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Financial Reporting and Regulatory Update

Third Quarter 2017

From the SEC

Major Accounting Standards Implementation

Implementation Matters to Improve Financial Reporting

In remarks on Sept. 21, 2017, in San Diego, SEC Deputy Chief Accountant Sagar Teotia focused on implementation of the major standards (revenue recognition, leases, and credit losses). He offered observations in the following areas:
  • Keep going/get going – that is, keep focused on implementation
  • Internal control over financial reporting
  • Transition disclosures required by SAB 74
  • New disclosures required by the new standards
  • Importance of reasonable judgment
  • Role of audit committees in the implementation of the new generally accepted accounting principles (GAAP) standards

For revenue recognition, he noted adoption is only a few months away. The SEC will accept well-reasoned judgments, but those generally take time to develop. The SEC is available to answer questions, and the time to submit those is now. Teotia also stressed the importance of the accompanying disclosures and noted that it takes time to develop how the disclosures will be made and time to implement system and internal control changes to gather and present the data.

Turning to leases, he encouraged companies to consider beginning their leases implementation efforts. The standard will require several steps including identifying relevant legal contracts, evaluating whether an arrangement is or contains a lease, and applying the standard to contracts within its scope. These steps can potentially be time-consuming, so getting started sooner rather than later is a best practice. He pointed to a few lessons learned from revenue recognition including making sure companies have the appropriate resources to evaluate the lease arrangements and setting the right tone at the top.

For credit losses, Teotia shared observations from the SEC’s monitoring activities. He stressed the importance of coordination among all stakeholders – namely preparers and auditors moving in parallel so that one group does not significantly get ahead of the other. He suggested registrants should bring interpretative concerns to the SEC and encouraged stakeholders to refer challenging issues to the FASB’s Credit Losses TRG. 

Chief Accountant Speech on CECL Implementation and SAB 74 Disclosure

SEC Chief Accountant Wesley R. Bricker addressed the 2017 American Institute of CPAs (AICPA) National Conference on Banks and Savings Institutions on Sept. 11, 2017. In his remarks, he discussed FASB’s standard for measuring current expected credit loss (CECL) and the improvements it offers, including earlier recognition of credit losses and transparency of a financial asset portfolio’s credit quality. Regarding CECL implementation, he reminded the audience that portions of Financial Reporting Release (FRR) 28 and Staff Accounting Bulletin (SAB) 102 will continue to apply and that existing practices are a good starting point for transitioning to the standard. Bricker also highlighted important judgments to consider related to selecting a methodology, identifying data, and developing assumptions. Finally, he emphasized the importance of internal control over financial reporting in adopting the standard, including the importance of the tone at the top, technology, and documentation.

At the end of his speech, he answered a question from the audience related to SAB 74 on disclosing the anticipated effect of new accounting pronouncements in a future period. His advice was that registrants should describe the relevant information about what the company does know, and companies should not disclose what they do not know about the anticipated effect, whether quantitative or qualitative.

Revenue Recognition Interpretations

On Aug. 18, 2017, the SEC staff issued three updates to conform its guidance to the FASB’s revenue recognition guidance in ASC Topic 606, as follows:

  • SAB 116, on revenue recognition. Upon the adoption of Topic 606, the new SAB eliminates guidance in SAB Topic 13, “Revenue Recognition,” because its interpretations and criteria for applying the previous revenue recognition model under GAAP (that is, ASC Topic 605) will no longer be applicable. In addition, SAB 116 eliminates SAB Topic 8 for department store retailers because the presentation and recognition guidance for leased or licensed store space will be superseded.
  • Release No. 33-10402, to eliminate existing revenue recognition guidance (specifically, Accounting and Auditing Enforcement Release 108, “In the Matter of Stewart Parness”) for bill-and-hold arrangements (that is, arrangements when delivery has not occurred). Under ASC Topic 606, revenue will be recognized on bill-and-hold arrangements when, as prescribed by the guidance, control has been transferred and other criteria are met.
  • Release 33-10403, to revise guidance (specifically, 2005 “Commission Guidance Regarding Accounting for Sales of Vaccines and Bioterror Countermeasures to the Federal Government for Placement Into the Pediatric Vaccine Stockpile or the Strategic National Stockpile”). Upon the adoption of ASC Topic 606, vaccine manufacturers will be required to recognize revenue and provide required disclosures when vaccines are placed into federal governmental stockpile programs because control of the enumerated vaccines will have been transferred to the customer and the criteria to recognize revenue in a bill-and-hold arrangement under ASC Topic 606 will have been met.

Release 33-10403 is applicable to only the following vaccines:

  • Childhood disease vaccines
  • Influenza vaccines
  • Other vaccines and countermeasures sold to the federal government for placement in the Strategic National Stockpile 

The new staff guidance on revenue recognition is consistent with the effective dates for ASC Topic 606.

Revenue and Lease Standards Adoption Dates for Certain PBEs

At the FASB Emerging Issues Task Force meeting held on July 20, 2017, the SEC staff made an announcement specifically related to providing relief for PBEs that otherwise would not meet the definition of a PBE, except for a requirement to include or the inclusion of its financial statements or financial information in another entity’s filing with the SEC (certain PBEs). Common examples of SEC rules that trigger a requirement to include one entity’s financial statements or financial information in another entity’s SEC filing include rules 3-05 (significant business acquisitions), 3-09 (separate financials of an entity that is a significant nonconsolidated equity method investment), or 4-08(g) (summarized financial information of a significant group of nonconsolidated equity method investments) of Regulation S-X.

Essentially deferring the effective date for certain PBEs by one year, the SEC will not object if certain PBEs adopt the revenue recognition and lease accounting standards using the non-PBE effective dates, which are as follows:

  • Revenue recognition (Topic 606), for annual reporting periods beginning after Dec. 15, 2018, and interim reporting periods within annual reporting periods beginning after Dec. 15, 2019, which first applies to Dec. 31, 2019, annual financial statements for calendar year-end entities
  • Lease accounting (Topic 842), for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020, which first applies to Dec. 31, 2020, annual financial statement for calendar year-end entities

The deferral is applicable only to certain PBEs for the revenue recognition and lease accounting standards. It does not apply to the credit loss standard because that standard already contains staggered effective dates for PBEs that are not SEC filers.

The FASB codified this SEC announcement in ASU 2017-13, “Revenue Recognition (Topic 605), Revenue From Contracts With Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments.”

Capital Formation Simplifications

Financial Statement Relief in Confidential Registration Statements

The SEC’s Division of Corporation Finance (Corp Fin) on Aug. 17, 2017, updated its Compliance & Disclosure Interpretations (C&DIs) to reflect staff policy that companies may omit certain financial information from confidential registration statements. If a company reasonably believes that interim or annual financial statements will not be required at the time of the contemplated offering (for emerging growth companies – EGCs), or at the time of publicly filing the registration statement (for non-EGCs), those financial statements are not required in the confidential submission.

Contacting Corp Fin for Financial Statement Relief

On Aug. 25, 2017, Corp Fin updated its Financial Reporting Manual by adding a section on how to communicate with Corp Fin’s Office of Chief Accountant (CF-OCA) and whom to contact regarding financial statement relief in filings with the SEC under Rule 3-13 of Regulation S-X. Under Rule 3-13, registrants might, in certain circumstances, request relief from Rule 3-05 of Regulation S-X for financial statements of a significant acquired business. These types of formal requests should be emailed to the CF-OCA staff, and relief, if appropriate, would be granted in the form of a waiver letter from the staff. In addition, the new section addresses registrant requests for interpretations of financial statement requirements in SEC filings.

The updated manual also references the new C&DIs that clarify guidance on the omission of financial information from draft registration statements.

PCAOB’s Auditor’s Reporting Model

On July 21, 2017, the SEC issued a release (34-81187) that seeks comment on the new auditing standard from the Public Company Accounting Oversight Board (PCAOB), “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion,” prior to the SEC taking further action on the standard.

The new standard would significantly modify the auditor’s report while retaining the pass-fail reporting model. The most significant change to the auditor’s report is the requirement to communicate in the report any critical audit matters (CAMs) arising during the current-period audit. A CAM is defined as a matter that has these elements:

  • Has been or was required to be communicated to the audit committee
  • Relates to accounts or disclosures that are material to the financial statements
  • Involves especially challenging, subjective, or complex auditor judgment 

The auditor’s report will include:

  • The identification of the CAMs
  • A description of the principal considerations that led the auditor to determine that the matter was a CAM
  • A description of how the CAM was addressed
  • A reference to the relevant financial statement accounts and disclosures
  • Disclosure of auditor tenure
  • Clarifications of the auditor’s role and responsibilities 

Comments were due to the SEC on Aug. 18, 2017.

In his remarks before the 2017 AICPA National Conference on Banks and Savings Institutions on Sept. 11, 2017, Chief Accountant Bricker commented on PCAOB activity and the requirement for the SEC to take action on the PCAOB’s new auditor’s reporting model standard by Oct. 26, 2017. He stated that the SEC staff is evaluating comments received at this point. 

Cyber Matters

SEC Chair’s Focus on Cybersecurity

On multiple occasions recently, SEC Chair Jay Clayton emphasized his concerns about cybersecurity risks, including that investors may not currently have the information they need to understand those risks that issuers are facing and that more disclosure on cybersecurity is warranted. He has reminded issuers of Corp Fin’s existing disclosure guidance on cybersecurity risks and incidents, “CF Disclosure Guidance: Topic No. 2.”

Clayton has stated that the SEC is examining the cybersecurity disclosures of public companies, including after a breach has occurred. He has cautioned issuers to carefully consider disclosure obligations for material cybersecurity risks and events in periodic and current reports.
The chair’s recent speechmaking on this topic include the following:

  • Remarks before the Senate Committee on Banking, Housing, and Urban Development on Sept. 26, 2017
  • Public statement on cybersecurity on Sept. 20, 2017
  • Remarks at the Economic Club of New York on July 12, 2017

Offerings and Sales of Virtual Assets in Cyberspace

The SEC issued a report on July 25, 2017, related to offers and sales of digital assets by a virtual entity (or a decentralized autonomous organization) that exists in the form of computer code (that is, in a virtual environment). The SEC determined that offerings of such digital assets are subject to federal securities laws and must be registered with the SEC unless a lawful exemption applies.

Recently, virtual entities have raised capital through offerings of digital assets called “initial coin offerings” or “token sales.” Typically, the digital assets are purchased by investors using virtual currency (that is, currency that does not represent the legal tender of any particular country or jurisdiction, such as bitcoin and Ethereum).

The SEC concluded that, unless an exemption applies, digital asset issuers are subject to the same presentation and disclosure requirements as traditional issuers of securities as well as to other regulations that promote investor protection. For these entities, consultation with securities counsel is encouraged.

In his remarks before the 2017 AICPA National Conference on Banks and Savings Institutions on Sept. 11, 2017, Chief Accountant Bricker discussed initial coin offerings (or token sales) and the recent SEC report clarifying that federal securities laws apply to these digital token sales or offerings purchased using either traditional currency or virtual currency. He emphasized that the digital token offerings are subject to SEC oversight and registration whether the entity is a traditional company or not. He also illustrated financial reporting considerations for both issuers and holders of these digital tokens.

Pay Ratio Disclosure Rule

On Sept. 21, 2017, the SEC adopted interpretive guidance in Release No. 33-10415 to assist companies that are required to make the pay ratio disclosure (that is, the ratio of the compensation of the principal executive officer to the median employee’s compensation) beginning in 2018. The interpretive guidance addresses the following related to developing the disclosure:
Use of reasonable estimates, assumptions, and methodologies and statistical sampling
Use of existing internal records
Use of a widely recognized test under another area of the law to determine which workers are employees
Simultaneous with the SEC’s release of interpretive guidance, Corp Fin released staff guidance in the form of questions and answers to cover acceptable methodologies for developing the pay ratio disclosure and provide examples of reasonable methodologies.