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Communicate Consistently – It Really Does Matter

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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

  1. 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

 

  1. 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!

Things are Changing More!

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By: George M. Wilson & Carol A. Stacey

 

On February 6, 2017, Acting Chairman Michael Piwowar announced that the SEC will be reconsidering implementation of the Pay Ratio Rule required by the Dodd Frank Act. Chairman Piwowar’s announcement said in part:

“I am seeking public input on any unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed. I welcome and encourage the submission of detailed comments, and request that any comments be submitted within the next 45 days.

I have also directed the staff to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.”

As you know this new disclosure, unless changed, applies for years beginning on or after January 1, 2017.

 

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!

Revenue Recognition – Raytheon Sets the Pace!

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By: George M. Wilson & Carol A. Stacey

 

Reed Wilson, our Form 10-K In-Depth Workshop leader, closely follows reporting by major companies. He found that Raytheon, in its fourth-quarter earnings release, announced it has adopted the new revenue recognition standard as of January 1, 2017, a full year before the required adoption date. Raytheon also elected the full retrospective adoption method. (Nice catch Reed!) You can find the earnings release here.

Here is an excerpt from the earnings release:

Effective January 1, 2017, the Company adopted the new revenue recognition standard utilizing the full retrospective transition method. Under this method, the standard was applied to each prior reporting period presented and the cumulative effect of applying the standard was recognized at the earliest period shown. The impact of adopting the new standard on the Company’s 2015 and 2016 net sales and operating income was not material. The 2016 net sales, effective tax rate and EPS from continuing operations in the financial outlook table below have been recast to reflect this change.

While it will obviously be a while until Raytheon reports a full quarter on the new method, this SAB 74 disclosure from its third-quarter Form 10-Q provides the story of the company’s adoption process. It provides an understanding of the steps in the process, and the depth of the process. Notice the comment about frequent reports over a two-year period! And all this work was in spite of the fact that the new standard did not have a material impact for Raytheon!

 

Note 2: Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which will replace numerous requirements in U.S. GAAP, including industry-specific requirements, and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. In July 2015, the FASB approved the deferral of the new standard’s effective date by one year. The new standard is effective for annual reporting periods beginning after December 15, 2017. The FASB will permit companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.

 

In 2014, we established a cross-functional implementation team consisting of representatives from across all of our business segments. We utilized a bottoms-up approach to analyze the impact of the standard on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the requirements of the new standard to our revenue contracts. In addition, we identified, and are in the process of implementing, appropriate changes to our business processes, systems and controls to support recognition and disclosure under the new standard. The implementation team has reported the findings and progress of the project to management and the Audit Committee on a frequent basis over the last two years.

 

We have been closely monitoring FASB activity related to the new standard, as well as working with various non-authoritative groups to conclude on specific interpretative issues. In the first half of 2016, we made significant progress toward completing our evaluation of the potential changes from adopting the new standard on our future financial reporting and disclosures. Our progress was aided by the FASB issuing ASU 2016-10, Identifying Performance Obligations and Licensing, which amended the current guidance on performance obligations and provided additional clarity on this topic, and the significant progress of the non- authoritative groups in concluding on specific interpretative issues. We also made significant progress on our contract reviews and detailed policy drafting. Based on our evaluation, we expect to early adopt the requirements of the new standard in the first quarter of 2017 and anticipate using the full retrospective transition method.

 

The impact of adopting the new standard on our 2015 and 2016 total net sales and operating income is not expected to be material. We also do not expect a material impact to our consolidated balance sheet. The immaterial impact of adopting ASU 2014-09 primarily relates to the deferral of commissions on our commercial software arrangements, which previously were expensed as incurred but under the new standard will generally be capitalized and amortized over the period of contract performance, and policy changes related to the recognition of revenue and costs on our defense contracts to better align our policies with the new standard. The impact to our results is not material because the analysis of our contracts under the new revenue recognition standard supports the recognition of revenue over time under the cost-to-cost method for the majority of our contracts, which is consistent with our current revenue recognition model. Revenue on the majority of our contracts will continue to be recognized over time because of the continuous transfer of control to the customer. For U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit, and take control of any work in process. Similarly, for non-U.S. government contracts, the customer typically controls the work in process as evidenced either by contractual termination clauses or by our rights to payment for work performed to date to deliver products or services that do not have an alternative use to the company. Under the new standard, the cost-to-cost measure of progress continues to best depict the transfer of control of assets to the customer, which occurs as we incur costs. In addition, the number of our performance obligations under the new standard is not materially different from our contract segments under the existing standard. Lastly, the accounting for the estimate of variable amounts is not expected to be materially different compared to our current practice.

 

 

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!

IPO’s – Getting Ready and Keeping Up

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By: George M. Wilson & Carol A. Stacey

If you are contemplating an IPO or advising companies in this process, PLI’s “Securities Offerings 2017: A Public Offering: How it is Done” will provide you with valuable knowledge and how-to tools about the IPO process. The program simulates an offering from start to finish, builds a foundation in the law and SEC guidance, and walks through each step in the process. The program is on March 3, 2017 and you can learn more here.

The program also includes up to 2 hours of ethics credit (see program page on www.pli.edu for credit by state).

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!

A Control Environment and History Follow-Up

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By: George M. Wilson & Carol A. Stacey

 

This famous quote has been in our thoughts over the last several months:
“Those who cannot remember the past are condemned to repeat it.”

George Santayana, the poet and essayist, wrote these famous words in his book The Life of Reason. Many other people including Winston Churchill have thoughtfully incorporated this fundamental principle of life in speeches and remarks.

Another favorite variation of the idea comes from Mark Twain:
“History doesn’t repeat itself, but it does rhyme.”

The lesson here is that if we learn history we can hopefully avoid making the same or similar mistakes in the future. As we discussed a couple of posts back, recent public company news shows that many organizations have not been learning from the past.

 

One person who can help us learn about history we do not want to repeat is Cynthia Cooper. She was the WorldCom head of internal audit who built and lead the team that worked almost “under cover” to find the largest fraud ever discovered. This was a tone at the top fraud, involving the CEO, CFO and CAO. Her book is a sometimes-chilling story of how bad tone at the top results in fraud.

 

Sharron Watkins is another person who can help us learn how to not repeat history. She was the Enron Vice President, a direct report to Andy Fastow, who blew the whistle about Enron’s accounting irregularities. And we all know perhaps too much about that fraud which was even the subject of a book and related movie “Enron: The Smartest Guys in the Room”.

 

Corporate ethics will never be easy, but as history and current events show, it does matter. If leadership of an organization sends the message that making money is the most important thing an organization does, if it sends the message that if you don’t make money you will be fired, if it sends the message that other values can be sacrificed if you make money, the ultimate result is inevitable. In countless frauds over centuries, from Ivar Kreuger, the match king in the early 1900s, to Equity Funding in the 1970s, to Madoff, to Enron, to the companies we are talking about today, this lesson has been proven time and time again.

 

These stories can help us learn and avoid the mistakes others have made. They can be the focus of training and learning. They can be the foundation for building awareness and support for these issues in organizations large and small.

 

As always, your thoughts and comments are welcome.