ImprovementsPosted: July 10, 2019
The Financial Accounting Standards Board (FASB) has been busy lately issuing exposure drafts on disclosure improvements, income tax disclosures and income tax accounting. You note that I said disclosure improvements, not simplification and especially not reduction for the first exposure draft. The exposure draft was in response to a Securities and Exchange Commission (SEC) request to consider incorporating several SEC mandated disclosures in generally accepted accounting principles (GAAP). Most of the changes are minor and will not require any significant additional work by preparers, but there are a few you might want to take a look at a little closer.
The first is a requirement to disclose the calculation method for dilutive securities in determining earning per share (EPS). GAAP requires preparers to calculate the dilutive effect using two methods and then use the method that results in the lowest EPS. This means that a company might be switching methods from quarter to quarter to comply with GAAP.
The proposal is for companies to disclose the specific method used each quarter. Making the disclosure does not really require any additional work, but to the uninitiated investor seeing a company change calculation methods each quarter might raise questions about “shenanigans” going on at the company when, in fact, the company is simply following a GAAP requirement. When companies have a choice in methods, it makes perfect sense to disclose that choice. When companies are required to use a specific method each quarter, even if that method changes, disclosing the change only serves to confuse rather than inform investors.
The second proposal is to require that prior financial information – think income statement and balance sheet – for acquired companies be included in the footnotes to a newly consolidated company’s audited financial statements. The practicality of this requirement could be problematic from an audit perspective. If a predecessor auditor existed, there are potential concerns about how to incorporate that work into the successor auditor opinion, but at least a path on how to handle those situations exists within the auditing standards.
The bigger problem comes from cases where the acquired entity was not audited. I know that would be rare to nonexistent for material public company acquisitions, but this is a change in GAAP and a private company acquiring an unaudited entity would have to comply with the disclosure requirement or get an adverse opinion. It is possible that a private entity may not even be able to comply with the disclosure requirement if they wanted to. An auditor may not be able to audit certain amounts – think inventory or cost of goods sold – that happened in the past. If those numbers can’t be audited, then a clean opinion may be impossible to obtain. Is that really a proper result for private companies acquiring small, but material unaudited entities?
Finally, an overall concern is the migration of public company reporting requirements from the SEC to reporting requirements for all companies, whether public or private. We already have a strain between the requirements in GAAP that is focused on public companies and the needs of private company financial statement preparers and users. While a majority of the changes proposed seemed appropriately applicable to both, the precedent-setting aspect of a public company focused SEC dictating GAAP used by private companies is something we all need to recognize as a path fraught with pitfalls that requires an extra layer of deliberation to make sure GAAP is serving all constituents, not just the fewer larger public companies.