welcome!

Why, Oh Why, Is It Always Segments?

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By: George M. Wilson & Carol A. Stacey

If you have been involved with SEC reporting for more than say, five minutes, you have heard about or discussed with someone the SEC’s focus on operating segments. Segment related disclosures are included in several Form 10-K Items, including:

Item 1 – Description of the business,

Item 2 – Properties,

Item 7 – MD&A, and of course

Item 8 – Financial Statements.

Almost every SEC conference or workshop addresses the importance of segment disclosures.

The latest segment “message” from the SEC is in the November 7, 2016 Accounting and Auditing Enforcement Release dealing with PowerSecure.

It is the same familiar message we heard in the Sony case in 1998 and the PACCAR case in 2013. When companies avoid making proper GAAP disclosures for operating segments to try and bury problems in one part of a business with profits from another part of their business, trouble will result.

In the “classic” Sony case the company used profits from its music business to mask problems in its movie business. This case also has a great known trend disclosure problem and becomes an almost scary “double trouble” example. To escalate this case to “triple trouble” the SEC also made it clear that Sony’s assignment of MD&A to the IR manager was not appropriate by naming that person in the case and forcing Sony to reassign this responsibility to the CFO. With all that was going on with Sony the SEC went so far as to require the company to engage its auditors to “examine” MD&A. Surprisingly, under the attest standards, auditors can issue a full opinion report on MD&A!

In the PACCAR case problems in new truck sales were hidden with profits from truck parts sales. This SEC Complaint includes a very detailed summary of the operating segment disclosure requirements, discussing in detail how PACCAR’s management viewed the business and how, in the SEC’s judgement, PACCAR was not following the GAAP requirements. It includes this language:

“However, in reporting its truck and parts results as a single segment, PACCAR did not provide investors with the same insight into the Company as PACCAR’s executives.”

This story line repeats in PowerSecure. For the periods in question PowerSecure reported one segment when that was not how management actually viewed the business:

“PowerSecure also misapplied ASC 280 by concluding that its CODM – who was determined to be the Chief Executive Officer (“CEO”) – did not regularly review operating results below the consolidated level to make decisions about resource allocations and to assess performance. This was inconsistent with the way in which the CEO regularly received, reviewed, and reported on the results of the business and how the company was structured. On a monthly basis, the CEO received financial results that reflected a measure of profitability on a more disaggregated level than the consolidated entity. Further, on a quarterly basis, the CEO met with each business unit some of the business unit leaders had business unit level budgets and forecasts and received incentive compensation based, at least in part, upon the results of their business unit.“

The message is clear, don’t use segments to try and hide problems! As a last reminder, don’t forget that these disclosure requirements may go to an even lower level than operating segments in MD&A. Regulation S-K Item 303 makes this clear:

“Where in the registrant’s judgment a discussion of segment information or of other subdivisions of the registrant’s business would be appropriate to an understanding of such business, the discussion shall focus on each relevant, reportable segment or other subdivision of the business and on the registrant as a whole.”

As always, your thoughts and comments are welcome!

 

Third Annual Form 10-K Tune-Up

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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.

http://www.pli.edu/Content/Seminar/Third_Annual_Form_10_K_Tune_Up_/_/N-4kZ1z10jog?Ns=sort_date%7c0&ID=301955

Revenue Recognition –Some Example Implementation Judgements and an Update on the AICPA’s Industry Task Forces

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By: George M. Wilson & Carol A. Stacey

Some of the New Revenue Recognition Judgments

If you have begun your implementation work for the new revenue recognition standard you know that this one-size-fits-all, principles based model will require many new judgments for most of us. Among the challenging questions are:

  1. When does an agreement with a customer become legally enforceable and include the five elements that bring it in scope for revenue recognition?
  2. How do we properly account on the balance sheet for transactions with customers before there is an in-scope, legally enforceable contract?
  3. When does a product or service we deliver to a customer meet the new criteria of “distinct” and become a performance obligation, the unit of account for revenue recognition?
  4. How do we make the now required estimate of variable consideration and apply the new constraint?
  5. What will be the best method to make the required estimate of stand-alone selling price when it is not directly observable?
  6. When does control transfer to a customer now that delivery, ownership and risk of loss are no longer the points in time when revenue is recognized?

 

This list is, of course, in no way complete. Individual companies may find their judgments more or less extensive and complex.

While the FASB has produced all of these new principles and the related judgments, it has also included a fair amount of implementation guidance in the new standard and clarified several issues in updates to the ASU. There are a few more soon to be final technical corrections in another ASU that you can read about here.

 

AICPA Help for Specialized Industries

 

Since this new standard is a “one-size-fits-all” approach to revenue recognition and it supersedes all industry specific guidance we have today, industries like oil and gas, airlines and others face unique challenges. In addition to the FASB’s efforts to assist us in this process you may have heard that the AICPA has also formed special task forces to deal with industry specific challenges in implementing the new standard.

You can learn about the AICPA’s efforts surrounding the new revenue recognition task force here.

The industry groups are:

 

There are over 100 specific position papers that have been put in process for the working groups and task forces which will ultimately be reviewed by FINREC. If you work in one of these industries, the links above will help you find the related working papers and their status.

 

As always, your thoughts and comments are welcome!