Tag Archives: XBRL

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!

More About S-3 and the Transition to the New Revenue Recognition Standard

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In a recent post we explored a very complex securities registration issue within retrospective application of the new revenue recognition standard. (The issue arises with any retrospective application, so it will also arise in the new leasing standard.) In a nutshell the registration issue comes up when you:

 

(1) Adopt the new revenue recognition standard as of January 1, 2018 (assume a December 31 year-end), then

(2) File your March 31, 2018 10-Q and then

(3) File an S-3 to register to sell securities.

 

The S-3 incorporates your 2017 Form 10-K by reference which includes 2015 financial statements. The 2015 financial statements would not normally be retrospectively adjusted for the new revenue recognition standard. In this case though that could be necessary. You can read all the technical details here.

 

This first post led to a really interesting question from a reader. What happens if you file the S-3 before you file your March 31, 2018 10-Q? We explored the issue in this post.

 

This then led to a really great comment from another reader. In our workshops we always emphasize building research skills and using all the relevant SEC resources, especially the CorpFin Financial Reporting Manual (FRM). This really astute reader found this section in Topic 13 of the FRM:

 

13110.2  In the case of a registration statement on Form S-3, Item 11(b)(ii) of that form would specifically require retrospective revision of the pre-event audited financial statements that were incorporated by reference to reflect a subsequent change in accounting principle (or consistent with staff practice, discontinued operations and changes in segment presentation) if the Form S-3 also incorporates by reference post-event interim financial statements. If post-event financial statements have not been filed, the registrant would not revise the pre- event financial statements in connection with the Form S-3, however, pro forma financial statements in accordance with Article 11 of Regulation S-X may, in certain circumstances, be required. In contrast, a prospectus supplement used to update a delayed or continuous offering registered on Form S-3 (e.g., a shelf takedown) is not subject to the Item 11(b)(ii) updating requirements. Rather, registrants must update the prospectus in accordance with S-K 512(a) with respect to any fundamental change. It is the responsibility of management to determine what constitutes a fundamental change.

 

 

Here there is at least some relief for the S-3 filed after year-end but before the Form 10-Q is filed! As a reminder S-X Article 11 contains this requirement:

 

  • 210.11-01   Presentation requirements.

(a) Pro forma financial information shall be furnished when any of the following conditions exist:

………………….

(Note: (1) to (7) omitted)

(8) Consummation of other events or transactions has occurred or is probable for which disclosure of pro forma financial information would be material to investors.

 

Some judgment will be required to make that decision! If the effect of the new revenue recognition standard is large enough, it could well be material to investors.

 

Similarly, for the S-3 shelf takedown S-K 512(a) includes this requirement (in bullet ii):

 

(ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement.

 

Again, some judgment will be required to make that decision!

 

Thanks to both the readers who contributed to this discussion, and as always your thoughts and comments are welcome!

 

Disaggregation – Comment Letters and the New Revenue Recognition Standard

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How often do you think of disaggregation in your financial statements? Generally, companies don’t present a lot of line-item details in their financial statements. Recently this issue has come up for us in two separate places.

 

If you have attended one of our large Midyear or Annual Forums you have had the fun of listening to Carol do an in-depth analysis of the comment letter process. She usually picks an interesting letter for a specific company and reviews both the overall process as well as the specific comments in the company’s letter.

 

In this year’s May and June Midyear Forms, Carol’s example letter included this interesting and “deep in the weeds” comment:

Consolidated Balance Sheets, page 33

  1. Please tell us how you have complied with Rule 5-02.20 of Regulation S-X. In this regard, we note your quantified disclosure of insurance liabilities and construction accruals. Please tell us whether there are any additional items included in other current liabilities that exceed five percent of total current liabilities.

The big theme here is of course disaggregation. Regulation S-X Article 5 has requirements about disaggregation for areas such as other current assets, other assets, other current liabilities and other liabilities. Generally, the requirements are that any individual account over 5% of the relevant total must be separately disclosed. Here is one example:

  • 210.5-02   Balance sheets.
  1. Other current assets. State separately, in the balance sheet or in a note thereto, any amounts in excess of five percent of total current assets.

There is also a similar requirement for components of revenue over 10% of total revenues:

  • 210.5-03   Income statements.

…………

(b) If income is derived from more than one of the subcaptions described under §210.5-03.1, each class which is not more than 10 percent of the sum of the items may be combined with another class. If these items are combined, related costs and expenses as described under §210.5-03.2 shall be combined in the same manner.

As you can see, the consistent theme is to provide appropriate detail so readers can understand appropriate issues in the F/S.

 

This theme of disaggregation is a topic of discussion in the FASB’s financial statement presentation project and also is an important issue in the disclosure requirements in the new revenue recognition standard:

Disaggregation of Revenue

ASC 606-10-50-5

An entity shall disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. An entity shall apply the guidance in paragraphs 606-10-55-89 through 55-91 when selecting the categories to use to disaggregate revenue.

This new revenue recognition disclosure requirement will require substantial judgment to determine how much detail a reader will need to understand how the “nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors”. This is really the opposite of the S-X disclosure requirements above based on mechanical, quantitative 5% and 10% thresholds. The overall theme is the same though, be sure to consider how much detail readers really need to understand your financial condition, results of operations and cash flows.

 

As always, your thoughts and comments are welcome!

Leases and the Five-Year Selected Financial Data in Form 10-K

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Within the required retrospective transition method for the new lease accounting standard is a very familiar question:

Will we be required to revise all five years of the selected financial data presented in Item 6 of Form 10-K?

As you may already know the SEC formally granted relief in the five-year summary for companies that use a full retrospective implementation for the new revenue recognition standard. For leases, they have done exactly the same.

 

At the March SEC Regulations Committee meeting of the CAQ this issue was addressed and if you read the minutes of the meeting you will see the SEC Staff’s announcement that:

“The selected financial data table should follow the transition provisions of the ASU (i.e., the new leasing standard should be applied as of the beginning of the earliest comparative period presented in the financial statements).”

Thank you letters may be appropriate!

As always, your thoughts and comments are appreciated!

Brexit and your Second Quarter 10-Q

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In the massive press coverage about “Brexit” one of the most frequently used words is “uncertainty”. While the impact of Brexit will differ from company to company it is important, as we come to the end of the June 30, 2016 quarter (or whenever your next quarter end will be), to think about whether the vote and the resulting uncertainty should be dealt with in your SEC reporting.

 

The two most straightforward issues are likely risk factors and MD&A known trends.

 

The risk factor disclosure in Part II Item 1A of 10-Q refers back to S-K 503(c) and requires disclosure of what makes owning your company’s securities “speculative or risky”. Companies should consider whether the uncertainties and already known impacts of Brexit increase risk and deserve mention in risk factors.

 

When a risk factor becomes more probable of having a material impact the risk factor should transmogrify into an MD&A “known trend” disclosure. This disclosure is required when there are “known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” (S-K Item 303). There are similar known trend disclosures for liquidity and capital resources. If you could be affected by market uncertainty, reasonably possible changes in exchange rates or other impacts of Brexit this disclosure may be necessary in MD&A. Lots of judgment here.

 

It is always important to remember that the “reasonably expects” probabilistic test in FR 36 requires disclosure if you cannot say the trend is “not reasonably likely” to come to fruition. (Sorry for the double negative, but it is in the test!). So if there is a 50/50 chance of a material impact, disclosure should likely be made.

 

Lastly, beyond these two issues there are a wealth of other possible accounting and disclosure ramifications, ranging from issues such as possible elevated risk of impairment to tax consequences, depending on your circumstances.

 

As always, your thoughts and comments are welcome.

Comment of the Week – Be Consistent in All Communications

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One of the themes we discuss in our workshops is how the SEC does not limit their review process to information in a company’s SEC filings. Here is an example of a comment (which also deals with known trends and uncertainties, another favorite topic) that demonstrates how the Staff finds issues by looking in places such as earnings releases, conference call recordings and web pages:

 

Results of Operations, page 23

 

  1. Please expand your discussion to address any known trends or uncertainties that are reasonably expected to have a material impact on revenue, cost of revenue, or income from operations. For example, we note that during your 2015 fourth quarter and full year earnings call on February 11, 2016, your management quantitatively described the volume increase, as well as discussed your customer mix changes by segment and certain trends in 2016. In addition, disclosure appearing on page 11 of your filing on Form 10-K under your risk factors indicates that extended periods of low fuel prices can also have an adverse effect on your results of operations and overall profitability, as well as on the valuation of inventory to the extent your hedges are not effective at mitigating fluctuations in fuel prices. However, you have not provided a discussion in your filing with respect to an analysis of known material trends, demands and uncertainties.

 

Refer to Section III of Financial Reporting Release No. 72, codified in FRC §501.12 and Item 303 of Regulation S-K.

 

It is important to assure that all the vehicles you use to communicate with your shareholders and the rest of the public are consistent and that issues raised in one place are appropriately dealt with across all communication channels.

 

As always, your thoughts and comments are welcome!

Comment of the Week – Critical Accounting Estimates

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It has been a while since we posted about critical accounting estimates. While this is now a normal part of MD&A it is surprising how many folks in our workshops don’t know where the “official” guidance for this disclosure is found.

 

There is a bit of confusion in the history of this disclosure. It all started in the post-Enron period with concerns about the quality of accounting principle selection discussed in FR 60 (the FRs are Financial Reporting Releases, interpretations that are approved by the SEC Commissioners). This release addressed the aggressive use of accounting principles and required disclosure in plain English of “Critical Accounting Policies”. FR 60 did not describe in great detail exactly what a critical accounting policy was or what disclosures should be made. You can find this brief FR, for perhaps historical purposes, here.

 

FR 60 was issued as a “quick fix” and the SEC planned to follow it with a formal rule for this disclosure. The rule was proposed, but it was never actually finalized. Instead the SEC dealt with this disclosure in FR72. If you scroll to Section V towards the end of FR 72 you will find the requirements for disclosure of critical accounting estimates.

 

www.sec.gov/rules/interp/33-8350.htm

 

(As you read this FR, note the evolution in terminology from Critical Accounting Policies to Critical Accounting Estimates.)

 

Don’t forget to look at the most recent Staff guidance in this area in FRM Section 9500, which gives guidance on disclosure of critical accounting estimates in the area of goodwill impairment.

 

Here are a few key issues about disclosure of Critical Accounting Estimates:

 

  1. Critical accounting estimates are not the same as significant accounting policies, and this part of MD&A should not simply duplicate this information from the financial statements. The focus should be on estimates and assumptions used in GAAP that have a material impact on financial condition and operating performance and on comparability over time.
  2. This disclosure should focus on why the estimate is “critical” and what is challenging about the estimate. Why is it difficult to make this estimate and what creates uncertainty about the precision of the estimate?
  3. Most companies won’t have that many of these “critical” estimates. Most companies start with a few and build from there. Often, lessons from past changes in estimates can help your identification process.
  4. The staff sometimes will ask about the quantified sensitivity analysis discussed in the last part of FR 72, so if information is available and will help investors understand the significance of the estimate and its uncertainty, consider disclosing it.

 

To help understand this disclosure, here is a recent comment from the SEC:

Critical Accounting Policies and Estimates

  1. In future filings please provide a more robust discussion of your critical accounting policies and estimates to focus on the assumptions and uncertainties that underlie your critical accounting estimates rather than duplicating the accounting policy disclosures in the financial statement footnotes. Please quantify, where material, and provide an analysis of the impact of critical accounting estimates on your financial position and results of operations for the periods presented. In addition, please include a qualitative and quantitative analysis of the sensitivity of reported results to changes in your assumptions, judgments, and estimates, including the likelihood of obtaining materially different results if different assumptions are applied. If reasonably likely changes in inputs to estimates would have a material effect on your financial condition or results of operations, the impact that could result given the range of reasonable outcomes should be disclosed and quantified. Please refer to SEC Release No. 33-8350. In your response, please show us what your disclosure would have looked like if these changes were made in your most recently filed Form 10-K.

 

 

As always, your thoughts and comments are appreciated!

Getting the New Revenue Recognition Standard into Perspective

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As we all know, the new revenue recognition standard will be effective for public companies for periods beginning after December 15, 2017. This change will have challenges for everyone. Even if the new five-step, contract based model does not dramatically change the timing of your company’s revenue recognition, documenting how the new model applies in your case will require some time, and all of us will have to deal with the significant increase in disclosures, particularly the requirement to disaggregate revenues.

 

One place we see some confusion is about what these challenges will look like. This new standard is a complete departure from our old revenue recognition guidance and the detailed, rule based nature of the old standards. Some writers still talk about the “hundreds of pages” of guidance that must be dealt with. This makes it sound like the new standard is a large collection of detailed rules that simply replaces the large collection of detailed rules in the old revenue recognition GAAP.

 

This is not the case.

 

In the ASU the core of the new revenue model starts on page 14 and ends with the last of the disclosures on page 48.   Seems pretty short!

 

It is very principles base guidance! In our workshops, the broad, principles based nature of the new standard creates some of the biggest challenges for companies.

 

The whole standard is based on this principle, from paragraph 606-10-10-2:

 

“the core principle of the guidance in this Topic is that an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”

 

Notice the lack of language about an earnings process being complete or revenue being “realized or realizable”.

 

Each of the five steps and the disclosure requirements also start with a broad principle. Here is an example from step three, determining the transaction price (606-10-32-2):

 

“An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.”

 

On interesting aspect of this principle is that if there is variable consideration in a contract, it must be estimated! That is a whole new principle and each company will have to assess how to apply it to their circumstances.

 

Because this new revenue recognition model establishes a whole new set of principles, the FASB knew we would all need some help in how to interpret these principles. So, the standard, after the disclosure requirements, includes a number of implementation guidance discussions to explain what the principles are intended to mean. Terms such as “satisfied over time” and “distinct within the context of the contract” are explored. But you won’t find any detailed rules.

 

After the implementation guidance are a number of examples, and here you can find some actual interpretations of the principles which are very helpful. There are not too many of them.

 

As a last source of support for your process of learning about these principles and how to interpret and apply them don’t forget about the TRG. While the TRG does not issue formal guidance, their discussions are rich with examples of how some very experienced professionals are interpreting the standard. And, as you may have heard, the SEC Chief Accountant has said if companies depart from TRG discussions, they should be prepared to support such positions to the SEC staff. (You can read more about that in this speech.)

 

 

So, our tip for today, as you move through your implementation be ready to build an understanding of the principles and how to apply them to your specific circumstances!

 

As always, your thoughts and comments are welcome!

Form S-3 and the New Revenue Recognition Standard

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The new revenue recognition standard allows for two transition methods. One is a kind of hybrid “retrospective with a cumulative effect” approach, where in the year of adoption a company records the cumulative effect and goes forward (with some significant “old GAAP” disclosures). The other is full retrospective implementation.

The full retrospective implementation comes with a lot of baggage beyond the amount of work it might require.

One question is what about the five-year summary? In Form 10-K is it necessary to retrospectively adjust the two earliest years in the five year summary along with the three years in S-X audited financial statements? The SEC staff has addressed this question and said this is not necessary. The CorpFin Financial Reporting Manual now states:

11100 REGISTRANT FINANCIAL INFORMATION

 

11100.1 Selected Financial Data

 

Question

A registrant elects to adopt the new revenue standard using the full retrospective approach. Must it apply the new revenue standard when reporting selected financial data (S-K Item 301)) for periods prior to those presented in its retroactively-adjusted financial statements?

 

Answer

No, but registrants must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented.

This second question is a lot more intricate. What if a company does an S-3 after the first quarter of implementation? To set this issue up, here is a fact set:

Company year-end: December 31

Revenue Recognition Standard adoption date: January 1, 2018

Full retrospective method of adoption is used. In this method, for the 2018 Form 10-K the years 2016, 2017 and 2018 would be presented using the new revenue recognition standard.

Now assume that in 2018 (thus before the December 2018 Form 10-K is filed), the company reports for the first quarter of 2018 and files Form 10-Q on April 30, 2018. If the company then files an S-3 to raise capital on May 31, 2018, the previous Form 10-K for the year ended December 31, 2017, would be incorporated into the Form S-3. That Form 10-K would have financial statements for 2017, 2016 and 2015. The financial statements for 2015 are the key issue here, as they would not be required in the December 31, 2018 Form 10-K. But, since they are incorporated into the S-3 and the company has adopted the new revenue recognition standard, Item 11(b) in Form S-3 will apply (emphasis added):

 

Item 11. Material Changes.

 

(a) Describe any and all material changes in the registrant’s affairs which have occurred since the end of the latest fiscal year for which certified financial statements were included in the latest annual report to security holders and which have not been described in a report on Form 10-Q (§249.308a of this chapter) or Form 8-K (§249.308 of this chapter) filed under the Exchange Act.

 

(b) Include in the prospectus, if not incorporated by reference therein from the reports filed under the Exchange Act specified in Item 12(a), a proxy or information statement filed pursuant to Section 14 of the Exchange Act, a prospectus previously filed pursuant to Rule 424(b) or (c) under the Securities Act (§230.424(b) or (c) of this chapter) or, where no prospectus is required to be filed pursuant to Rule 424(b), the prospectus included in the registration statement at effectiveness, or a Form 8-K filed during either of the two preceding years:

 

(i) information required by Rule 3-05 and Article 11 of Regulation S-X (17 CFR Part 210);

 

(ii) restated financial statements prepared in accordance with Regulation S-X if there has been a change in accounting principles or a correction in an error where such change or correction requires a material retroactive restatement of financial statements;

 

(iii) restated financial statements prepared in accordance with Regulation S-X where one or more business combinations accounted for by the pooling of interest method of accounting have been consummated subsequent to the most recent fiscal year and the acquired businesses, considered in the aggregate, are significant pursuant to Rule 11-01(b), or

 

(iv) any financial information required because of a material disposition of assets outside the normal course of business.

 

This would seem to require that the new revenue recognition standard be applied to the year ended December 31, 2015.

Not a happy outcome!

This question has come up in earlier accounting standard transitions, and the SEC Staff is clearly aware of this issue. Wes Bricker, Deputy Chief Accountant, said this in a recent speech:

“I am also aware that registrants have expressed concern about the requirement to provide restated financial statements when a Form S-3 registration statement is filed after the registrant has filed its first Form 10-Q reflecting adoption of the revenue standard. This requirement to restate the financial statements means that companies that adopt the revenue standard under a full-retrospective transition approach would be required to restate an additional year in its Form S-3 to show the effect of the new revenue standard on that earlier period.

While this issue is not specific to the new revenue standard, the pervasive impact of the new revenue standard amplifies the issue.

To this, I would observe the transition provisions in the new revenue standard reference existing GAAP, which provides for an impracticability exception to retrospective application if, for example, a company is unable to apply the requirement after making every reasonable effort to do so. OCA is available for consultation if a registrant believes that, based on its facts and circumstances, a retrospective application of the new revenue recognition standard to all periods required to be presented in a Form S-3 is impracticable.”

The actual language he refers to in the excerpt above is from ASC 250:

250 – 10 – 45 – 5

An entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.

And:

Impracticability

250 – 10 – 45 – 9

It shall be deemed impracticable to apply the effects of a change in accounting principle retrospectively only if any of the following conditions exist:

  1. After making every reasonable effort to do so, the entity is unable to apply the requirement.
  2. Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
  3. Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
  4. Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
  5. Would have been available when the financial statements for that prior period were issued.

That’s where this issue is for now, and this could well be a problematic issue for any company raising capital in the year of adoption of the new revenue recognition standard!

As always, your thoughts and comments are welcome!

SEC News – The FAST Act Form 10-K Summary

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The SEC, on June 1, 2016, adopted an Interim Final Rule and Request for Comment to implement the Form 10-K summary provisions of The FAST Act. Passed earlier this year, the FAST Act contains a number of SEC reporting requirements, many of which the SEC has already implemented.

 

The Interim Final rule provides that a company may, at its option, include a summary in its Form 10-K. Each item in the summary must include a cross-reference by hyperlink to the material contained in the company’s Form 10-K to which the item relates.

 

The summary is a new Item 16 in Form 10-K:

 

Item 16. Form 10-K Summary.

 

Registrants may, at their option, include a summary of information required by this form, but only if each item in the summary is presented fairly and accurately and includes a hyperlink to the material contained in this form to which such item relates, including to materials contained in any exhibits filed with the form.

 

Instruction: The summary shall refer only to Form 10-K disclosure that is included in the form at the time it is filed. A registrant need not update the summary to reflect information required by Part III of Form 10-K that the registrant incorporates by reference from a proxy or information statement filed after the Form 10-K, but must state in the summary that the summary does not include Part III information because that information will be incorporated by reference from a later filed proxy or information statement involving the election of directors.

 

 

While perhaps not particularly dramatic, this is a nice step towards making Form 10-K a better communication tool, which is of course a big part of the disclosure effectiveness activities of the SEC. We could even debate whether such a rule is necessary as some companies, GE in particular, already provides such a summary.

 

You can read the Interim Final Rule and request for comment here.

 

And, if you have not read it recently, Carol and George, your bloggers, suggest taking a look here at the GE Form 10-K. You will find it interesting and the summary is on page 217.

 

As always, your thoughts and comments are welcome!