The FASB and the SEC each have projects underway to look at and understand how to increase the effectiveness of disclosure. While most preparers hope these projects will reduce the volume of disclosures, I think recent comments make it clear that the ability to do that is really in the hands of preparers themselves already.
GAAP already includes a requirement that the codification, including disclosures, does not apply to immaterial items. And, the SEC is clear that they allow cross-reference to other disclosures and do not want, or expect, the repetition of the same language from section to section in the 10-K. For example, the critical accounting estimates section is not supposed to be a repeat of accounting policies from footnote 1. Instead, this section of MD&A is supposed to have information about the assumptions and process of developing critical estimates, rather than the policy statement.
The issue with reducing disclosure is twofold. First, there is no penalty for over disclosure, but there is risk related to under disclosure in the form of comment letters and lawsuits. When asked at the AICPA SEC and PCAOB Developments Conference if the SEC would ever provide a comment on a company including excessive disclosures which might therefore make it harder to determine the relevant, important information, the answer was a quick no. So the legal situation is there is no penalty for over disclosure and there is a possibly significant penalty for under disclosure. Given that dynamic, is it any surprise that we are being overwhelmed in disclosure.
A statement was also made at the AICPA conference that what it really takes to eliminate disclosure is courage by the preparer to hold their ground with the auditor, and audit committee, that certain disclosures are not material. The reality is that even if a disclosure is not material today, you have to set up the infrastructure to monitor every year in the future to continue to conclude it is immaterial. So you are essentially asking a preparer to save no time and resources, and have a discussion every year about why something should not be disclosed. That may actually take more time for the preparer than just simply providing the unnecessary disclosure. As the saying goes, “I apologize for the length of this letter, but I didn’t have the time to make it short.”
Given the risk math discussed above and the lack of savings from the preparer perspective, is it any surprise we are disclosing more than ever? I say no, and until these root causes are addressed, we won’t ever be able to reduce the volume of disclosures.
Last week I attended and presented at the AICPA SEC & PCAOB Developments Conference in Washington DC. At least I attended the second and presented on the third day in DC. Due to weather problems in both Dallas and Washington, my Sunday flight was cancelled and the earliest flight available was Monday evening. So instead of trying to figure out a way to get there for Monday I decided to spend a night in my own warm bed and attend the first day of the conference virtually on the internet. From what I heard from the speakers and the chats on the internet, I was one of many that had trouble getting to Washington from all over the country. Attending virtually was great. While you don’t have the networking opportunities of being there in person, the chat kept me interested and I was able to get a great feel for the tone of the conference.
While my opinion is biased (I served on a panel discussing the revised COSO Internal Control Integrated Framework), the theme of the conference this year was internal control over financial reporting. It wasn’t that the AICPA picked this theme. The speakers did it by mentioning internal control in presentation after presentation and panel after panel. I am not overstating fact when I say ever single SEC and PCAOB panel talked about internal control. From asking why companies don’t disclose internal control failures until after a restatement to questioning management’s positive assertions about internal control when the auditors are found not to have performed an appropriate audit over that assertion, the SEC is clearly looking to renew its interest in internal control reporting for the first time since in several years. Meanwhile the PCAOB’s recent report questions whether auditors are consistently complying with AS 5. Even without a revised internal control framework to deal with preparers should be spending more time documenting, testing and evaluating their internal controls over financial reporting.
I will spend more time talking about internal controls in my next blog. Meanwhile, here is a list of other quotes and notes from the three day conference:
- Keynote speaker David Walker – we’ve tripled the national debt to over $17 Trillion in 13 years, but that is only what is on the balance sheet; what is not on the balance sheet makes the debt number over $70 Trillion from “only” $20 Trillion 13 years ago.
- Paul Beswick, SEC Chief Accountant – IFRS took a back seat to the rule making requirement so Dodd-Frank and the JOBS Act; it was not a matter of lack of importance of IFRS, but simply a rule-making bandwidth issue that has kept IFRS on the back burner of the SEC for the last couple of years.
- OCA Panel/FASB-IASB Panel – the Chief Operating Decision Maker reporting package is increasingly irrelevant in determining which segments to report when CODM’s have drill down access to details that didn’t exist when the standard was written – this needs to be addressed when the FASB relooks at segment reporting.
- Enforcement Division Panel – Whistleblowers are increasingly important to the enforcement division; many of their cases are now starting from whistleblower action and the use of whistleblowers is changing the willingness of companies to self-report issues as well as increasing their willingness to cooperate with the SEC
If you want to know more check out the many articles and press releases that come out in conjunction with the conference
With all the attention on the standards coming out of the FASB and IASB, it might be easy to forget about the SEC, but the SEC is also busy with a number of projects and I wanted to use this blog to mention a few that will impact most public companies in the coming year.
New Chairman – Mary Jo White was confirmed as the new Chairman of the SEC. Ms. White is a prosecutor but stated during the nomination process that her top priority is to complete all of the rulemaking required by the Dodd-Frank Act and the JOBS Act. Additional priorities include strengthening the SEC’s enforcement program and focusing on the technology used by the SEC.
Conflict Mineral Reporting – Despite the U.S. Chamber of Commerce and National Association of Manufacturers lawsuit, the requirements to file the first report on May 31, 2014 (actually June 2 since May 31 falls on a Saturday) for the 2013 calendar year are still in place. The question many professional accountants are asking themselves about these rules is what role should they be playing? The final rule made the report a separate filing distinct from the 10-K and only required that it be signed by an “executive officer” of the company, not the CFO or CEO. As such this has truly become a procurement and/or legal led project and some Finance departments are quietly moving to the background of this reporting effort. The one point that Finance needs to be involved in the short term is the selection of the auditor for the report. While many companies will naturally lean toward their financial statement auditor to provide this service, since it is no longer part of the 10-K that is no longer as obvious a decision and, in fact, it does not even have to be a traditional CPA audit firm under the rules.
Political Spending – The SEC issued a notification of proposed rulemaking covering the disclosure of political spending by public companies. This means the SEC is considering a rule in this area, but has not yet issued anything more specific. The SEC has a lot on its plate, but many see this as the administration’s response to the Supreme Court’s ruling allowing unlimited political donations by corporations. This also covers a topic that is a perennial favorite shareholder submission for a proxy vote. While the shareholders almost always vote down the proposals, you can bet there will be plenty of support from a vocal group (I won’t opine as to whether it is a minority or majority) if a rule is proposed.
Social Media – After the minor uproar over the Netflix CEO’s disclosure of important company information on his personal Facebook account, the SEC has released guidance on how a company can use Social Media to communicate material information. Basically, the company has to tell investors – ahead of time – all potential sources of public disclosures. Look for a lot of CEOs to gain a lot more Facebook friends and Twitter followers in the coming months. I wonder how long it will be before someone starts selling advertising space linked to these pages to stock brokers.
Executive Compensation – two of those Dodd-Frank outstanding rules cover new requirements around executive compensation. The first will be a rule requiring clawback provisions in executive compensation programs if the financial statements are later found to be materially misstated. You need to be careful when implementing these requirements. If improperly implemented, clawback provisions can impact the accounting for share-based compensation and get some very unwanted results. The second rule will be on required disclosures comparing CEO pay the other employees in the company. That will obviously be a very sensitive disclosure and the calculations a likely to be under a lot of scrutiny, both internally and externally, whenever the rule is proposed and finalized.
MD&A versus Financial Statement Disclosures – Finally, the SEC Chief Accountant, Paul Beswick announced a planned effort to be launched with a roundtable sometime this summer to review disclosure gaps and overlaps and look at what type of information should appear in the financial statements versus the rest of the annual reporting package including the MD&A. While it won’t result in rulemaking right away, this might provide a lot of interesting fodder for discussion about the future of financial reporting.
The on again off again battle on the potential U.S. adoption of IFRS took a couple of interesting turns last week. The first interesting turn was the nomination of a former prosecutor to head the SEC. All the stories talk about how the appointment of Mary Jo White is sending a clear signal about bolstering the SEC reputation for enforcement. I’m not here to dispute that, but if the focus is going to be on enforcement then I am guessing IFRS will continue to be down the list of SEC priorities for at least a while which means we will continue down the path of U.S. GAAP for U.S. public companies, IFRS for Foreign Issuers filing with the SEC and lots of continuing rhetoric about the U.S. not adopting IFRS from everybody.
The second interesting turn was a study released by the U.K. that showed how IFRS Impairment rules were being used inconsistently across Europe. This supported a similar SEC finding in its work plan report. The lack of consistency puts a major dent in the argument that the U.S. needs to adopt IFRS so that everyone will be reporting results the same way. If IFRS is not being used consistently then what difference does it make if there are also a few differences between U.S. GAAP and IFRS, or so the anti-IFRS argument goes.
But that wasn’t what really bugged me about the whole issue. The part that bugged me was what Hans Hoogervorst, Chairman of the IASB said in defense of IFRS. I agreed with his statement “that even an unevenly applied global standard provides much more global comparability than an equally unevenly applied multitude of diverging national standards,” but I disagreed with his next statement strongly. He went on to say 735 restatements required by the SEC in 2010 show that even U.S. GAAP has issues with consistent application of standards. I say that statistic is at best totally irrelevant to the issue of comparability and at worst, might prove just the opposite of what Mr. Hoogervorst was trying to say. By requiring restatements the SEC was, in fact, forcing consistency in the application of the standards. What the U.K. and SEC studies found were inconsistent application of standards that were apparently perfectly acceptable to the various regulatory organizations responsible for enforcing consistency in IFRS.
So, a statistic is used to purported prove that application of U.S. GAAP is just as inconsistent as the application of IFRS, but it actually may prove just the opposite if you are really informed about the subject. It certainly brings to mind that old saying about statistics being the biggest lies of all.
I was reading a publication produced by our auditor, Ernst & Young on all of the standard setting activity for 2012 and I realized I have good reason to feel like I can’t keep up with everything going on.
The FASB only issued 3 final standards (now called ASUs for all of us who grew up with FAS’s for all those years). Of course, maybe it’s really 4 because they issued separate ASUs for technical corrections to the ASC in general and technical corrections to the SEC portion of the ASC, but who am I to quibble with my auditor on such things. Either way, not too bad so far, but the FASB also issued or worked actively on 12 exposure documents. Now were starting to get up in the numbers. Of course 12 documents would not be so bad if they covered specific topics related to different industries so everyone is not impacted by all 12, but that is not the case here. We’re talking about messing with revenue leases and impairment of customer receivable which means just about every business that exists will be impacted by many of these proposed standards. Of course it doesn’t stop there, the FASB launched the PCC to look into private company accounting issues and started two other projects on disclosures and going concern. The EITF was also busy reaching 3 consensus opinions and exposing documents on 4 other issues.
Not to be outdone, the SEC issued 3 final rules including rules on reporting on conflict minerals (if you think you are not impacted, you may need to think again as some reports expect that thousands of companies – public and private – will be impacted by the reporting requirements). The SEC also issued 16 proposed rules and other releases in 2012 and that doesn’t include any of the work on IFRS, XBRL or work to be done under the JOBS act. The PCAOB also started to get busy again and issued one final auditing standard as well as one audit practice alert document. The PCAOB also released 9 other documents outlining proposed rules or asking for input on concept releases. These include the now infamous release on mandatory auditor rotation as well as an equally important release on potentially significant changes to the auditor report.
Of course the ASB also issued a new standard as well as several other documents and the GASB issued 4 new standards, 2 exposure drafts and at least 3 other significant documents. The AICPA also issues its proposed framework for private company reporting and COSO issued 2 exposure drafts to revise its Internal Control framework which is the de facto internal control standard for 85% of public companies that have to comply with Sox section 404.
And that’s just the U.S. accounting and auditing standards. It doesn’t include all of the IRS changes, the new developments in the valuation world (didn’t you know the SEC expects all of you public company preparers to be valuation experts now), and international standards for accounting from the IASB and auditing from the IAASB. I must admit I have to laugh when people tell me they can’t get enough CPE done to maintain their license. You could spend 140 hours on CPE and not keep up let alone only the 40 required in most jurisdictions. I want to look at them and ask, then how do you plan to keep your job because you are expected to know about all of these changes and more!
Preparers of public company financial statements should be very familiar with the requirements of SAB 74 to disclose of the known impacts of changes in accounting standards. Typically this disclosure is covered by the quick and dirty “the change is not expected to be material” or the “the impact of the change is not yet known.” While the SEC doesn’t like it, that answer works for many of the standard changes that only impact disclosures or only impact a small subset of public companies.
That logic won’t work with the revenue recognition and leasing standards set to be released in 2013. First, in responses to the FASB, many industries have made it clear that even with the changes in the revised exposure drafts the new standards will significantly impact the timing and amount of revenue and expense recognition. Second, companies are likely to have significant information on the impact of these standards well before they are actually implemented for several reasons including the length of time to implement the standards and the likelihood that many companies will implement dual accounting processes as a way to deal with the retrospective application requirement currently proposed in the standard.
It might be acceptable to say you don’t know when the standard is issued one year and effective the next, but these standards are likely to have an implementation phase of three years of more. The SEC might allow you to get away with “I don’t know” the first year, but they are likely to ask serious questions if you keep it up in years two and three. I could see the SEC asking if you don’t know, or at least have a solid estimate of the impacts in years two and three, how can you say you have the proper controls in place to produce financial statements once the standard is implemented.
And it gets even better; the SAB 74 disclosure is part of your audited financial statements (note this is not forward looking information, but information on what your current financial results would look like under the new standard). That means any estimates you give are part of what will get audited. Most importantly that means you have to have a properly controlled process in place to come up with the estimates that can be audited. An additional implication is that once the standard is in place the amounts included in your actual financial results better be close to what you disclosed previously. If not, there are likely to be serious questions about your controls and processes on all of your financial results, not just your SAB 74 disclosures.
Bottom line, even if the FASB gives us until 2015 or 2016 to implement the new standards, because of SAB 74 you better be ready to start disclosing some solid numbers under the new standard by the time you release your 2014 (I think we will get a pass in 2013) financial statements. So forget about those three year implementation plans and start thinking about how to track this information starting in one year on January 2014.
Another area of coverage at the AIPCA SEC and PCAOB Developments Conference in December that surprised me was the focus on internal control. I knew the last session of the conference was going to be on the forthcoming update to the COSO Internal Control Integrated Framework, but I did not expect other presentations to hit on the topic as well.
Paul Beswick, Acting SEC Chief Accountant, got the ball rolling by reminding everyone that internal control has five components, not just control activities. The implication is that the SEC is seeing too much focus on the Control Activities component when it asks questions about Sox 404 compliance. As a reminder the five components of internal control are:
- Control Environment
- Risk Assessment
- Control Activities
- Information and Communication
- Monitoring Activities
The COSO framework, which is used by 85% of the companies complying with section 404, requires all five components to be present, functioning and operating together in an integrated manner to have an effective system of internal control. While many companies do address all five components, the weighting of the work is often tilted toward control activities and monitoring activities when it comes to documenting and testing of key controls. These are only 2 of 5 components (and 5 of 17 control principles in the proposed update to the framework).
And it was not just the SEC that discussed internal controls. James Doty, Chairman of the PCAOB also brought up the issue when discussing auditors work on internal controls. While he did not specifically get into the component issue, he questioned the adequacy of the documentation to reach a conclusion about the effectiveness of internal control. Putting two and two together, it seemed clear he was also talking about the need to properly emphasize all five components
The new framework, scheduled to be released on March 31, 2013 is going to provide a renewed emphasis on all of the components of internal control as well as the 12 principles of control in the control environment, risk assessment and information and communication components. This really provides a great opportunity to revisit your control documentation and make sure you have everything you need to prove your assertion that you have an effective system of internal control with all five components present, functioning and operating together.
…or you can wait for that SEC comment letter.
It seems the fissures in the IASB-FASB relationship have continued to grow and risk becoming so fractured that the U.S. movement to IFRS may be put off indefinitely.
The latest salvo game from IASB chairman Hans Hoogervorst. His statement that the IASB has “broken deadlines so often that nobody believes in them anymore” seems to be purely a self assessment at first blush, but in standard setting, like politics, nothing is ever that simple. The IASB Chairman also referred to “dysfunctional working processes and dysfunctional decision making” in his recent self assessment of the IASB. Considering the FASB is part of that decision making process and the only standards singled out as issues where joint projects, one has to believe at least some of the criticism was squarely aimed at the FASB.
Mr. Hoogervoorst also laid down the gauntlet that the IASB would finish its conceptual framework project by September 2015. Given that aggressive time frame, it is clear the IASB won’t have time to work with the FASB on any convergence projects once the big three – revenue recognition, leases and financial instruments are complete. In fact, one has to wonder if the IASB will continue to work closely with the FASB to work out a single solution on those projects – in particular the leasing project – or if they will simply go their own what and effectively tell the FASB you can come along or not; we don’t care which you do.
And the IASB also seems to be getting the backing of the EU with comments from officials referring to stakeholders impressions that “we are going backwards” on accounting standards. The EU has even raised the idea of kicking the SEC off of the monitoring board providing oversight to the IASB. While that has not happened, if it ever does, it will be very interesting to see the SEC response. Given the SEC’s mandate through law about accounting standards, would the SEC be willing to continuing accepting financial statements based on accounting standards they have no oversight on whatsoever?
So it increasing looks like we may have a world of two or three (never count out the Chinese) major sets of accounting standards. A friend on mine from Canada mentioned this is increasing starting to look like the adoption of the metric system. The U.S. initially puts out plans to adopt the metric system, but never really gets on board with the rest of the world. That leaves business stuck in the middle dealing with users of both systems and muddling through as best they can.
The SEC can’t seem to make up its mind on integrated reporting. Their actions seem to both support and hinder the movement to integrated reporting. The support comes from the SEC’s recent de facto rule making on cyber security reporting. The SEC sent a series of letters to more than twenty companies telling them the SEC expects to see significant new disclosures on actual security breaches. There was no discussion in the SEC letters of “financially significant” breaches – just breaches.
The hindrance comes from the SEC rule making on conflict mineral reporting. By backing away from requiring the disclosure to be included in the 10-K, the SEC has relegated the new reporting to a separate – unintegrated – report. In fact it could be argued that as a result of not including it in a report with the same distribution requirements as the annual report, conflict mineral reporting is destined to be read by very few actual investors.
The point of integrated reporting is to combine all relevant information about a company into one report that shows how the financial and non-financial information relates to the overall success (or lack there of) of the enterprise. It’s possible that the SEC action on conflict minerals is as much a statement about the lack of relevance of such information to the success of the business as it is any statement about integrated reporting. But if that is the case, then it might make for some interesting discussions around two other pet disclosures of the sustainability/integrated reporting crowd.
The first is information on access to and use of fresh water. Much like cyber security is a critical business risk to certain technology firms, access to the necessary amounts of fresh water is just as critical to a series of other businesses. On the other hand, absent artificial government imposed limits, carbon emissions do not pass the same criticality test.
Are these recent SEC decisions a peek at the future regulation over integrated reporting? Is the SEC going to look at the direct relation to the success of a business of non-financial disclosures when deciding what is required and what is not in the future required integrated report? Or am I reading too much into isolated decisions? What do you think?
A few months ago the FASB and IASB made an announcement that didn’t make many headlines, but it now seems to be significant statement about the future of “a single set of global accounting standards.” The statement essentially said that the Boards were not seeing a lot of benefit, and were seeing increasing costs, in continuing to work jointly on new standards. It went on to state that when the current list of convergence projects was complete, no new projects would be undertaken by the Boards working as a single unit. On the one hand, if all of the convergence projects were completed, one could come to the conclusion that there really wouldn’t be many differences left to work on anyway. On the other hand, this might have been seen as a prophetic statement of the inability of the Boards to see eye-to-eye on what the appropriate accounting standards should be.
In isolation, this announcement might not seem like much, but since then two more events have occurred to put that announcement in new light. First, the SEC staff issued its final work plan with no recommendation of how or when to transition the U.S. (public company reporting) to IFRS. Second, the FASB made several tentative decisions on the accounting for impairments of financial instruments that will take the U.S. in a different direction than the current proposal from the IASB.
Looking at the work plan report, it seems clear there are several layers of concern with IFRS that the FASB seems to be latching onto in its renewed assertiveness. First, the notion that U.S. standards are somehow prescriptive and IFRS’s are principle based was somewhat debunked by the SEC. Sure the U.S. standards tend to come with a lot more guidance, but that has the benefit of reducing diversity in practice and isn’t that the point of a single set of standards. Second, the SEC hinted that IFRIC (the IASB equivalent of the EITF) isn’t doing a job good enough for the U.S. market and would need to be much more active if the U.S. were to ever adopt IFRS. In a document as politically sensitive as the work plan report, that hint was the same as you or me yelling something at the local town square.
The work plan report also pointed out that IFRS continues to be underdeveloped in several critical areas (e.g. regulated industry and investment company accounting) and effectively said going pure IFRS and eliminating standards in these areas would be a major step backwards for U.S. investors. The work plan seems to suggest a major role for the FASB if the U.S. were to ever adopt IFRS by apparently promoting an endorsement process as the best way to eventually incorporate IFRS into the U.S. market.
With this renewed support from the SEC, the FASB appears to have decided that they don’t have to get along with the IASB if they don’t want to. The first salvo is the aforementioned decisions on financial instrument impairments, but I am wondering what is next. We’ve already seen cracks in the unified solution to leasing. Will a single standard in that complicated area also disappear like a balloon in the wind? And what about revenue recognition? The re-deliberations on that standard have just begun. Is more contention on that final standard coming as well? I sure don’t know the answers to those questions, but like fans flocking to a NASCAR race, many of us will be looking on not to see the results of the race but to watch the wrecks happen along the way.