Tag Archives: SECI

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!

Audit Committee Evolution – Some Next Steps

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Over the last two months we have done a series of posts about the evolution of the role of the audit committee and related disclosures:

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

 
In this last post in the series we discuss two resources for audit committees:

  1. The PCAOB’s outreach to audit committees, and
  2. Our PLI programs for audit committee members

 

PCAOB Outreach to Audit Committees

Recognizing the importance of audit committee oversight of the audit process, the PCAOB has included information for audit committees on their webpage to help audit committees in their oversight role. They have also begun a regular newsletter, “Audit Committee Dialogue”. The newsletter is on the same webpage, along with a number of other resources.
pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

 

PLI Programs for Audit Committee Members

And, lastly, here are some of our PLI programs that will help audit committee members and other directors build and maintain the knowledge and expertise to appropriately fulfill their responsibilities. Most of these programs are available via web archives, webcast and live attendance. You can learn more about all our programs at www.pli.edu.

Audit Committees and Financial Reporting 2016: Recent Developments and Current Issues
www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z11i36?fromsearch=false&ID=259781

Audit Committees and Financial Reporting 2015: Recent Developments and Current Issues www.pli.edu/Content/OnDemand/Audit_Committees_and_Financial_Reporting/_/N-4nZ1z129aq?ID=221250

Corporate Governance — A Master Class 2016

www.pli.edu/Content/Seminar/Corporate_Governance_A_Master_Class_2016/_/N-4kZ1z11ij4?fromsearch=false&ID=259397

 
Directors’ Institute on Corporate Governance (Thirteenth Annual)www.pli.edu/Content/OnDemand/Directors_Institute_on_Corporate_Governance/_/N-4nZ1z129if?fromsearch=false&ID=221435

 

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!

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!