AICPA & CIMA Conference Highlights – December 8, 2021
Representatives from Accounting Research Manager are attending the 2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments. This conference is being held Monday-Wednesday, December 6-8, 2021. The following are some highlights from conference speeches or presentations.
Division of Corporation Finance Developments
Staff from the SEC’s Division of Corporation Finance (Corp Fin) discussed a number of topics related to SEC accounting and disclosure requirements.
Special Purpose Acquisition Companies (SPACs)
Corp Fin indicated that it has seen a significant uptick in transactions driven by IPOs and the use of Special-Purpose Acquisition Companies (SPACs). The number of IPOs reviewed by Corp Fin has doubled compared to the previous fiscal year. SPAC transactions present some novel reporting and disclosure issues that are being addressed in Corp Fin’s review process. Given that these SPAC transactions are novel, careful consideration should be given to disclosures around the transaction. Corp Fin has an overall focus on disclosures during the IPO stage.
SPAC disclosures should adequately explain the financial incentives involved for all parties in the SPAC transaction, especially the incentives the SPAC sponsor may reap as part of the transaction upon completion of the business transaction. In many cases, the sponsors’ incentives do not line-up with those of the non-redeeming shareholders. Complete and clear disclosures surrounding these incentives related to the SPAC transactions should be made. Other issues Corp Fin is focused on related to SPACs and that parties should consider include:
- Conflicts of interest involved in the transaction;
- Projections and assumptions used to make these;
- Valuation and related assumptions used; and
- Risks to the non-redeeming shareholders.
Corp Fin indicated that as part of its rulemaking process, it is considering guidance on these and other issues related to SPAC transactions.
Business spin-off transactions are complex and have certain financial statement requirements as part of the initial registration statement. These transactions often involve the transfer of assets and operations into a newly formed registrant. It may also include pre-existing subsidiaries into a new entity or a combination of these items. In most cases, these transactions involve substantial judgment to determine the correct reporting. This determination requires careful consideration of SEC regulations and related staff or SEC reporting guidance. Carve out financial statements that are provided as part of these spin-off transactions. The scope of these carve out financials must balance the importance of providing historical information against the composition of the business going forward. Corp Fin suggested guidance in Staff Accounting Bulletin (SAB) 1B, which provides guidance on costs reflected in historical financial statements. Corp Fin cautioned that this SAB does not directly address the scope of activities or revenue streams to be included in the spin-off financial statements. In advance, consider the appropriate reporting for a spin-off (including reverse spin transactions) to both parties of the transaction. If extremely complex, Corp Fin urges consultation with it before the transaction is completed. The implications of getting the transaction and reporting wrong could be significant.
Corp Fin discussed determining the materiality of accounting errors identified. In general, if an accounting error is identified, an assessment of whether the error is a “Little r” or “Big r” restatement. Little r restatements occur when a company’s immaterial errors accumulate to a material error in a given year and usually are reported as a revision to financial statements in the current filing. Big r restatements are larger and must be reported on Form 8-K as a material event. Big r results in restatement of previously issued financial statements and withdrawal of the auditor opinion.
Corp Fin indicated that the guidance in SAB 99, Materiality, remains guidance and requires quantitative and qualitative considerations when determining if something is material to a reasonable investor. Corp Fin discussed two recent accounting error examples in which the division did not agree to the Little r treatment by the particular company. In both cases, Corp Fin asked for SAB 99 considerations and judgments to gauge how the company determined that the particular errors did require Big r restatement and withdrawal of the audit opinion. In the two examples, quantitative factors were significant (i.e., 20% change in net income, 50% change in loss on discontinued operations). However, in the company’s SAB 99 analysis it relied on qualitative factors to overcome these significant quantitative factors. Some of the qualitative factors considered by the company included that the:
- Error generally was isolated to the discontinued operations portion of the financial statements;
- Error was already now corrected since it was revised (not restated).
- The sale was complete;
- The most recent financial statements really are the ones that are most useful to investors.
Corp Fin appreciated the qualitative factors and they are things that it sees generally with SAB 99 analysis. As a result, Corp Fin did not necessarily disagree that these qualitative factors weren't relevant. However, Corp Fin determined that these qualitative factors were not enough to overcome the magnitude of the quantitative errors. Corp Fin indicates that several of the qualitative factors cited could be broadly categorized under a passage of time concept. Many companies take the view that errors in historical financial statements are no longer material given that current financial statements are available and provide the most material information to investors. Corp Fin does not agree with this analysis. Investors do focus heavily on current financial results, but it is a balance with historical information and an entity’s track record. Corp Fin cautioned that it does not believe the answer is one size fits all for all fact patterns. This does not mean that Corp Fin would never accept these qualitative factors as part of a SAB 99 analysis of an accounting error. When an error is quantitatively large, it may be difficult for qualitative factors to overcome this in order to determine something is not material.
Corp Fin is actively working on over twenty rulemaking projects as directed by SEC Chair Gary Gensler. Recent rulemaking includes:
- Final Rule, Holding Foreign Companies Accountable Act Disclosure. This final rule applies to registrants the SEC identifies as having filed an annual report with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB is unable to inspect or investigate.
- Final Rule, Universal Proxies. This final rule requires parties in a contested election to use universal proxy cards that include all director nominees presented for election at a shareholder meeting. The SEC indicates that the rule changes will give shareholders the ability to vote by proxy for their preferred combination of board candidates, similar to voting in person. The final rules will require dissident shareholders and registrants to provide shareholders with a proxy card that includes the names of all registrant and dissident nominees. The rules will apply to all non-exempt solicitations for contested elections other than those involving registered investment companies and business development companies. The rules will require registrants and dissidents to provide each other with notice of the names of their nominees, establish a filing deadline and a minimum solicitation requirement for dissidents, and prescribe presentation and formatting requirements for universal proxy cards.
- Proposal, Proxy Voting Advice. The SEC published for public comment proposed amendments to its rules governing proxy voting advice. The proposed amendments “aim to address concerns expressed by investors and others that the current rules may impede and impair the timeliness and independence of proxy voting advice and subject proxy voting advice businesses to undue litigation risks and compliance costs.” The proposed amendments would rescind two rules applicable to proxy voting advice businesses that the SEC adopted in 2020. Specifically, the SEC is proposing to rescind conditions to the availability of two exemptions from the proxy rules’ informational and filing requirements on which proxy voting advice businesses often rely.
Climate Change Disclosures
Corp Fin indicated that it is actively working on a recommendation for consideration by the SEC on climate change disclosures. No timetable on the issuance of a proposal was given. Corp Fin urged conference participants to review its previously issued Sample Letter to Companies Regarding Climate Change Disclosures. This letter provides views of the Corp Fin staff, indicating that the “letter contains sample comments that the Division may issue to companies regarding their climate-related disclosure or the absence of such disclosure. The sample comments do not constitute an exhaustive list of the issues that companies should consider. Any comments issued would be appropriately tailored to the specific company and industry, and would take into consideration the disclosure that a company has provided in Commission filings.”
The letter reminds companies that SEC disclosure rules may require disclosure related to climate change. Companies also must disclose, in addition to the information expressly required by SEC regulation, “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”
In addition, Corp Fin urged conference participants to review the guidance in Commission Guidance Regarding Disclosure Related to Climate Change. This interpretive release was issued in 2010 and provides guidance to public companies regarding the SEC’s existing disclosure requirements as they apply to climate change matters. Disclosures may be appropriate under existing requirements in:
- Description of Business;
- Legal Proceedings;
- Risk Factors; and
- Management’s Discussion and Analysis.
Corp Fin indicated that its review program has been providing comments on company social responsibility reports and disclosures that discuss legislative or regulatory developments that may impact the company.
Non-GAAP Financial Measures
The SEC’s rules on non-GAAP financial measures have not changed in years. Corp Fin continues to comment often on the use of non-GAAP financial measures. Corp Fin provided a number of reminders to keep in mind when using non-GAAP financial measures, including:
- Disclosure should include a discussion of why management believes a particular non-GAAP financial measure provides useful information to investors.
- When providing a non-GAAP financial measure, the company must provide the most directly comparable GAAP measure with equal or greater prominence. In some cases, companies are presenting the non-GAAP measure more prominent that the GAAP measure. A lengthy discussion of the non-GAAP measure may overshadow or bury the GAAP measure.
- Caution should be used in labeling non-GAAP financial measures. Often, the same or similar non-GAAP measure is labeled differently by various companies. It is important to clearly label and describe the non-GAAP adjustments in the particular measure so that investors are able to compare similarly titled measures across more than one company. Corp Fin reminded preparers that the additional number of adjustments and lack of consistency across companies’ non-GAAP measures may add unnecessary complexity for investors. Non-GAAP measure disclosures should include clear descriptions of the measures and what adjustments they include in sufficient detail for an investor to understand all material components of the measure.
- Care should be taken when presenting metrics in SEC filings. Companies continue to discuss or disclose key financial and nonfinancial metrics when describing the performance of their business. SEC guidance states that if a company is disclosing a metric, certain disclosures should be included such as a definition of the metrics and how it is calculated. In addition, a discussion of the reasons why the metric is useful to investors and how management uses the metric to manage the performance of its business should be provided. Corp Fin has been commenting more on issues related to the presentation of metrics as non-GAAP measures or a non-GAAP measure as a metric. The line between what is a non-GAAP measure and what is a metric is not clear. While Corp Fin encourages companies to continuously improve their financial disclosure, it is also important that there is a sound basis for deciding whether a measure is a metric or a non-GAAP measure. Preparers should review both the guidance on non-GAAP financial measures and metrics to ensure that they are appropriately classifying the information being disclosed. Caution should be used to make sure a non-GAAP financial measure or metric is not misleading.
Corp Fin reminded conference participants that company disclosure controls and procedures must cover non-GAAP financial measures since it is part of the disclosures being made in SEC filings.
Corp Fin urged conference participants to review the final rules issued by the SEC relating to Holding Foreign Companies Accountable Act (HFCAA). The SEC has adopted amendments to finalize rules implementing the submission and disclosure requirements in the HFCAA. The Final Rule, Release No. 34-93701, Holding Foreign Companies Accountable Act Disclosure, applies to registrants the SEC identifies as having filed an annual report with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB is unable to inspect or investigate (Commission-Identified Issuers). SEC Chair Gary Gensler recently indicated that while “more than 50 jurisdictions have worked with the PCAOB to allow the required inspections, two historically have not: China and Hong Kong.”
The final amendments require Commission-Identified Issuers to submit documentation to the SEC establishing that, if true, it is not owned or controlled by a governmental entity in the public accounting firm’s foreign jurisdiction. The amendments also require that a Commission-Identified Issuer that is a "foreign issuer," as defined in Exchange Act Rule 3b-4, provide certain additional disclosures in its annual report for itself and any of its consolidated foreign operating entities. Further, the release provides notice regarding the procedures the SEC has established to identify issuers and to impose trading prohibitions on the securities of certain Commission-Identified Issuers, as required by the HFCAA.
The SEC will identify Commission-Identified Issuers for fiscal years beginning after December 18, 2020. A Commission-Identified Issuer will be required to comply with the submission and disclosure requirements in the annual report for each year in which it was identified. If a registrant is identified as a Commission-Identified Issuer based on its annual report for the fiscal year ended December 31, 2021, the registrant will be required to comply with the submission or disclosure requirements in its annual report filing covering the fiscal year ended December 31, 2022.
The amendments are effective 30 days after publication in the Federal Register. The new addition to §232.405, Interactive Data File submissions, is effective from 30 days after publication in the Federal Register through July 1, 2023.
Corp Fin urged companies to consider providing applicable prominent disclosures related to risks associated with the HFCAA, including the possible risk of losing the listing in the future. Form 10-K now includes a new Item 9C, Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.
IASB Update: Dr. Andreas Barckow, IASB Chair
Dr. Andreas Barckow provided an update on the activities of the IASB. Dr. Barckow indicated that “although US companies are required to use US GAAP, many have international subsidiaries that report using IFRS Accounting Standards. Moreover, US investors investing internationally are prolific users of financial statements that comply with IFRS Accounting Standards. Your views matter to us, so please continue getting involved in our work.”
Dr. Barckow’s remarks focused on sustainability, the IASB’s current and future work program, and convergence.
Dr. Barckow discussed the IASB’s work on sustainability reporting, including the formation of a new International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs. Dr. Barckow indicated that while both the ISSB and the IASB will be independent, the IFRS Foundation Trustees have made clear that the two Boards are expected to work in very close cooperation to drive compatible reporting from the outset. This is a message that the IASB have also heard loud and clear from its stakeholders and advisory bodies, connectivity between accounting requirements and sustainability disclosure requirements is essential. The IASB will strive to make its standards compatible and complementary to facilitate seamless reporting by companies to provide investors with a comprehensive, decision-useful set of information.
IASB Work Program
Dr. Barckow discussed the following three current work program projects that the board has received comments on:
-Primary Financial Statements. This project aims to create a better structure for the statement of profit or loss by introducing an operating, an investing and a financing category of income and expenses and requiring companies to present two new subtotals. This proposal also includes provisions to improve the way companies aggregate and disaggregate information and would require disclosure of information of some management-defined performance measures. Dr. Barckow indicated that overall, the proposals have been well received. The IASB started its deliberations of the feedback in spring this year, and while it is making good progress, Dr. Barckow believes the IASB will certainly spend the next year, too, to get through all the feedback and make decisions.
-Post-implementation reviews. IASB due process procedures requires it to conduct a post-implementation review of any new standard or major amendment two to three years after the pronouncement has become effective. The objective of these reviews is to assess whether the standard is working as the IASB had intended and not to reopen rounds of known arguments. The IASB is currently conducting post-implementation reviews on the IASB’s suite of consolidation Standards (IFRS 10, 11 and 12) and the IASB’s financial instruments standard (IFRS 9).
-Goodwill and impairment. The IASB published a discussion paper on this topic in March 2020. At that time, the IASB had concluded that the existing impairment provisions could not be significantly improved rather than making changes at the fringes. Dr. Barckow indicated that having concluded that the IASB couldn’t respond to investors’ concerns about post-acquisition performance by improving the effectiveness of testing goodwill for impairment, the organization shifted gears and asked whether companies can provide investors with more useful information about the acquisitions they make to help them assess whether they have been a success. The IASB’s primary objective to bring transparency to the subsequent performance of a business combination was received well by users and less well received by preparers. Their concerns are ranging from an inability to track the performance of the acquired business to having to provide potentially company-sensitive and forward-looking information. Given the robustness and diversity in views, finding a solution is truly challenging. One approach the IASB is considering is to investigate a package of disclosures that could substitute, at least in part, the perceived loss of information that proponents of the impairment-only approach fear when abandoning that model. Over the coming months, the IASB will be testing sample disclosures with preparers, auditors and users and seek their feedback before making any hardwired decisions.
The IASB is committed to completing the projects on its current agenda, but is also looking at its future work program. Dr. Barckow indicated that the future work of the IASB and its priorities will be guided by feedback from its latest agenda consultation, which is required by the agencies due process to undertake every five years to seek views on whether we’ve got the right balance in our work and views on which issues we should prioritize. Some key themes are already becoming clear from this consultation process, including that the board should be mindful how much change it imposes on stakeholders and that the IASB should reserve time for working with the new International Sustainability Standards Board as well as on emerging issues. Stakeholders think the IASBs strategic direction and balance of activities are about right.
New projects suggested by stakeholders as high priorities for the IASB’s future work plan include:
- Work on climate-related risks (including pollutant pricing mechanisms);
- Cryptocurrencies and related transactions;
- Going concern;
- Intangible assets; and
- The statement of cash flows.
The IASB still needs to consider whether these issues warrant work on or whether they are more geared towards the work of the ISSB. Some of the projects Dr. Barckow mentioned in relation to both the IASB’s current and future work plan are topics the FASB has also received similar feedback on or are linked to projects the IASB and the FASB have worked on together in the past.
Preserving the convergence work of the Boards’ predecessors is an ongoing challenge, and it is now up to Dr. Barckow as IASB Chair and Rich Jones as FASB Chair to work together so that the gains of the earlier years’ convergence work are preserved for the benefit of investors around the globe.
Dr. Barckow indicated that keeping “each other informed is obviously vitally important. And as I said, our cooperation continues to this day. The FASB is and has been an active member of our Accounting Standards Advisory Forum since its inception; we have maintained fruitful annual joint education sessions; and we also have frequent engagements at board level and among our staff. And I for one would hope we can continue and deepen our relationship to the mutual benefit of our two boards and our stakeholders.”
SEC Enforcement: Gurbir Grewal, Director of Enforcement and Matthew Jacques, Chief Accountant in Enforcement
Gurbir Grewal and Matthew Jacques discussed the activities and focus of the SEC’s Division of Enforcement. The priorities of the division stress the importance of the accounting and audit’s profession in the work of the division. Grewal indicated that he has observed that people have declined their trust in our institutions, including government and financial institutions. He believes there is a playbook to restore the public’s trust that includes robust enforcement, remedies, and compliance. This requires both regulators like the SEC and professionals like accountants or auditors. Regulators must continue to enforce traditional securities laws areas but also must stay ahead of emerging threats. Remedies must appropriately deter relevant conduct. Grewal is open to reviewing the SEC’s current admission policy in which wrongdoers do not admit or deny their guilt. In some cases, wrongdoers should step up and admit they were wrong. Many of the enforcement cases show that gatekeepers must play a significant role in ensuring people play within the rules. The division will continue to have a focus on cases involving inadequate audits, auditor independence, earnings management, and revenue recognition.
Jacques cautioned that the global pandemic continues to impact financial reporting. It is important to stay attuned to what impact the pandemic has had and continues to have on financial reporting. Management is encouraged to bring a heightened scrutiny to their annual assessments of the effectiveness of internal controls over financial reporting (ICFR). This may include considering whether modifications made while in a remote environment were or are sufficient. As personnel come back to the office, companies may want to identify potential pandemic related deficiencies or weaknesses in their internal control structures and what adjustments may be made.
Enforcement discussed some of the reporting and disclosure cases they have brought. Some of the themes from these cases include:
- Disclosures have to be accurate and cannot be misleading. SEC rules require companies to disclose trends in their businesses and they can't mischaracterize the reasons for the growth that they experienced. How a company reaches numbers is as important as what's reported.
- Companies must maintain effective internal accounting controls and disclosure controls. These controls are essential to the sort of robust compliance necessary. Companies must have qualified staff involved in the financial reporting processes, including developing robust internal accounting controls and disclosure controls. Internal accounting controls are critical to both the company's business and is also critical to investors getting truthful information about a company's performance.
- Companies need to consider all the information, not just the facts that support its conclusion or its desired narrative of how things are going to be. This is not an aspirational process when companies are reporting actual numbers. Gathering and evaluating all information is important in reaching GAAP decisions. It's important to company disclosure obligations and ignoring bad facts leads to bad results. The information considered should not be guided by your hopes and dreams, but must be guided by what actually took place and faithfully represent the underlying transaction.