By: George M. Wilson & Carol A. Stacey

On October 23, 2017, the SEC formally approved the PCAOB’s new Auditor’s Reporting Standard, now AS 3101. The final PCAOB standard was submitted to the SEC for approval on July 19 and published in the Federal Register on July 28.

The new standard takes effect in two phases:

The first phase adds information to and modifies the format of the auditor’s report and is effective for audits of periods ending after December 15, 2017, this calendar year end. This change applies to all reporting companies.

The second phase, which adds information about critical audit matters (CAMs) to the auditor’s report, does not apply to EGC’s, and is effective:

For audits of large accelerated filer for fiscal years ending on or after June 30, 2019

For audits of all other companies to which the requirements apply for fiscal years ending on or after December 15, 2020.

The new Auditor’s Report requirements that will be effective this year, for periods ending after December 15, 2017, include these modifications:

• Auditor tenure – a statement disclosing the year in which the auditor began serving consecutively as the company’s auditor;
• Independence – a statement regarding the requirement for the auditor to be independent;
• Addressee – the auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted);
• Amendments to basic elements – certain standardized language in the auditor’s report has been changed, including adding the phrase “whether due to error or fraud,” when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatement; and
• Standardized form of the auditor’s report – the opinion will appear in the first section of the auditor’s report, and section titles have been added to guide the reader.

The second phase, with the later effective date, requires the auditor’s report to discuss critical audit matters, which are defined as:

“A matter that was communicated or required to be communicated to the audit committee and that:

(1) relates to accounts or disclosures that are material to the financial statements and

(2) involved especially challenging, subjective, or complex auditor judgment.”

Chair Clayton, in a statement about the new standard, said:

I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships — with Main Street investors ending up in a worse position than they were before.

I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release

As a thought question, it will be interesting to see how a company’s disclosures of Critical Accounting Estimates will relate to the auditor’s discussion of Critical Audit Matters. More about this in our next post!

As always, your thoughts and comments are welcome!

By: George M. Wilson & Carol A. Stacey

In this post about sustainability and ESG disclosures we compared two companies’ disclosures about the same topic, the use of water in their products. This comparison showed that without standards to guide companies as they prepare disclosures it is very difficult to draw conclusions about who is more effectively and economically using resources. The Sustainability Accounting Standards Board has been addressing this issue. Over the last few years they developed their provisional standards and sought feedback in input to their process. This has culminated in the release for comment of their Exposure Draft Standards for 79 industries. You can read more about the process here.
The Comment Period for the Standards is 90 days, ending on December 31, 2017.

As always, your thoughts and comments are welcome!

By: George M. Wilson & Carol A. Stacey

On October 11, we posted about the Treasury Department’s recently issued financial system report which contained a recommendation that the SEC move forward with the FAST Act’s requirement to review disclosures required by Regulation S-K.

Later that day, in the first open meeting of Chairman Clayton’s tenure, the SEC proposed amendments to “modernize and simplify disclosure requirements for public companies” to implement this FAST Act requirement. In a press release Chairman Clayton said:

“The FAST Act has given the Commission the opportunity to update our rules, simplify our forms, and utilize technology to make disclosure more accessible. An effective disclosure regime provides investors with the information necessary to make informed investment choices without imposing unnecessary burdens of time and money on issuers, and today’s action embodies that goal.”

The 253 page proposed rule deals with a number of areas, including:

Description of Property (Item 102)

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 303) – Year-to-Year Comparisons (Instruction 1 to Item 303(a))

Directors, Executive Officers, Promoters, and Control Persons (Item 401)

Compliance with Section 16(a) of the Exchange Act (Item 405)

Corporate Governance (Item 407)

Outside Front Cover Page of the Prospectus (Item 501(b))

Risk Factors (Item 503(c))

Plan of Distribution (Item 508)

Undertakings (Item 512)

Description of Registrant’s Securities (Item 601(b)(4))

Information Omitted From Exhibits (Item 601)

Material Contracts (Item 601(b)(10)(i))

Subsidiaries of the Registrant and Entity Identifiers (Item 601(b)(21)(i))

Incorporation by Reference – Item 10(d)

Securities Act Rule 411, Exchange Act Rule 12b-23 and Rule 12b-32 and Related Rules under the Investment Company Act and Investment Advisers Act Forms

Tagging Cover Page Data

Exhibit Hyperlinks and HTML Format for Investment Companies

The proposed rule would also make several similar changes to reports under the Investment Company and Investment Advisers Acts.

As you can see, the proposal addresses a significant number of areas! We will dive into these proposals in more depth in coming posts. We will, of course, also review the proposal in detail in our Annual Reporting Forums in Dallas, New York and San Francisco in November and December.

As always, your thoughts and comments are welcome!

By: George M. Wilson & Carol A. Stacey

In two prior posts, we began making the case that as we get ready for year-end, it’s time to begin or continue learning about sustainability reporting issues. We also explored how the SASB is beginning to build a set of standards for disclosing sustainability information.

With that as background, our next step is to review a few actual sustainability disclosures made by companies. This will help us build an understanding of why standards in this arena are necessary. In their extensive report, “The State of Disclosure 2016”, the SASB reviewed the latest annual reports on Form 10-K and Form 20-F for the top ten companies in 79 industries. While these were large companies, the sample used was substantial. The executive summary of the SASB report revealed the following findings:

“Overwhelmingly, companies have recognized the existence of, or the potential for, material impacts related to the sustainability topics included in SASB standards. Indeed, 69 percent of companies in the analysis reported on at least three-quarters of the sustainability topics included in their industry standard, and 38 percent provided disclosure on every SASB topic.

In all, 81 percent of entries analyzed, across all sectors and topics, included some form of disclosure; this is a clear indication that companies acknowledge the majority of the sustainability factors identified in SASB standards are currently having—or are reasonably expected to have—material impacts on their business.

The most common form of disclosure—across the majority of industries and topics—was generic boilerplate language, which is inadequate for investment decision-making.
Such vague, non-specific information was used 53 percent of the time when companies addressed a SASB topic.

Companies used metrics—obviously more useful to investment analysis—in less than 24 percent of the cases where disclosure occurred. Importantly, even in these cases the metrics were non-standardized, and therefore lacked comparability from one industry firm to the next.”

Clearly companies are seeing investor demand for sustainability information. Even with no current requirements for such disclosure in place many companies are making sustainability disclosures. Investors are obviously asking for or demanding this information. That said, as the last point above discusses, the lack of formal standards can result in challenges when trying to compare companies in the same industry.

As an example, consider Coca Cola and PepsiCo. Both companies bottle soda and other beverages and hence use substantial amounts of water. Availability of water in these quantities can be an issue in many parts of the world, and obviously water comes with a cost. And these are simple examples of the ESG issues surrounding water. Use of water, not surprisingly then, is an important part of the sustainability disclosures for both Coca Cola and PepsiCo. In the context of ESG disclosures there are clearly financial issues, as more efficient use of water will result in cost savings, as well as environmental and long-term performance issues, based on reducing water use over time, that will be relevant to many investors.

Here are a few excerpts from the water related section of Coca Cola’s sustainability report.

WATER STEWARDSHIP

For every drop of water we use, we aim to give one back.

Water quality and availability are key to our business. As we work to establish a more water-sustainable business on a global scale, we have focused water stewardship efforts on the areas where we can have the greatest impact, including improving water-use efficiency and reuse, managing waste water, mitigating water risk and replenishing the water we use in our finished beverages.

221B LITERS

Projects implemented by end of 2016 provide a replenish benefit of 221 billion liters per year through community and watershed projects across the globe

3M PEOPLE

Projects helping communities gain sustained access to safe drinking water alone are estimated to have benefited nearly 3 million people as of end of 2016.

USING WATER MORE EFFICIENTLY

In 2004, we were using 2.7 liters of water to make 1 liter of product. At the end of 2016, we were using 1.96 liters of water to make 1 liter of product. And we’re working to potentially reduce it to 1.7 liters of water by 2020.

Meanwhile, here are PepsiCo’s disclosures surrounding water use:

15% improvement in water-use efficiency among our direct agricultural suppliers in high-water-risk sourcing areas

Helped protect and conserve global water supplies, especially in water-stressed areas, and provided access to safe water

OPERATIONAL WATER-USE EFFICIENCY +25.8%

We are pleased to report that we met or exceeded all of our water-related goals set for 2015. By year-end, we had reduced our water use per unit of production by 25.8 percent since 2006, exceeding our goal of 20 percent, while saving approximately $80 million in costs over five years.

In 2015, we also continued to pursue integrated watershed management, prioritizing PepsiCo sites in water-stressed or water-scarce areas and supporting growers in our value chain in better managing their water use (see “50 in 5” on page 21). And the PepsiCo Foundation and its partners successfully worked to provide access to safe water for more than 9 million people globally since 2006, significantly exceeding our goal of 6 million by 2015.

Having recently exceeded all of our first‐decade Performance with Purpose water goals, PepsiCo will work to address the world’s largest user of freshwater — agriculture — by working to improve water‐use efficiency among our direct agricultural suppliers by 15 percent, and to deliver an additional 25 percent increase
in water‐use efficiency in our direct manufacturing operations.

As you can see in comparing these two disclosures, it is challenging to assess the relative performance of these two companies in water use issues. For example, it would be helpful t have information about the amount of water each company uses and from where the water is sourced. Both companies tout significant decreases in water use, but only one priovides a financial perspective. In addition both companies present qualitative information, but again assessing relative performance is difficult.

Clearly some form of standards to provide consistent and comparable information would be helpful. And just as clearly, the SASB, in taking on this challenge, has a lot of work ahead of them before investors can meaningful compare this information for companies in the same industry. With the development of their provisional standads the SASB is well into this process to help the market access consistent and comparable information. You can learn more about the provisional standards and the SASB’s process at SASB.org.

As always your thoughts and comments are welcome!

By: George M. Wilson & Carol A. Stacey

In a recent post we discussed reasons why now is an opportune moment to begin learning about sustainability standards. Likely most of us have heard discussion or mention of how this reporting area is becoming important and that investors are beginning to ask for sustainability information.

When you embark on the sustainability reporting learning journey a number of questions arise. What exactly does sustainability reporting entail? Are there certain areas that should be included? Are there standards to follow? It turns out, through the Sustainability Accounting Standards Board (“SASB”), that there is a substantial amount of industry specific guidance.

A Starting Point

Our current reporting model focuses on historical financial information and related non-financial information that helps us build context to understand financial performance. In addition to history, public companies also make disclosures about what is “out there” that might hurt financial performance in the future. (For example, MD&A known-trend disclosures.)

Sustainability information goes well beyond our current model. Here is a quote from a report prepared by the SASB titled “The State of Disclosure 2016: An analysis of the effectiveness of sustainability disclosure in SEC filings”:

“Investors and their portfolio companies have become increasingly aware of the link between sustainability factors and business outcomes. For example, increased energy efficiency can lead to operational cost savings; effective resource management can reduce input price volatility and the risk of supply disruptions; and stronger data security practices can mitigate the risk of fines, litigation, and reputational harm, while also lowering a firm’s cost of capital. As a result, the investment community—in particular, investors with longer term views—are increasingly asking for improved disclosure around financial risks based on non-financial statement information, while companies have begun to disclose more information about how they manage key sustainability issues but provide little in the way of information on financial impact.” (Emphasis added.)

This goes well beyond our historical reporting model. For example, our current disclosures about environmental matters focus on where we may have problems with a state or federal regulator and how much of our capital expenditures are related to environmental compliance. Sustainability reporting is an extension of this thought process and looks at whether a long-term investor might also want to know about whether a company is committed to investing in technology that focuses on reducing such costs on an overall basis, and how much cost savings are expected.

A simple example would be a company with a large fleet of vehicles. If all the company’s current vehicles are powered by internal combustion engines and all burn regular gas or diesel fuel, an investor might be interested to know whether the company plans to replace vehicles as they are retired with vehicles that burn alternative fuels or even electric vehicles. The economics of such issues are not simple. Electric vehicles may have larger original costs, but they have dramatically fewer moving parts and are expected to have lower maintenance costs. If a company commits to such a strategy an investor might look at that company differently than one that plans to replace its fleet with regular internal combustion powered vehicles. The differences in future financial performance between companies pursuing these different strategies could be a very relevant issue for investors.

Here is a quote from the SASB’s web page:

Investors increasingly acknowledge that environmental, social and governance (ESG) factors impact a company’s ability to manage risk and deliver financial performance over the long-term. As such, many investors use ESG information to develop a comprehensive view of company performance and to evaluate a company’s long-term value. However, to do so in a rigorous and scalable way, investors need data that is relevant, reliable, and comparable. This is the need SASB was created to address.

Standard Setting by Industry

Building guidance for these kinds of disclosures is a massive task. The issues and relevant information vary by industry. An industry based approach is actually hard-wired into the SASB’s mission:

The Sustainability Accounting Standards Board sets industry-specific standards for corporate sustainability disclosure, with a view towards ensuring that disclosure is material, comparable, and decision-useful for investors.

The SASB has initially built their standard-setting process to tailor standards based on this sector breakdown:

Health Care

Financials

Technology & Communications

Non-Renewable Resources

Transportation

Services

Resource Transformation

Consumption I

Consumption II

Renewable Resources & Alternative Energy

Infrastructure

To begin learning about the guidance for sustainability standards in your industry you start with your sector. Each sector is then divided into industries. For example, the Consumption/Sector includes the following industries:

Agricultural Products

Alcoholic Beverages

Meat, Poultry and Dairy

Tobacco

Processed Foods

Household and Personal Products

Non-Alcoholic Beverages

A tailored set of standards is then built for each of these industries within the sector. The volume of information, not to mention the amount of work behind this process is substantial. Here for example, for Consumption I, is a summary of areas addressed:

As you might expect, how to build and codify a set of standards dealing with such a variety of issues is constantly evolving process. You can read about the SASB’s plans to codify their standards and how this will change their topical organization in their technical agenda.

In our next post we will look at some of the detailed standards and actual disclosures in a few industries.

As always, your thoughts and comments are welcome!

With the financial reporting world in a constant state of change, it’s challenging to keep up with new and evolving accounting standards, as well as regulations and policy shifts from the new administration. Attend SECI’s live program, 33^rd Annual SEC Reporting & FASB Forum being held November 13-14 in Dallas, December 11-12 in San Francisco and December 18-19 in New York City with an accompanying webcast. Get the latest information on emerging issues and the regulatory landscape.

http://www.pli.edu/Content/33rd_Annual_SEC_Reporting_FASB_Forum/_/N-1z10lpuZ4k?ID=298605&t=LBK7_DPADD

By: George M. Wilson & Carol A. Stacey

More than a quarter in advance of the effective date of the FASB’s new revenue recognition guidance the SEC has made necessary changes in their own revenue recognition guidance. As you can read here, the Commission and Staff have addressed three areas:

1. SAB Topic 13 and other Staff revenue recognition guidance
2. Bill-and-hold guidance
3. Vaccines for Government Stockpiles

SAB 116 rescinds SAB Topic 13, which contained much of the Staff’s legacy GAAP revenue recognition guidance. In addition, SAB Topic 8, Retail Companies, and Section A, Operating-Differential Subsidies of SAB Topic 11, Miscellaneous Disclosure, have been updated to conform with the new FASB revenue recognition model.

To update bill-and-hold guidance, this Commission Release rescinds existing bill-and-hold guidance, which interestingly was from an Accounting and Auditing Enforcement Release (AAER No. 108, In the Matter of Stewart Parness). Upon adoption of ASC 606 companies will instead use the guidance in ASC 606-10-55 paragraphs 81 to 84.

The third update relates to vaccines sold into government stockpiles under the Vaccines for Children Program or the Strategic National Stockpile. The new guidance replaces a 2005 release and continues the practice of recognizing revenue at the time a vaccine is placed in a stockpile program. In this release the commission states that in such arrangements revenue should be recognized at the time of the transfer of the vaccine to the stockpile because the customer will have obtained control of the vaccine and the criteria for revenue recognition under the new bill-and-hold guidance will be met.

As always, your thoughts and comments are welcome!