Critical Accounting Policies and How They Differ From Significant Accounting Policies
In an effort to help improve my client’s filings, and of course avoid SEC Comment Letters, I am constantly reminding them that the disclosures required by SEC Rules Release 33-8098, contained in the MD&A, are considerably different than the significant accounting policies disclosed in the footnotes. Too frequently issuers simply cut and paste their summary of significant accounting policies into this section, which I believe will result in comments from the SEC if selected for a full review by Corp Fin.
I believe the intent of the critical accounting policies disclosures is for issuers to identify and disclose only those accounting policies that require significant judgment and estimation with a degree of uncertainty. Further, simply narrating the assumptions used in a Black-Scholes model for valuing stock options does not provide the appropriate information contained in the rules release. Disclosures related an issuers critical accounting policies (estimates) should include the methodology used in developing assumptions and the corresponding estimates, how the estimates impact the financial statements, and the effect of a change in the estimates and / or underlying assumptions.
The SEC provides two questions issuers need ask in making the “critical” determination:
- Did the estimate require making assumptions about matters that are highly uncertain?
- Would reasonably developed, different estimates / assumptions, at the time or in future periods, have a material impact on our financial statements?
When both questions are answered yes, it should be included in this section of the MD&A.
The included disclosures should not simply be boilerplate (like significant accounting policies tend to be) or be overly accounting technical (as “plain English” as possible). Further, the SEC expects varying numbers of critical accounting policies amongst issuers, but they have indicated three to five as a reasonable range.
The rules release provides several examples of disclosures that can help issuers develop the approach and content for appropriate inclusion in future filings.
SOX 404(b) – The Tar Baby and the SEC
By Mark Bailey · 2 Comments
As a youngster the Song of the South stories penned by Joel Chandler Harris at the beginning of the 20th century and brought to life by Disney were some of my favorites. In one, Bre’r Fox and Bre’r Bear make a tar baby to catch Bre’r Rabbit. Bre’r Rabbit becomes offended when the inanimate tar baby doesn’t respond, strikes it and becomes stuck to it. The more he struggles the more inextricably attached he becomes. It certainly seems that the SEC has found a tar baby in SOX 404(b) as it pertains to non-accelerated filers.
Recently the SEC deferred the compliance date – once again. This time for 9 months. The reason for further deferral was explained as being necessary as the results of an on-line survey conducted by the SEC which was not completed in time. A survey, I venture, that was essentially unknown to virtually everyone it might have affected, so not having it available was irrelevant.
As you may recall the original rationalization for 404 included the premise it would reduce fraud while increasing investor confidence in the issuer’s reporting. Those interviewed for the survey above indicated they did not believe there had been any increase in investor confidence as a result of 404 applied by large filers. Yet in his public comment, Commissioner Aguilar stated ” I join Chairman Shapiro in assuring investors that there will be no further extensions of the compliance deadline.” What am I missing? By the SEC’s own survey, investors don’t care! So why is it mandated? Certainly there can and have been benefits enjoyed by larger issuers. For them it is good governance in many cases, and worthwhile. But not for small companies.
There is essentially no benefit to most non-accelerated filers either actual or perceived in most cases, and the cost is proportionately greater than for larger companies. Both the SEC and the PCAOB have exercised common sense in promoting ’scalability’ in other areas. They need to do so here as well by eliminating the requirement – one with no or negligible benefit and grossly disproportionate cost – for small non-accelerated issuers.
Will it reduce fraud in small companies? I seriously doubt it and I believe most public company audit partners would agree. The SEC has the weapon it needs to fight fraud in the 302 certifications.
Send this tar baby back to Congress and let the money be redirected for innovation and growth.
Oil and Gas Accounting and Disclosure Rules Revised under SEC Release 33-8995
Last Friday, the AICPA released a discussion draft of the audit and accounting guide for Entities with Oil and Gas Producing Activities. While not authoritative it is anticipated to reflect the current standards being revised by both the Financial Accounting Standards Board which sets US GAAP, and the International Accounting Standards Board, all of which is being done in response to SEC Release 33-8995.
While the changes are too voluminous and complex to even summarize here, I’ve included links and welcome questions,comments to this post or phone calls to discuss the implications.
The definitions in Rule 4-10 have been significantly changed. The pricing mechanism for reserves has been defined as a twelve month average. The definition of what is and is not considered ‘oil and gas’ has been clarified to include bitumen and other saleable hydrocarbon resources (geothermal has been excluded); the definitions of ‘proved’ ‘unproved’, ‘developed’ and ‘undeveloped’ reserves has been amended and clarified; and the disclosure requirements under Regulation S-K has been expanded.
Additionally, the disclosure requirements within the financials and for the K’s and Q’s have been expanded and clarified including the disclosure requirements for MD & A. The SEC continues to coordinate with the FASB and the IASB who continue to develop their standards for the oil and gas entities. Given the SEC has come to the party first, it’s hard to imagine the other standard setting bodies will do anything but comply.
Foreign filers using Form 20-F will be subject to the same disclosure as opposed to the previous disclosure requirements summarized under Appendix A. Canadian filers, however, will not be subject to the new disclosure rules given that the requirements under the Multi-Jurisdictional Disclosure System (MJDS) using form 40-F are already consistent.
Now some good news. The implementation date for registrations filed and for annual reports on Forms 10-K and 20-F is for fiscal years ending on or after January 1, 2010. While the implementation is mandatory, “a company may not apply the new rules to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required”. Implementation may be deferred as discussions between the SEC, FASB and IASB go forward.
A Matter of Trust
By Julia Kingston · 3 Comments
A number of countries don’t allow foreign people (including foreign business entities) to own land in certain areas. The most well known of these countries is Mexico, but I have recently come across a similar situation in Canada, and know of cases in Great Britain. As a work-around, the land is usually held in trust for the foreign owner. This may not seem as though it creates any tax issues, but it does. Unfortunately foreign trusts have at times been used to try to shelter income off-shore in foreign tax havens, so the IRS has strict reporting requirements for foreign trusts… and the penalties for not filing the related forms are huge! (In some cases 35% of the trust assets per year). Even if you don’t think of the trust as a “real trust” – the IRS probably will (they are commonly referred to as “Land Trusts” or “Mexican Land Trusts”). We recently enlisted the services of tax attorney, Jean Ryan at Sideman Bancroft, LLP, to analyze a Canadian land trust. Although the client “never thought of it as being a real trust,” her answer was that it the IRS may treat it as trust, because of the language in the document. So if you own beachfront property in Mexico – lucky you, but in all seriousness, talk to your tax advisor to make sure that you don’t lose it all in penalties.
SEC Extends ICFR for Small Issuers to 2010
Today, October 2, 2009, the SEC announced that independent audits of internal control over financial reporting has been extended for smaller reporting companies. The press release indicates small companies will now need to be compliant beginning with annual reports for fiscal years ending on or after June 15, 2010.
Fair Value – Inactive Markets and Orderly Transactions
Recently issued “guidance” provides that when determining the fair value of certain assets (liabilities) it is only appropriate to use comparable transactions that were not fire (liquidation) sales where an active market exists. The recent guidance (pre codification FSP FAS 157-4, codification 820-10-65-65-4), effective for interim and annual periods ending after June 15, 2009, simply provides additional items to consider for adding additional premiums or discounts when developing fair value estimates.
Further, the new guidance continues to reiterate the fair value definition that has been around for several decades, “Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Remember, the Company’s intent or ability to hold an asset should not be used in determining fair value as the estimate is market based and not entity specific.
In developing estimates, several factors provide an indication that significant adjustments to fair value (in this case quoted market prices – Level 1 inputs) may be necessary when market activity does not appear to be normal. Some of those factors include:
- Declines in recent transactions
- Price quotations are stale or vary substantially, including significant bid-ask spreads
- Indexes no longer correlate to values of individual assets or liabilities
After analyzing the market activity in general, the next step is to perform additional analysis to determine the transactions were not forced liquidations or distressed sales. Factors to consider when a transaction may constitute a distressed sale include:
- A recent transaction that appears to be an outlier compared to other recent transactions
- Signs indicate the seller is experiencing significant financial difficulty, e.g. at or near bankruptcy
- The asset (liability) was not marketed for an appropriate period or to multiple buyers
Three outcomes exist when analyzing transactions to determine if they fall within the fair value definition and require inclusion in estimates. First, if the transaction is not orderly, it would likely hold little weight in estimating fair value. Second, if the transaction is orderly, see above market activity analysis when determining how to include in fair value estimates including risk premiums. Finally, there may not be enough information available to conclude whether the transaction is orderly, in which case, it should still be considered, but not the sole indicator of fair value.
The guidance recognizes that issuers need not undertake undue cost and effort in making these market determinations, but should not ignore information that may be readily available in the public domain. Further, the degree of difficulty and subjectivity in developing risk premiums does not provide a sufficient basis to exclude risk adjustments to fair value.
At this point, you may be asking yourself – where does one obtain all of this information? That is a very good question and I am out of time…anyone, anyone, anyone?.!