{"id":2023,"date":"2021-06-24T12:44:08","date_gmt":"2021-06-24T16:44:08","guid":{"rendered":"https:\/\/seci.wpenginepowered.com\/?p=2023"},"modified":"2021-06-24T12:44:08","modified_gmt":"2021-06-24T16:44:08","slug":"the-new-mda-rule-part-three-critical-accounting-estimate-disclosure","status":"publish","type":"post","link":"https:\/\/seciblog.pli.edu\/index.php\/the-new-mda-rule-part-three-critical-accounting-estimate-disclosure\/","title":{"rendered":"The New MD&A Rule: Part Three – Critical Accounting Estimate Disclosure"},"content":{"rendered":"

In this post,<\/a> we overviewed the changes to MD&A in the SEC\u2019s Management\u2019s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information<\/a> Final Rule. This rule was published in the Federal Register<\/a> on January 11, 2021, and is effective for filings on or after February 10, 2021.<\/p>\n

The rule\u2019s transition provisions provide a mandatory transition date but also allow voluntary early compliance.\u00a0 The mandatory<\/strong> transition date is each company\u2019s first fiscal year that ends after August 9, 2021, which is 210 days after the effective date.\u00a0 Companies may voluntarily<\/strong> apply the new rule, on an S-K item-by-item basis, in any filing made on or after the effective date of February 10, 2021.<\/p>\n

If a company did not implement the rule early, it is not too soon to start planning for these required changes.<\/p>\n

In the second post in this series<\/a>, we reviewed the first of the changes to the MD&A requirements, the addition of an objective to S-K Item 303.<\/p>\n

This third post in the series addresses disclosure of critical accounting estimates.\u00a0 The history of this disclosure has created more than a bit of confusion about its goal.\u00a0 As a result, disclosure about critical accounting estimates is too often vague and uninformative.<\/p>\n

The first mention of anything \u201ccritical\u201d about accounting principles or estimates was a \u201cCautionary Advice<\/a>\u201d issued on December 2, 2001, in the wake of Enron\u2019s downward spiral.\u00a0 It is very short.\u00a0 It builds on the belief that:<\/p>\n

\u201cInvestors may lose confidence in a company’s management and financial statements if sudden changes in its financial condition and results occur, but were not preceded by disclosures about the susceptibility of reported amounts to change, including rapid changes.\u201d<\/p>\n

Without defining \u201ccritical accounting policy,\u201d the Release suggested several disclosure steps, including:<\/p>\n

\u201cEach company’s management and auditor should bring particular focus to the evaluation of the critical accounting policies used in the financial statements.\u201d; and<\/p>\n

\u201cPrior to finalizing and filing annual reports, audit committees should review the selection, application and disclosure of critical accounting policies.\u201d<\/p>\n

This was the first step in addressing accounting policies involving subjective and challenging estimates which could potentially create material financial statement volatility.\u00a0 The SEC issued a proposed rule in 2002 that would have required \u201ccritical accounting estimate\u201d disclosure.\u00a0 (Note the change in terminology from \u201cpolicy\u201d to \u201cestimate.\u201d)<\/p>\n

This rule was never finalized.<\/p>\n

One of the reasons the SEC never finalized this rule was their conclusion that existing MD&A guidance provides for \u201ccritical accounting estimate\u201d disclosure.\u00a0 The 2003 MD&A release, FR 72<\/a>, \u00a0formally changed the terminology to \u201ccritical accounting estimates\u201d and provided disclosure guidance:<\/p>\n

V. Critical Accounting Estimates<\/h5>\n

Many estimates and assumptions involved in the application of GAAP have a material impact on reported financial condition and operating performance and on the comparability of such reported information over different reporting periods. Our December 2001 Release reminded companies that, under the existing MD&A disclosure requirements, a company should address material implications of uncertainties<\/strong> associated with the methods, assumptions and estimates underlying the company’s critical accounting measurements.\u00a0In May 2002 we proposed rules, which remain under consideration, that would broaden the scope of disclosures beyond those currently required.<\/p>\n

When preparing disclosure under the current requirements<\/strong>, companies should consider whether they have made accounting estimates or assumptions where:<\/p>\n