Tag Archives: Financial Accounting Standards Advisory Committee

Form 10-K Tune-Up Tip Number Five for 2016

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The next topic from our 2016 Form 10-K Tune-up One-Hour Briefing is SAB 74 disclosures. You can listen to the briefing on-demand with CPE and CLE credit available at:

www.pli.edu/Content/OnDemand/Second_Annual_Form_10_K_Tune_Up/_/N-4nZ1z116ku?fromsearch=false&ID=278540

 
To begin, what does SAB 74, which is Topic 11-M in the SAB Codification, actually require? You can read the whole SAB at:

www.sec.gov/interps/account/sabcodet11.htm#M

 
Here are a few highlights.

First, it is clear that this disclosure is not required for all new Accounting Standards Updates:
“The Commission addressed a similar issue and concluded that registrants should discuss the potential effects of adoption of recently issued accounting standards in registration statements and reports filed with the Commission. The staff believes that this disclosure guidance applies to all accounting standards which have been issued but not yet adopted by the registrant unless the impact on its financial position and results of operations is not expected to be material.”
This part of the SAB dovetails very nicely with an important part of the SEC’s Disclosure Effectiveness Initiative, which is to eliminate immaterial disclosures that potentially “clutter up” a report and potentially obscure material information.
Here are two examples to explore this issue.

CocaCola did not mention recently issued accounting standards in their 2014 Form 10-K MD&A. They apparently made the judgment that there was no material impact in the current year from new accounting standards. They did include SAB 74 disclosures in their financial statements in note 1. You can check it out at:
www.coca-colacompany.com/content/dam/journey/us/en/private/fileassets/pdf/2015/02/2014-annual-report-on-form-10-k.pdf

 
Intel treated this disclosure in exactly the same way, and you can find their 2014 10-K at:
www.intc.com/secfiling.cfm?filingID=50863-15-15

 
So, the first theme for SAB 74 is focus on material information.

 

 

The second point to think about with this disclosure is what do we need to say about new standards that we believe will be material.

The SAB contains four disclosure requirements:

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

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

 
3. 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.

 
4. 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 you consider these disclosures, the first thing that arises is that over time there will be a progression in the detail of the disclosure.

For example, most companies at this point in time will not know which method they will use to implement the new revenue recognition standard. But, as we go through next year, we will get closer to that decision. When the decision is made, the disclosure should be updated to inform investors about which method will be used. The same issue applies to quantifying the impact of a change.

 
The fourth disclosure, the potential impact on other significant matters, points out that when such a situation exists, this information may not be appropriate to disclose in the financial statements, but would be disclosed in MD&A.

This means that this disclosure should not always be exactly the same in the financial statements and MD&A.
As a brief PS, we have blogged about this topic before and suggested some wording for SAB 74 disclosures about the new revenue recognition standard. You can read that post at:
seciblog.pli.edu/?p=171

 

As always, your thoughts and comments are welcome!

10-K Tip Number Three for 2016

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This post continues the series of deeper dives into the 10-K reporting issues we highlighted in our January 7, 2016 One-Hour Briefing, “PLI’s Second Annual Form 10-K Tune-Up”. (This One-Hour Briefing will be available on-demand soon.) This is the third topic in the briefing, audit committee disclosures.

In the Fall of 2015 we did a series of posts about audit committee issues, a topic that has been under discussion by the SEC and the reporting community. The SEC’s concept release about audit committee disclosures and a study by The Center for Audit Quality and Audit Analytics that shows that many companies are making audit committee disclosures well beyond those required by the SEC, the Exchanges and the NASDAQ brought this discussion to a new level of importance.

This is, of course, why we included this topic in our One-Hour Briefing. And, rather than repeat all the issues, here are the blog posts which you can peruse and dive into more deeply at your leisure:

 

 

Part One – Overview and Some History seciblog.pli.edu/?p=447

Part Two – Independence Oversight seciblog.pli.edu/?p=450

Part Three – Audit Fee Disclosures –A Few Common Problem Areas in This Independence Disclosure  seciblog.pli.edu/?p=456

Part Four – The SEC’s Concept Release seciblog.pli.edu/?p=462

Part Five – Voluntary Disclosures in the News   seciblog.pli.edu/?p=486

Part Six – Some Next Steps  seciblog.pli.edu/?p=496

 

 

 

As always, your thoughts and questions are welcome!

 

10-K Tip Number Two for 2016

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The second tip from our January 7th One-Hour Briefing “PLI’s Second Annual Form 10-K Tune-up” (which will also be available in an On-Demand version soon) is under the category of New and Emerging Issues – PCAOB Auditing Standard 18 Related Parties (Release No. Release 2014-002, http://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_18.aspx) and PCAOB Auditing Standard 17 Auditing Supplemental Information Accompanying Audited Financial Statements (Release No. 2013-008 http://pcaobus.org/Standards/Auditing/Pages/AS17.aspx)

A warning for those who see “PCAOB” and assume they can skip this one. AS 18 will require auditors to do more work, which could be significant depending on the facts and circumstances. This will likely trickle down to companies and their audit committees causing more work in the areas outlined below in the form of more inquiry, documentation, and testing, including ICFR. So read on…

AS 18

 

The PCAOB adopted AS 18 in Release 2014-002 mainly to strengthen auditor performance in the areas of:

Related party transactions,

Significant transactions that are outside the normal course of business, and

Financial relationships and transactions with executives

 

Collectively these areas are referred to as “critical areas”, essentially high-risk areas, and the new Audit Standards require specific audit procedures for each area. The adopting release cited increased risks of material misstatement and fraudulent financial reporting involving these areas as motivating factors in issuing AS 18.

 

AS 18 addresses:

 

  • Relationships and transactions with related parties: Related party transactions may involve difficult measurement and recognition issues as they are not considered to be arms-length transactions. Therefore these transactions could lead to fraud or misappropriation of assets, and in turn result in errors in the financial statements, and could increase the risk of a material misstatement.

 

  • Significant unusual transactions: Significant unusual transactions can create complex accounting and financial statement disclosure issues that could cause increased risks of material misstatement and fraud. Another risk cited is the potential for inadequate disclosure if the form of the transaction is disclosed over its substance.

 

  • Financial Relationships and Transactions with Executive Officers: Financial relationships and transactions with executive officers can create incentives and pressures for executive officers to meet financial targets, resulting in risks of material misstatement to the financial statements.

 

So, what hasn’t changed:

  • The definition of related party, which the PCAOB pegged to the definition in the applicable GAAP the company uses
  • The accounting for related party transactions
  • The financial statement or regulatory (SEC) disclosure requirements

 

So, what has changed?:

  • The procedures are more specific and risk-based
  • Additional required communications with the audit committee have been added, see paragraph 19 of Release 2014-002
  • Three matters were added to the auditor’s evaluation of significant unusual transactions (see paragraph AU 316.67 as amended by this AS, which is paragraph AS 2401.67 in the reorganized PCAOB Audit Standards)
  1. The transaction lacks commercial or economic substance, or is part of a larger series of connected, linked, or otherwise interdependent arrangements that lack commercial or economic substance individually or in the aggregate (e.g., the transaction is entered into shortly prior to period end and is unwound shortly after period end;
  2. The transaction occurs with a party that falls outside the definition of a related party(as defined by the accounting principles applicable to that company), with either party able to negotiate terms that may not be available for other, more clearly independent, parties on an arm’s-length basis
  3. The transaction enables the company to achieve certain financial targets.

 

What companies should do now:

  • Become familiar with AS 18
  • Document the company’s process and related controls over (see paragraph 4 of Release 2014-002) :
  • Identifying related parties and relationships and transactions with related parties,
  • Authorizing and approving transactions with related parties, and
  • Accounting for and disclosing relationships and transactions with related parties
  • Gather and document the information auditors are required to inquire about, (see PCAOB Release No. 2014 -002, page A1-3, starting at par. 5)

 

Audit committees should:

  • Become familiar with AS 18 and AS 17
  • Understand the company’s process and related controls over identifying related party transactions and
  • Be prepared for the auditor’s inquiry that is outlined in paragraph 7 on page A1-4 of Release 2014-002.

 

AS 17

 

The PCAOB adopted AS 17 to improve the quality of audit procedures performed and related reports on supplemental information that is required by a regulator when that information is reported on in relation to financial statements that are audited under PCAOB standards. The standard requires an audit for certain supplemental information, such as:

  • the schedules in Form 11-K (employee benefit plans) where the plan financial statements and schedules are prepared in accordance with the financial reporting requirements of ERISA, and
  • the supplemental schedules required by broker-dealers under SEC rule 17a-5

 

Paragraphs 3 & 4 of Appendix 1 specifies audit procedures that the auditor should perform, and paragraph 5 contains the management representations the auditor will be asking for. The auditor may provide either a standalone auditors report on supplemental information accompanying audited financial statements will or may include the auditor’s report on the supplemental information in the auditor’s report on the financial statements.

 

As always, your thoughts and comments are welcome!

 

 

 

10-K Tip Number One for 2016

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Happy New Year from all of us at the SEC Institute Division at PLI! We hope your new year is beginning well and if you are working on closing year-end December 31, 2015 that all is proceeding smoothly.

Last week, on January 7, 2016, Carol and George (that being us of course, the bloggers you are reading now!) presented a One-Hour Briefing, “PLI’s Second Annual Form 10-K Tune-up”. In the briefing we discussed three broad groups of issues to think about this year-end. These were New and Emerging Issues, Recurring Issues, and SEC Staff Focus Areas. Here is the complete list of the topics we discussed in the One-Hour Briefing:

  • New and Emerging Issues
    • Customer accounting for fees paid for cloud computing arrangements
    • PCAOB AS 18 Related Parties – impacts both auditors & registrants
    • PCAOB AS 17 Auditing Supplemental Info Accompanying Audited F/S
    • Audit Committee disclosure
    • ICFR and COSO
  • Recurring Issues
    • SAB 74 disclosures for Revenue Recognition and others
    • Disclosure effectiveness
    • Cybersecurity
    • Conflict minerals & Form SD disclosure
  • SEC Staff Focus Areas
    • Segments – focus on ASU 280
    • Statement of Cash Flows
    • Income taxes
    • Fair value
    • Foreign Exchange Rates, Commodity Prices, and Interest Rates

 

You can hear everything we discussed in an On-Demand version of the Briefing that will be available soon.

To augment the Briefing we are writing a series of blog posts to dive more deeply into each of the areas we discussed than the one-hour time limit allowed.

The first issue, customer accounting for fees paid for cloud computing arrangements, relates to ASU 2015-5. This ASU is effective for public business entities for periods beginning after December 15, 2015. For other entities the effective date is one year later.

One of the major issues in this new standard is that costs associated with a contract may be accounted for differently depending on whether the contract involves a software license or is only a service contract.

To get to that issue we need to review the major provisions of the ASU.

This project arose with the increase in the use of “cloud” based computing systems. These generally include “software as a service agreements” (SaaS) and other types of “software hosting” arrangements. There was no clear guidance about how customers should account for such arrangements. As a consequence, it was unclear whether these were software contracts subject to software accounting guidance or simply service contracts or perhaps a hybrid of the two accounting areas.

The ASU puts paragraph 350-40-15-4A into the ASC section dealing with internal use software:

“The guidance in this Subtopic applies only to internal-use software that a customer obtains access to in a hosting arrangement if both of the following criteria are met:

  1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
  2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.”

If the above criteria are not met then the contract does not involve a software license and is a service contact.

The key issue here is that if the two criteria are met, then the agreement is treated as a multiple element arrangement and the costs are allocated between the software license and a service element associated with the hosting contract. The costs associated with the software license fall into the guidance for costs related to internal use software, or if appropriate, another software model such as software to be used in research and development.

On the other hand, if there is no software license element, then the contract is treated as any other service contract.

The financial reporting implications of this distinction can affect issues such as balance sheet classification, since a software license would be accounted for as an asset in appropriate circumstances, i.e. if it was paid for in advance. Income statement geography can also be affected as software amortization versus service contract expense could be in different income statement line items. And, it is possible that the amount of costs recognized in each period could be different.

This perhaps more complex issue depends on whether the arrangement includes a software license. If it does include a software license the internal use software guidance applies. The expense recognition part of this guidance is articulated in ASC 350-40-30:

30-1     Costs of computer software developed or obtained for internal use that shall be capitalized include only the following:

  1. External direct costs of materials and services consumed in developing or obtaining internal-use computer software. Examples of those costs include but are not limited to the following:
  2. Fees paid to third parties for services provided to develop the software during the application development stage
  3. Costs incurred to obtain computer software from third parties
  4. Travel expenses incurred by employees in their duties directly associated with developing software.
  5. Payroll and payroll-related costs (for example, costs of employee benefits) for employees who are directly associated with and who devote time to the internal-use computer software project, to the extent of the time spent directly on the project. Examples of employee activities include but are not limited to coding and testing during the application development stage.
  6. Interest costs incurred while developing internal-use computer software. Interest shall be capitalized in accordance with the provisions of Subtopic 835-20.

These costs can even include the costs of data conversion.

For service contracts, there is no such guidance. And here in fact lies the more problematic issue. If a cloud based computing arrangement includes a software license the internal use software guidance for costs may require capitalization of costs that would not be capitalized if the contract is only a service contract. Thus the amount of expense recognized for an arrangement could be different if it has a software license or does not have a software license. If you have this situation, careful analysis is crucial!

As always, your thoughts and comments are welcome!

The New Revenue Recognition Standard – When to Start Implementation?

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Implementing the new revenue recognition standard is a major challenge that many of us face between now and January 1, 2018 (or whatever fiscal year you have that begins after that date of course.) Many professionals are happy to be close to retirement at this point in time!

With the magnitude of the change in this new standard, including the significantly expanded disclosures which apply to everyone, when is the appropriate time to begin implementation efforts? This is a very complex question. There are still some moving parts as the FASB and IASB continue to make changes to the final standard. The new standard can have varying impacts across companies depending on such issues as complexity of contracts, how product is delivered, do you have software licenses, and principal versus agent issues, to name a few. While the TRG has addressed many issues, there are only a few left to be resolved. While this may seem to be a good sign, the SEC staff has stated concerns that there are not more issues being raised, attributing the low number as a sign that perhaps implementation initiatives are not far enough along or are not being elevated to the TRG (see the September 17th speech by Wesley Bricker, Deputy Chief Accountant in the SEC’s Office of Chief Accountant at: http://www.sec.gov/news/speech/wesley-bricker-remarks-bloomberg-bna-conf-revenue-recognition.html)

There is much discussion about when to begin implementation discussions. To date there has not been much hard data about what companies are actually doing. The Financial Executives Research Foundation (FERF), which is an affiliate of FEI, and PwC have teamed up to survey companies about this issue.

As nearly as we can tell, this is the first really good data about where companies are in the implementation process. You can find the study at:

www.pwc.com/us/revrecsurvey

The survey deals with a number of issues surrounding the impact and implementation of the new standard. It is a good read, and worth spending some time digesting. Here are a couple of things to ponder while you read.

  1. Do you have a reasonable understanding of how the new standard will affect your accounting and disclosure?
  2. What resources will you need in this effort?
  3. What level of organizational involvement across functional areas will be necessary (e.g., sales, legal, etc.)?

As always, your comments and thoughts are welcome!

Comment of the Week – The Mystery of Market Risk Disclosures

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Market Risk Disclosures are one area that many participants in our workshops seem to shy away from. This Item is one of the less well understood disclosures in Forms 10-K and 10-Q. The mechanics of writing the disclosure are, well, at best, mysterious.

With all the volatility in exchange rates, oil prices and other markets in the current environment these disclosures will likely become more important for many companies this year end. Because of this, we thought “going to go back to the basics” of this disclosure would be helpful in many companies’ year end process. So, this post includes a review of the objective of the disclosure and some tips to navigate the requirements in S-K Item 305 as you prepare the disclosure.

Since this is a comment of the week post, there are also some comments at the end of the post. If you are already comfortable with what market risk disclosures are about and how they work, you can skip to the end!

Objective of the Disclosure

To prepare these disclosures well it is crucial to understand their objective, what they are supposed to tell a reader. To understand this objective the first step is to understand what kind of risk the term “Market Risk” means. Market risk is a term that can be interpreted in a number of different ways ranging from the market for a particular product to market driven rates such as interest rates or commodity prices.

Deep in the body of Regulation S-K – Item 305, likely one of the most challenging reads in all of Regulation S-K, you find these instructions:

Instructions to paragraph 305(b): 1. For purposes of disclosure under paragraph 305(b), primary market risk exposures means:

  1. The following categories of market risk: interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks (e.g., equity price risk); and
  2. Within each of these categories, the particular markets that present the primary risk of loss to the registrant. For example, if a registrant has a material exposure to foreign currency exchange rate risk and, within this category of market risk, is most vulnerable to changes in dollar/yen, dollar/pound, and dollar/peso exchange rates, the registrant should disclose those exposures. Similarly, if a registrant has a material exposure to interest rate risk and, within this category of market risk, is most vulnerable to changes in short-term U.S. prime interest rates, it should disclose the existence of that exposure.

To paraphrase, these disclosures are not about the “market” for a product like computers or smartphones. They are about the risks a company faces from market driven prices like interest rates or commodity prices. So, while the market for smart phones could affect a company, the Market Risk Disclosures are about issues like how a change in interest rates could affect a company if the company has significant investments or borrowings.

And that brings us to the next step in understanding the objective of these disclosures. Once we know what sort of market risk we need to describe, what should we say about it?

In S-K Item 305(a)(1)(ii)(A) you will find this language:

“sensitivity analysis disclosure that expresses the potential loss in future earnings, fair values, or cash flows of market risk sensitive instruments resulting from one or more selected hypothetical changes in interest rates”

In other words, this disclosure is designed to help a reader assess how much a change in a market driven price, such as an interest rate or a commodity price, would affect the business.

Conceptually what this disclosure is about is fairly easy to understand. However, the application of S-K Item 305 is complex. It requires both qualitative and quantitative information   Our review here is fairly brief. S-K Item 305 has a maze of detailed rules. If you will be drafting or reviewing the disclosure you should refer to the actual S-K language. Also, the comments below illustrate several of the complexities in this rule.

Qualitative Disclosures

The logical place to start drafting is with qualitative disclosures. Knowing what a company’s market risks are is necessary before quantitative information will make sense to a reader. Unfortunately, in Item 305, the qualitative disclosures are sort of hard to find, as they are not the first thing listed. You can find them in paragraph (b), which says:

(b) Qualitative information about market risk.

(1) To the extent material, describe:

(i) The registrant’s primary market risk exposures;

(ii) How those exposures are managed. Such descriptions shall include, but not be limited to, a discussion of the objectives, general strategies, and instruments, if any, used to manage those exposures; and

(iii) Changes in either the registrant’s primary market risk exposures or how those exposures are managed, when compared to what was in effect during the most recently completed fiscal year and what is known or expected to be in effect in future reporting periods.

This qualitative information is really pretty simple; say what market driven prices such as interest rates, exchange rates, commodity prices or other types of prices affect the company; talk about how you manage them; and tell if they have changed. Note that the rules do not require that a company manage these risks, so if you don’t manage them, you should disclose that, along with the other information in (b) (10) above.  (Here is one place to review Item 305 in detail, as this disclosure needs to be broken down in pretty specific ways by type and source of risk.)

Quantitative Disclosures

The second part of this disclosure is quantitative, and is designed to help a reader understand how much a hypothetical change in market prices or rates could affect the business. Again, this is a very detailed requirement, but in essence starts with a choice among three alternatives:

Tabular Disclosure

S-K Item 305(a)(1)(i)(A)(1) describes a tabular presentation of information related to market risk sensitive instruments. This information includes fair values of the market risk sensitive instruments and contract terms sufficient to determine future cash flows from those instruments, categorized by expected maturity dates. In essence you are providing a reader with the input they could use to build a spreadsheet, make a price change assumption, and see how much the price change would affect the company’s income, cash flows or fair values.

Sensitivity Analysis

S-K Item 305(a)(1)(ii)(A) describes a sensitivity analysis disclosure that expresses the potential loss in future earnings, fair values, or cash flows of market risk sensitive instruments resulting from one or more selected hypothetical changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates or prices over a selected period of time. In essence, in this disclosure you build your own spreadsheet and assume a hypothetical change in rates or prices and compute the impact.

Value at Risk Analysis

S-K Item 305(a)(1) (iii)(A) describes value at risk disclosures that express the potential loss in future earnings, fair values, or cash flows of market risk sensitive instruments over a selected period of time, with a selected likelihood of occurrence, from changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates or prices. This is actually a complex econometric modeling process, and we won’t discuss it any further in this post. If your treasury or risk management group already uses this technique to assess risk it may well be a good disclosure option.

Again, this is very complex disclosure. You can choose one of the three alternatives for different risks, however you must disclose the most significant impact based on future earnings, fair values, and cash flows. Therefore, you must calculate the impact of a price change on income, cash flows and fair value to determine which has the greatest change, and thus is disclosed. Of course, If future earnings had the greatest impact last year, and this year the greatest impact is in fair value, then you would need to recast the prior year. These are only some of the judgments necessary to prepare this disclosure.
One last note, as you can see this disclosure is very forward looking, and is another reason the 1995 Private Securities Litigation Reform Act safe harbors are so important!
Example Comments

Last but not least, as this is a comment of the week post, here are some comments. Notice the focus on simple compliance with the S-K Item 305 disclosure requirements!

Foreign Currency Fluctuations, page 37

  1. We note from your disclosure on page 28 and in Note 26 that a substantial portion of your cash is held by foreign subsidiaries and 46% of your net sales to unaffiliated customers for fiscal 2014 were attributed to your foreign subsidiaries, respectively. We believe your market risk disclosures should be enhanced to provide a more robust discussion of the effects of foreign currency risk on your results of operations and financial condition. Additionally, your discussion of this market risk does not appear to comply with the guidance outlined in Item 305 of Regulation S-K. Please revise to expand your discussion of foreign currency risk to comply with one of the disclosure alternatives in Item 305(a) of Regulation S-K.

Quantitative and qualitative disclosure about market risk, page 70

  1. Please tell us how you considered the disclosures required by Item 305(a) of Regulation S-K with respect to your term loan.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Foreign Currency Risk, page 125

  1. Please tell us what consideration you gave to providing a sensitivity analysis for each currency (e.g., British Pounds and Euro) that may have an individually significant impact on future earnings.

Item 7A – Quantitative and Qualitative Disclosures About Market Risk, page 30

  1. We note your quantitative disclosure of interest rate risk associated with your investments in cash and cash equivalents and investment securities. We also note that your disclosure does not address market risk for other financial instruments such as the senior unsecured notes. Please revise to include qualitative and quantitative information about market risk in accordance with one of the three disclosure alternatives within Item 305 of Regulation S-K and that addresses the interest rate risk for the senior unsecured notes.

Evolution of the Audit Committee – Part Five – Voluntary Disclosures in the News

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Over the last two months we have done a series of blog posts about audit committee oversight and disclosure issues. One of the major topics under discussion within, among and about audit committees is what information should they disclose about their oversight of the audit, financial reporting and ICFR processes. Most observers agree that effective audit committee oversight is critical to success in these areas. And, many also believe that more information about how individual audit committees exercise this oversight will be valuable to investors and other stakeholders.

In our post on October 30 we reviewed the SEC’s Concept Release discussing possible incremental disclosures about this oversight. You can review it here:

seciblog.pli.edu/?p=462

Out in the real world it turns out that many companies are voluntarily making disclosures beyond those currently required by the SEC. On November 3, 2015 the Center for Audit Quality and Audit Analytics released their second “Audit Committee Transparency Barometer”. This “Barometer” is a survey of actual audit committee disclosures. Interestingly, this report shows that many companies are voluntarily going beyond required audit committee disclosures.

If you are not familiar with the CAQ you can read about it in our June 16, 2015 post at:

seciblog.pli.edu/?p=405

The press release about this second “Barometer” report and a link to the full report are at:

www.thecaq.org/newsroom/2015/11/03/second-annual-audit-committee-transparency-barometer-reveals-encouraging-disclosure-trends-for-public-companies-of-all-sizes

It makes for very interesting reading and provides valuable information in the search for “best practices” for audit committee disclosures. The report focuses on audit committee disclosures about external auditor oversight for companies in the S&P Composite 1500. As you read it you will see many companies voluntarily disclose information about topics ranging from issues considered in recommending the audit firm for appointment/reappointment to the audit committees role in selecting the engagement partner.

 

As always, your thoughts and comments are welcome!

Debt Versus Equity – More on Ratchets

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On November 3 we blogged about debt versus equity issues and how in late stage financings investors were demanding price adjustment and conversion rate adjustment features such as ratchet provisions. In essence this was to protect late round investors if the valuations they used for their investment was substantially higher than the IPO valuation.

As you may have been following, Square has just completed their IPO. Here is an excerpt from Square’s stockholder’s equity note in their financial statements:

The initial conversion price for the convertible preferred stock is $0.21627 for the Series A preferred stock, $0.71977 for the Series B-1 preferred stock, $0.95369 for the Series B-2 preferred stock, $5.79817 for the Series C preferred stock, $11.014 for the Series D preferred stock, and $15.46345 for the Series E preferred stock. In the event the Company issues shares of additional stock, subject to customary exceptions, after the preferred stock original issue date without consideration or for a consideration per share less than the initial conversion price in effect immediately prior to such issuance, then and in each such event the conversion price shall be reduced to a price equal to such conversion price multiplied by the following fraction:

the numerator of which is equal to the deemed number of shares of common stock outstanding plus the number of shares of common stock, that the aggregate consideration received by the Company for the total number of additional shares of common stock so issued would purchase at the conversion price immediately prior to such issuance; and

the denominator of which is equal to the deemed number of shares of common stock outstanding immediately prior to such issuance plus the deemed number of additional shares of common stock so issued.

Series E preferred stock contains a provision for the adjustment of conversion price upon a public offering. In the event of such offering, in which the price per share of the Company’s common stock is less than $18.55614 (adjusted for stock splits, stock dividends, etc.), then the then-existing conversion price for the Series E preferred stock shall be adjusted so that, as of immediately prior to the completion of such public offering, each share of Series E preferred stock shall convert into (A) the number of shares of common stock issuable on conversion of such share of Series E preferred stock; and (B) an additional number of shares of common stock equal to (x) the difference between $18.55614 and the public offering price, (y) divided by the public offering share price.

The language above is not very easy to understand, but there are various price adjustment features and the instruments that have them were entered into at various points in time, including some later stage investments. So, the debt versus equity issues is present.

Square’s IPO priced at $9, (actually below the expected price range, but the company did get a nice day one price rise on the exchange) so Square will have to make up shares to these later stage investors. This is a simple example where late stage financing valuations were higher than the IPO price.

Here are two links to information about the transaction. Buzzfeed has a nice summary of the deal at:

www.buzzfeed.com/williamalden/square-valued-at-29-billion-in-ipo-short-of-expectations?utm_medium=email&utm_campaign=News+-+1119+Thursday&utm_content=News+-+1119+Thursday+CID_8ba44ca9bcced29cacc07f7e086f01c4&utm_source=BuzzFeed%20Newsletters&utm_term=.uxrLvq8pj#.amezg5KWJ
Here is a WSJ article where the WSJ somehow wanted to call this ratchet a “penalty”:

blogs.wsj.com/digits/2015/11/18/square-pays-93-million-penalty-to-some-investors-in-ipo/

As always, your thoughts and comments are welcome!

 

 

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

Revenue Recognition Help From FinREC

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As you know the new FASB and IASB revenue recognition standards supersede all our existing revenue recognition guidance. Here in the US the new standard was such a major change that it was placed in a brand new codification section (ASC 606). One of the major changes with the new model is how it treats “specialized industries”. Many industries, such as software and construction, had specialized industry revenue recognition guidance. All those standards are also superseded. These industries now face many questions and uncertainties about how to apply the new revenue recognition model to unique and different transactions.

The new model, designed to make revenue recognition principles consistent across all industries, is much more general and does not include the detailed kind of guidance that old GAAP frequently provided. This potentially increases the risk that there could be diversity within industries in the application of the new standard.

FinREC, the Financial Reporting Executive Committee of the AICPA, and the AICPA’s Revenue Recognition Task Force have been working to help deal with these issues. They have established 16 industry groups and are developing a new “Accounting Guide for Revenue Recognition”. These resources will be developed with participation and review of standard setters, but will not be authoritative. The groups describe them as eventually providing “helpful hints and illustrative examples for how to apply the new Revenue Recognition Standard.”

They have published a list of potential implementation issues identified to date which you can find at:

www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/DownloadableDocuments/RRTF_Issue_Status.pdf

As always, your thoughts and comments are appreciated!

XBRL Starting to Bubble-Up to the Comment Letter Surface?

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One of the questions that SEC reporting companies have asked about XBRL (among the many questions we ask about XBRL!) is when will the SEC start to write comments about XBRL submissions?

Very few companies have ever seen a comment letter include any mention of their XBRL submissions.

It appears that comments may be starting to be issued about XBRL.  One of the ways the SEC sends messages in in a kind of generic comment letter that they call a “Sample Letter Sent to Public Companies”, which we refer to as a “Dear CFO Letter”.

While this seems to lack the impact of a comment letter sent directly to a company, the Dear CFO Letter is actually just as important as a directly received comment letter.  It is a message to a broad group of companies about an issue that the SEC thinks is pervasive, and is, in essence, a broadly transmitted comment letter.

The most recent Dear CFO Letter actually deals with XBRL!  You can find it at:

http://www.sec.gov/divisions/corpfin/guidance/xbrl-calculation-0714.htm

The letter reminds registrants to be sure to include all calculation relationships.

It also includes this language:

“Acceptance of your filing by EDGAR does not mean that your filing is complete or in compliance with the Commission’s requirements.”

This Dear CFO letter coupled with the XBRL report we blogged about last week could be the start of a greater emphasis on XBRL matters in filings.

We would love to hear your comments!  Leave them here or email Carol or George.