The annual AICPA Conference on Current SEC and PCAOB Developments was held in Washington D.C. with a wide range of representatives from the Securities and Exchange Commission (SEC), Public Company Accounting Oversight Board (PCAOB), Financial Accounting Standards Board (FASB), the Center for Audit Quality (CAQ) and the American Institute of Certified Public Accountants (AICPA). A number of other stakeholders, including preparers and audit professionals also served as panelists throughout the conference, including two of our own partners, Liz Gantnier and Cheryl Levesque.
Speakers shared their views on trending auditing, accounting and financial reporting topics with attendees. The importance of collaboration and involvement of all stakeholders in order to provide high quality financial reporting was a recurring theme throughout. Reinforcing this notion, SEC Chairman Jay Clayton and SEC Chief Accountant Wes Bricker shared an illustration on the "blueprint" for U.S. Financial Reporting Structure for Public Issuers with all stakeholders depicted.
This publication is not meant to be all inclusive of the topics discussed at the conference. Rather, it is intended to focus on the highlights and key themes that may be relevant to our clients. The following hot topics had stakeholders talking…
Most public entities adopted the new revenue recognition standard in 2018. Overall the SEC staff commended registrants' implementation efforts, but noted that it will continue to be an area of focus. The SEC staff is monitoring the potential diversity in application that could occur due to the judgments required in applying the standard. Taking into account comment letter trends and pre-filing consultations, areas to consider are principal versus agent, identifying performance obligations, timing of revenue recognition and disaggregation of revenue streams. Registrants should provide clear and transparent disclosures and continue to refine their disclosures for experience and for new information that becomes available.
Lease accounting is the next big standard nearing its effective date. Russ Golden, Chair of the FASB, specifically stated that the FASB does not expect any delays in the upcoming effective date which means that any registrant that has not begun the process of analyzing the impact of the new lease accounting standard or preparing for implementation may need to make haste. Panelists noted the challenge of evaluating the population of leases and identifying embedded leases as the number one challenge they faced. The lack of software solutions was close behind, along with the increased need for policy training for stakeholders. Registrants were reminded of the importance of considering the impact to internal controls over financial reporting in implementing the new lease standard and to keep stakeholders (particularly audit committees) informed and involved in the process. As the effective date nears, the SEC staff expects a company's SAB 74 disclosures to be robust and consider quantitative implications, practical expedients expected to be elected, and any other qualitative information important to the adoption of the lease standard for investors.
PCAOB – Auditor's Reporting Model - Critical Audit Matters
Many are awaiting the incorporation of critical audit matters (CAMs) into the auditor's report, but getting to a final "product" will take significant effort on the part of many stakeholders. The addition of CAMs to the audit report will take significant auditor judgment and should be based on an individual company's facts and circumstances. Panelists urged stakeholders to get involved in understanding the implications CAMs could have on the financial reporting process, encouraging auditors to start conversations early and often with management and audit committees. Registrants should also consider if there are other stakeholders within the company that should be involved in CAM discussions such as investor relations personnel to respond to any potential questions regarding the auditor's CAMs. One preparer panelist noted that this is also an opportunity to review current disclosures and the relationship with CAMs. Many acknowledge that the actual drafting of CAMs is proving to be challenging and that it is important to retain the intended value of the information included within the CAM, to ensure they do not become boilerplate.
Hedging – Transition Away from LIBOR
Regulators are monitoring the transition away from LIBOR to acceptable alternative rates. The FASB issued ASU 2018-16 to add the secured overnight financing rate (SOFR) overnight index swap (OIS) rate to the list of benchmark interest rates. The FASB also added a project to their agenda to address the potential effects of the transition on financial reporting, including the effects on existing cash flow hedges where the risk being hedged relates to changes in LIBOR.
Internal Control Over Financial Reporting (ICFR)
Evaluating the operating effectiveness of ICFR
Evaluating ICFR includes evaluating both the design and operating effectiveness of the controls. Regulators specifically stressed the importance of the latter and evaluating whether the controls were operating as designed in considering the related risks. Registrants and auditors should also pay special attention to when a control is designed with multiple steps to address an identified risk. In order for sufficient appropriate evidence to be obtained, items such as sample sizes should correlate with the level of risk associated with that control.
Evaluating control deficiencies
Regulators reminded attendees that the evaluation of the severity of a control deficiency is not limited to the actual misstatement. Further, performing a thorough root cause analysis would assist in determining whether other financial statement areas are affected by the deficiency. Any compensating controls identified that might reduce the severity of the control deficiency should be designed to address the same objectives as the deficient control and should operate at an appropriate level of precision to prevent or detect a material misstatement in a timely manner.
Comment Letter Trends
The SEC Staff listed the top ten most commented on financial reporting areas,1 which included (in order of most common):
- Non-GAAP measures
- Management's discussion and analysis (MD&A)
- Revenue recognition
- Fair value measurements
- State sponsors of terrorism
- Intangible assets and goodwill
- Acquisitions and business combinations
- Income taxes
- Segment reporting
The most common commented on area continues to be non-GAAP measures, as it continues to be a focus of the SEC and other stakeholders. The SEC acknowledged the improved quality of non-GAAP disclosures in recent filings, but continued to emphasize the need for increased transparency and consistency in the use of non-GAAP measures, particularly as it relates to why management believes they are important and useful to investors. Chairman Clayton mentioned that non-GAAP measures are important for investors because they should represent how management evaluates their own performance.
Non-GAAP measures are defined as a numerical measure that includes or excludes amounts from the comparable GAAP measure. Registrants should be cautious of non-GAAP measures that extend beyond those calculated amounts and begin to incorporate individually tailored accounting principles that modify recognition or measurement, as they may violate Regulation G. Registrants should consider the following questions in determining whether accounting is "individually tailored" that may be inappropriate under Regulation G.
- Does the adjustment shift the accounting from an accrual basis to a cash or modified basis of accounting?
- Does the adjustment include transactions that are also reported in another company's financial statements?
- Does the adjustment reflect part, but not all, of an accounting concept?
- Is the adjustment inconsistent with the economics of a transaction?
Management's discussion and analysis is holding at number two, which is no surprise as SEC staff continue to view MD&A disclosure as a crucial vehicle for management to discuss the "why" about what is occurring in the financial statements. Revenue recognition has also moved up the list primarily due to the adoption of Topic 606, Revenue Recognition, and the new disclosures required under the new standard (DHG would anticipate leases to make the list going forward, given its upcoming adoption). Fair value measurements is holding strong at number four due to the significant judgments used to estimate fair value. Being subject to judgment is a common factor for many of the topics that have landed on the list of comment letter trends; we anticipate that those areas that use significant judgment will continue to be a focus of SEC staff in future periods.
There were a number of topics discussed at the conference, but the topics discussed in this publication were the trending topics that repeated throughout and kept attendees talking after the day ended. If you have questions, or wish to discuss further, reach out to your DHG advisor or visit dhg.com.
Partner, DHG Assurance
1. Source: Audit Analytics – Comment letter taxonomy for SEC staff comment letters issued to registrants related to Forms 10-K from October 1, 2016 to September 30, 2018.