Tag Archives: SOX

Year-End Planning – Number Four – Recently Issued Accounting Standards and a Few Example Comments

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In recent weeks we have been posting about areas to deal with in advance of year-end. So far we have addressed:

Issues in the Statement of Cash Flows

Evaluating and Auditing ICFR

The New Item 16 Form 10-K Summary

 

The spirit and rationale behind these posts is that it is always a good idea to proactively anticipate problems that may arise and act to keep issues from becoming problems.

As we continue this series our next post is about SAB 74 (Topic 11-M in the SAB Codification), the requirement for disclosures about recently issued accounting standards.

 

With the major changes coming from the new revenue recognition standard, the new lease standard, and for financial companies the new financial instrument impairment standard, these disclosures become increasingly important. Users need to be forewarned about the expected impact of these new standards. This is essentially a known trend disclosure in your MD&A.

 

Here is an excerpt from Topic 11-M. You can read the entire SAB here.

 

Interpretive Response: The staff believes that the registrant should evaluate each new accounting standard to determine the appropriate disclosure and recognizes that the level of information available to the registrant will differ with respect to various standards and from one registrant to another. The objectives of the disclosure should be to (1) notify the reader of the disclosure documents that a standard has been issued which the registrant will be required to adopt in the future and (2) assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. The staff understands that the registrant will only be able to disclose information that is known.

 

The following disclosures should generally be considered by the registrant:

 

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

 

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

 

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.

 

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 a company gets closer to the adoption date for a new standard these disclosures should evolve. And although “[t]he staff understands that the registrant will only be able to disclose information that is known”, the other side of this disclosure is that when you know something, you should disclose it!

 

One last heads up – when you file your 10-K for the year before adoption, in other words you will adopt the day after that year-end, the staff will likely expect robust disclosure, including quantification of the impact of adoption.

 

When a company has decided which method it will use to adopt, it should disclose that information!

 

As a company researches and builds an understanding of how much a new standard will affect the financial statements, this impact should be disclosed.

 

Frequently we are concerned that there is uncertainty in this process, and that is never comfortable to discuss in an SEC report. Here are two excerpts that are examples of this disclosure from a June 30, 2016 Form 10-K. They deal with this uncertainty (emphasis added):

 

Leases

 

In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.

 

The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We currently anticipate early adoption of the new standard effective July 1, 2017 in conjunction with our adoption of the new revenue standard. Our ability to early adopt is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.

 

We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for office, retail, and datacenter operating leases.

 

Revenue from Contracts with Customers

 

In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.

 

The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We currently anticipate early adoption of the new standard effective July 1, 2017. Our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.

 

We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for software license revenue. We expect revenue related to hardware, cloud offerings, and professional services to remain substantially unchanged. Specifically, under the new standard we expect to recognize (Product A) revenue predominantly at the time of billing rather than ratably over the life of the related device. We also expect to recognize license revenue at the time of billing rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing.

 

We currently believe that the net change in (Product A) revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard.

 

Lastly, as we always like to do, here are two example comments to reinforce the issues in this disclosure:

 

Please revise your disclosures to fully comply with Question 2 of SAB Topic 11:M for each standard listed. Specifically, if early adoption is permitted, you should state the date that you plan to adopt the standard. You should also discuss the impact that adoption of each standard is expected to have on your financial statements or, if applicable, make a statement to the effect that you are still assessing the impact that adoption of each standard will have on your financial statements and the impact is not known or reasonably estimable at this time.

 

Please revise to include a discussion of the potential effects that recently issued accounting standards will have on your financial statements when adopted in a future period. Refer to SAB Topic 11.M. For example, please revise to disclose the potential effect of ASU No. 2014-09, Revenue from Contracts with Customers.

How Prepared are you for SEC Annual Reporting Season or your next 10-Q?

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It has been a very active time at the SEC, FASB and PCAOB. Have you stayed on top of recent developments, activities and proposals? For example, the Leases Standard is final and the FASB is awash in simplification and other projects. Register now for our upcoming live seminar and webcast, 32nd Annual SEC Reporting & FASB Forum being held November 14-15 in Dallas, December 12-13 in New York City and December 19-20 in San Francisco. Prepare for year-end and reporting season by attending this highly anticipated and popular annual seminar and hear a roundtable discussion of current events, including simplification overload, disclosure effectiveness, juggling Rev. Rec., Leases, CECL adoptions and more. Our expert faculty will also discuss the new CDIs on non-GAAP measures, the Regulation S-K Concept Release, frequent accounting and disclosure comments, Revenue Recognition and guidance on lease accounting, MD&A disclosure and much more.

http://www.pli.edu/Content/32nd_Annual_SEC_Reporting_FASB_Forum/_/N-1z11c8sZ4k?ID=262904

Developments for Foreign Private Issuers

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In the SEC world Foreign Private Issuers (FPI’s) are companies organized outside the United States who have stock that trades on a US exchange. Foreign Private Issuers are permitted to use a special reporting system which includes the Form 20-F Annual Report and Form 6-K for other reporting. This system has a number of accommodations for companies organized outside the United States. For example, FPI’s are actually allowed to report to the SEC using IFRS and the volume of compensation disclosures can be substantially less than for domestic registrants.

 

Like all SEC reporting regimens, the FPI system has its own nuances and subtleties. For example, simply being organized outside the US does not entitle a company to use the FPI system. The more formal definition of a FPI is in an Exchange Act Rule:

 

  • 240.3b-4   Definition of “foreign government,” “foreign issuer” and “foreign private issuer”.

 

(Note: (a) and (b) omitted)

 

(c) The term foreign private issuer means any foreign issuer other than a foreign government except for an issuer meeting the following conditions as of the last business day of its most recently completed second fiscal quarter:

 

(1) More than 50 percent of the issuer’s outstanding voting securities are directly or indirectly held of record by residents of the United States; and

 

(2) Any of the following:

 

(i) The majority of the executive officers or directors are United States citizens or residents;

(ii) More than 50 percent of the assets of the issuer are located in the United States; or

(iii) The business of the issuer is administered principally in the United States.

 

This means that a company that is currently a FPI must monitor its status to see if it continues to meet this definition. If at some point it no longer meets the definition it must switch to the regular Form 10-K, Form 10-Q and Form 8-K reporting regimen. You may also find Topic 6 of the Financial Reporting Manual, Foreign Private Issuers & Foreign Businesses, helpful.

 

To help FPI’s deal with some of the unique aspects of this special system PLI is offering a One-Hour Briefing on October 6 entitled “Accessing the U.S. Capital Markets:  What Foreign Private Issuers Need to Know.” You can learn more about the briefing here.

 

Also, while we have offered our SEC Reporting Skills Workshop for 20-F Filers on an on-site basis over the past few years, we will have a public session of the workshop in New York late next year along with our Annual Forum in New York.

 

As always, your thoughts and comments are welcome!

$100 Million in Whistleblower Awards!

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Way back in April of 2015 we did a post about whistleblowers and the upside financial risk in blowing the whistleblowing to the SEC. The Sarbanes-Oxley whistleblower process requires an anonymous path to the audit committee, but the Dodd-Frank process, which is direct to the SEC, is the whistleblower path that can result in financial rewards.

 

This week the SEC announced that awards under this program have now exceeded $100 million. This happened after the recent payment of the program’s second largest award, $22 million.

 

To add a bit of focus, in the related press release, Enforcement Division Director Andrew Ceresney said:

 

“The SEC whistleblower program has had a transformative impact on the agency, enabling us to bring high quality enforcement cases quicker using fewer resources,” said Andrew Ceresney, Director of the SEC Division of Enforcement. “The ultimate goal of our whistleblower program is to deter securities violations and paying more than $100 million in whistleblower awards demonstrates the value that whistleblowers have added to our enforcement program.”

 

As always, your thoughts and comments are welcome!

Some Cybersecurity Risk-Management Support

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Cybersecurity Risk continues to be a huge and problematic issue. Processes and tools to respond to Cybersecurity incidents are constantly evolving. To help you keep up to date with these issues our “Cybersecurity 2016: Managing Cybersecurity Incidents” program will be offered on September 20 live in NY and via webcast.

 

Topics to be addressed will include:

 

Overview of the cyber insurance market and what to look for when purchasing

Cybersecurity provisions to include in vendor and business partner agreements

Managing a forensic investigation

Threat landscape: how can companies protect themselves?

Cybersecurity Act of 2015 and its ramifications for the private sector, plus SEC activity

EU developments on breach notification in the GDPR and NIS Directive

 

The program will also include these special features:

 

Cyberattack simulation

Hacker’s perspective: what are they seeking?

CISO and Regulators panel: strategies for global companies and guidance on sharing information with the government

 

You can learn more here.

 

As always, your thoughts and comments are welcome!

Year End Planning Topic 3 – The New Item 16 Form 10-K Summary (and Disclosure Philosophy!)

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Everyone who works with SEC periodic reports knows that making changes to disclosure is not a simple process. Reporting involves so many stakeholders and so many approval points that without an early start it is almost impossible to make improvements (or even simple changes such as formatting!).

This post is about one possible change that will need some time for consideration, adding the new Item 16 summary. With this reminder hopefully you will have enough time to consider whether this optional item makes sense for you.

This kind of summary has always been permitted, or at least never prohibited. However, in the process of making periodic reports more about communication than compliance, the FAST Act required the SEC to formally put a summary into Form 10-K, hence new Item 16. You can read the text of Item 16 in this post.

Your Communication Philosophy

If you read a lot of Form 10-K’s (and what is more fun than that?) you will see a variety of communication styles. We discuss different communication styles or “philosophies” in our workshops. We encourage companies to articulate their “philosophy” of disclosure.

To simplify a bit, some companies adopt a very “compliance” based philosophy for disclosure. In this model companies disclose what the SEC requires to be disclosed and essentially nothing more. This can be done in a fairly mechanical fashion and is usually very simple and direct, if not almost terse.

At the other end of a disclosure spectrum some companies adopt a more “communications” based philosophy where they disclose more than the bare bones requirements in an effort to tell a more complete “story” of how their company operates.

A simple example of this difference can be found in Form 10-K Item 1. This is the description of the business and the required disclosures are in Regulation S-K Item 101. Nowhere in Item 101 is there any requirement to disclose a company’s business strategy. And many companies do not say anything about the strategic orientation of their business. And yet, many companies discuss their strategy at length. Check out the differences in these two companies:

Here is a very well done example for an SRC (Golden Enterprises) of the compliance approach. Golden makes snack foods and does a simple, direct presentation. (Also, best potato chips ever!)

Here is another well-done example of a company (Square) that uses a more communications oriented approach. Square is a payment processor and supports businesses in many ways.

To be clear, there is no right or wrong way in this discussion; we are talking about a judgment you need to make. So, why do some companies disclose more than the S-K requirement?   These companies are considering disclosure as more than a compliance process. They are using the reporting process as a communications tool.

If you are going to focus more on communication the SEC’s Interim Final Rule about a Form 10-K summary could be a new element in your communication strategy. Almost every business writer will suggest that an executive level overview for a long document is a good communication strategy.

FR 72 suggested this for MD&A way back in 2003:

Many companies’ MD&A could benefit from adding an introductory section or overview that would facilitate a reader’s understanding. As with all disclosure, what companies would appropriately include in an introduction or overview will depend on the circumstances of the particular company. As a general matter, an introduction or overview should include the most important matters on which a company’s executives focus in evaluating financial condition and operating performance and provide the context for the discussion and analysis of the financial statements. Therefore, an introduction or overview should not be a duplicative layer of disclosure that merely repeats the more detailed discussion and analysis that follows.

In recent remarks the SEC staff has said they are seeing more companies using their filings as communication documents and this trend certainly fits into the SEC’s disclosure effectiveness program.

So, as you get into your annual reporting process, be sure you articulate this overall strategy for disclosure, and if you think it appropriate, put consideration of the new Item 16 summary into your thought process.

As always, your thoughts and comments are welcome!

Summertime Planning Topic Two – Evaluating and Auditing ICFR

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As we blogged about (or perhaps nagged about), in our last post it is never too soon to start planning for year-end. That post suggested some proactive steps to avoiding some commonly occurring problems in the statement of cash flows. In this post we will discuss another frequently problematic issue, the annual management’s assessment and external audit of ICFR. It is likely an understatement to say that in recent years there has been substantial change in how management assesses and auditor’s audit ICFR. Areas such as management review controls, how to use system generated information, what are appropriate scopes for testing and how to evaluate whether a control deficiency is a material weakness are all in play.

 

In our annual reporting process it makes sense to get out in front of these issues!

 

Here are two resources that we hope can help in your ICFR evaluation and auditing process.

 

  1. In our August 5, 2016 PLI Smartbrief (you can learn more and sign-up to receive the SmartBrief here) we referenced an Accounting Web article about a Protiviti SOX Compliance survey. The findings can help inform your own SOX planning and the evolution of your ICFR. According to the survey SOX related audit costs are generally increasing. Here is a telling quote from the executive summary:

 

“Sarbanes-Oxley compliance once was thought to be a relatively stable, predictable process that organizations could rely on to be routine and, for the most part, static. Yet market and regulatory changes continue to make this a more dynamic process, with costs and hours continuing to rise for many organizations. The good news is that more organizations are recognizing the benefits of their compliance efforts through improved internal control structures and business processes.”

 

 

  1. The PCAOB has published a helpful resource in planning your SOX ICFR evaluation and audit. In their most recent Staff Inspection Brief they discuss the plan, scope and objectives for the coming cycle of inspections. As expected ICFR is one of the points of focus:

 

“During the 2016 inspection cycle, Inspections staff will, among other things, consider the sufficiency of auditors’ procedures performed to identify, test and evaluate controls that address the auditors’ assessed risk of material misstatement, and auditors’ testing of controls that contain a review element. “

 

As always, your thoughts and comments are welcome!

Cash Flows Topic One – Comment of the Week and EITF Fun!

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High risk accounting and reporting areas, those most prone to problems and the risk of amendment or restatement, are discussed in all our conferences and workshops. We always encourage folks to be aware of these risks and to address them in their reporting processes.

 

Now that we are into August, is it fair to put some of these issues on the planning calendar for year-end? Yes, because many of them require significant amounts of time and work to address. (For example, have you ever tried to make improvements in your MD&A?) So, even though it is only August, we are going to start a series of posts with some considerations for year-end planning! We will also bring all of them together later in the fall.

 

Perhaps surprisingly, one of these frequent problem areas is preparation of the statement of cash flows. For a variety of reasons the statement of cash flows is the source of many SEC comments and even restatements. Perhaps this is because the statement of cash flows is usually prepared late in the reporting process, perhaps because it is sometimes viewed as a mechanical process, perhaps because it is sometimes prepared by less experienced professionals and/or perhaps controls are not effective in this area. There are likely many underlying causes for the statement of cash flows being a frequent problem area, but if we are forewarned there is no reason that we should have problems here.

 

As a starting point, here are some example SEC comments.

 

Statement of Cash Flows

We note your presentation on the statement of cash flows of sales and maturities of short- term investments as one combined line item. In light of the fact that short term investments represent a significant part of your balance sheet, please revise to present sales and maturities of these investments as separate line items within the investing section in accordance with ASC 320-10-45-11.

The comment above is a great example of where a seemingly logical combination of similar cash flows runs afoul of the codification guidance. The referenced paragraph is not even in the ASC section about the statement of cash flows! What it says is:

Cash flows from purchases, sales, and maturities of available-for-sale securities and held-to-maturity securities shall be classified as cash flows from investing activities and reported gross for each security classification in the statement of cash flows. Cash flows from purchases, sales, and maturities of trading securities shall be classified based on the nature and purpose for which the securities were acquired.

Here is another example:

Please tell us how you determined it was appropriate to classify restricted cash collateralizing your outstanding letter of credit and cash secured loans as investing activities in the statement of cash flows. Please reference the authoritative accounting literature management relied upon.

This is an area where there may be no clear guidance. The distinction between operating and investing seems like an easy question to ask here. And, as you will see below, this is a question that was taken to the EITF.

 

Here are a few more comments with similar issues. This first one is pretty darn long!

Consolidated Statements of Cash Flows, page F-8

Please tell us your basis for recording the deposit related to the acquisition of land use right as operating activities as opposed to investing activities. Refer to ASC 230.

We note your line item, advances to suppliers, in your balance sheets and other trade receivables included in Note 4 on page F-30 related to your lending provided to some of your suppliers. Please tell us the nature of your lending activities to your suppliers and the difference in amounts included in the two accounts. Additionally, please tell us your basis for recording amounts in operating activities as opposed to investing activities in your statements of cash flows. Refer to ASC 230.

Please reconcile for us the purchase of property and equipment for 2014 in the amount of $256,027,300 to the change of $301,716,262 derived from your disclosure in Note 7.

 

This one seems fairly straightforward:

We note cash flows from financing activities include non-cash transactions consisting of common shares issued for debt conversions and as compensation for services as well as losses on settlement of debt through equity issuances. Please refer to ASC 230 and revise to separately disclose non-cash financing transactions in supplemental disclosure of noncash investing and financing activities and to disclose losses on debt settlements in cash flows from operating activities. Please note that this comment also applies to Form 10-Q filed February 2, 2016.

 

The Need For Clarification – The EITF to the Rescue!

 

Because of the frequent nature of these issues and diversity in practice surrounding many of them the EITF has two projects that are at the Exposure Draft stage and should finish before year end:

 

EITF Issue 16-A: Restricted Cash would require the statement of cash flows to reconcile the total change in cash including restricted cash.

 

EITF Issue 15-F: Statement of Cash Flows: Classification of certain cash receipts and cash payments deals with a variety of issues in the cash flow statement, including:

 

Issue 1—Debt Prepayment or Debt Extinguishment Costs

Issue 2—Settlement of Zero-Coupon Bonds

Issue 3—Contingent Consideration Payments Made after a Business Combination

Issue 4—Proceeds from the Settlement of Insurance Claims

Issue 5—Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including

Bank-Owned Life Insurance Policies

Issue 6—Distributions Received from Equity Method Investees

Issue 7—Beneficial Interests in Securitization Transactions

Issue 8—Predominant Cash Receipts and Cash Payments

 

 

With all of this comment activity and related standard setting going on, it is advisable to “scrub” your process for preparing the statement of cash flows in your upcoming periodic filings.

 

As always your thoughts and comments are welcome!

A Busy Summer for the SEC!

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The SEC has been busy on many fronts this summer. If you review the summary of proposed rules here on their web site you will see they have proposed five rules so far this summer and the summary of final rules here has another six rules issued in final form.

 

That is a busy summer!

 

The proposed rules contain some of the first concrete, early steps in the SEC’s disclosure effectiveness project. The proposal will “clean-up” some areas where the SEC’s rules overlap or are redundant with GAAP, IFRS or other guidelines. They also include a proposal to change the threshold to use the Smaller Reporting Company system to $250,000,000 in public float.

 

You can see the details of each proposal below:

 

Disclosure Update and Simplification

 

Amendments to Smaller Reporting Company Definition

 

Modernization of Property Disclosures for Mining Registrants

 

 

The final rules range from the final resource extraction payment rules required by Dodd/Frank, which replace the earlier version overturned in the courts, to the FAST Act 10-K summary.

 

You can see the details of each final rule below:

 

Disclosure of Payments by Resource Extraction Issuers

 

Adoption of Updated EDGAR Filer Manual

 

Form 10-K Summary

 

 

As always, your thoughts and comments are welcome!

Another Reason to do the Right Thing – Litigation is on the Rise!

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Our last post was about the on-going messaging from the SEC’s Enforcement Division to all of us to “do the right thing” for investors. Of course, another reason to do the right thing is the risk of litigation. And this risk, according to a report from the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research, shows that securities class action litigation is up substantially. According to the report filings are “up 36.7% from the first half of last year and up 16.6% from the second half of last year.”

 

In a startling statistic the report shows that on an annualized basis 6.4% of the S and P 500 were subject to class action filings.

 

Interestingly, the report indicates a substantial part of the increase relates to filings concerning merger and acquisition activity.

 

You can find a press release and the report here.

 

The Stanford Law School Securities Class Action Clearing house is a pretty scary website. If you would like to review it you can find it here.

 

Lastly, a great way to supplement what you read here on our blog and keep up with developments like this is to subscribe to the PLI Smart Brief, a periodic e-newsletter with lots of great information.

 

You can sign-up to receive the Smart Brief here.

 

As always, your thoughts and comments are welcome!