Earlier this month, at the 2016 AICPA conference on current developments, the SEC’s Chief Accountant and several staff members of his office shared their insights on a variety of key accounting topics, among them the following:

Internal control over financial reporting was a key topic addressed by several speakers. Chief Accountant Wesley Bricker set the stage by observing that it was hard to think of an area more important than ICFR to the SEC’s mission of providing high-quality financial information on which investors can rely. “If left unidentified or unaddressed,” he cautioned, “ICFR deficiencies can lead to lower-quality financial reporting and ultimately higher financial reporting restatement rates and higher cost of capital. Over the next several years, updating and maintaining internal controls will be particularly important as companies work through the implementation of the significant new accounting standards.”

Marc Panucci, Deputy Chief Accountant, remarked that “ICFR remains a significant area of focus at the Commission, including through OCA’s coordinated efforts with the Divisions of Corporation Finance and Enforcement. For example, the Division of Corporation Finance continues to monitor ICFR disclosures and raise questions in its reviews of registrants’ filings when appropriate. In addition, SEC enforcement actions include consideration of ICFR where warranted….” He identified the following as important takeaways on this issue:

  • “First, management has the responsibility to carefully evaluate the severity of identified control deficiencies and to report, on a timely basis, all identified material weaknesses in ICFR. Any required disclosure should allow investors to understand the cause of the control deficiency and to assess the potential impact of the identified material weakness.“
  • Second, it is important to maintain competent and adequate accounting staff to accurately reflect the company’s transactions and to augment internal resources with qualified external resources, as necessary. Qualified accounting resources and appropriate processes and controls will be of vital importance in connection with the adoption of the new accounting standards [such as revenue recognition].
  • “And finally, management has to take responsibility for its assessment of ICFR. That responsibility cannot be outsourced to third party consultants. At the same time, third party consultants can play an important and critical role when assisting management in its evaluation of ICFR.”

Non-GAAP reporting was, not surprisingly, among the many other topics discussed by Bricker. He observed that, although “substantial progress has been made in addressing the problematic practices,” more progress is needed, “for example, in the evaluation of the appropriateness of the measure and its prominence, as well as the effectiveness of disclosure controls and procedures.” He recommended that audit committee members “seek to understand management’s judgments in the design, preparation, and presentation of non-GAAP measures and how those measures might differ from approaches followed by other companies. These discussions will require an understanding of the company’s business model and how it is managed. For example, it is important to keep in mind that businesses operate in uncertain environments. If non-GAAP adjustments replace that business reality with smooth earnings over time, accelerate unearned revenues, or defer incurred expenses, those adjustments and disclosures should be evaluated closely under the C&DIs.”

Auditor independence was another topic addressed by both Bricker and Panucci. Bricker observed that impairment of auditor independence is evaluated by reference not only to the list of prohibited relationships and non-audit services, but also to the “general standard” of independence. In particular, he referred to two recently settled enforcement actions brought under the general standard of independence. (See this PubCo post, which discusses the two actions that arose out of personal relationships, and this PubCo post, which discusses the effect on the two companies of impaired auditor independence.) Bricker recommended that both auditors and audit committees review these cases and that audit committees “consider whether any enhancements by management are needed to corporate governance, policies, and procedures to help deter costly independence issues from occurring.”

Panucci noted that, this year, there has been an uptick in questions under the general standard concerning relationships and/or services not specifically prohibited. He cautioned that everyone be aware of “scope creep” during an engagement that could result in the service impairing the auditor’s independence. More specifically, he suggested that consideration “be given to whether any relationship or service to be provided by an auditor:

  1. Creates a mutual or conflicting interest with its audit client;
  2. Places the auditor in a position of auditing their own work;
  3. Results in the auditor acting as management or an employee of the audit client; or
  4. Places the auditor in a position of being an advocate for the audit client.”

He also recommended continued vigilance in connection with “the growth of audit firms’ consulting practices and how it might impact independence and audit quality overall.”

Bricker also highlighted that, in this period of significant accounting change, “auditors may be asked to provide input or feedback as management makes changes to accounting policies, processes, and controls.” While dialogue between auditors and management regarding new accounting standards can have a positive impact on the quality of the audit and of financial reporting, he cautioned that “auditors should recognize that there are boundaries to their involvement as companies implement new accounting standards. Determining the extent to which an auditor can provide accounting advice to its audit client requires professional judgment and common sense. Auditors should never act as management or be involved in decision-making; otherwise, the auditor could later be put in the position of auditing what is essentially his or her own work. However, auditors can still provide their knowledge and point of view during the transition period, as long as they are mindful of the independence rules.”

The importance of transition disclosures related to the new revenue recognition standard was emphasized in the remarks of Sylvia Alicea, Professional Accounting Fellow. If a company cannot reasonably estimate the impact of adoption of the new standard, she indicated, then the company should make a statement to that effect and add qualitative disclosures to help investors assess the impact of the new standard, including a description of the effect of the policy and a comparison to the current policy. For example, “this type of disclosure might include a statement that the registrant expects the timing of revenue recognition to be accelerated because it anticipates that license revenue will be recognized at a point in time, rather than over time, which is its current practice.” A company should also describe the status of its implementation process and any significant issues yet to be addressed, such as by stating that the company “has completed an initial assessment, but has yet to determine its accounting policy for capitalization of costs to obtain a contract.”

In her view, first, companies

“should not be reluctant to disclose reasonably estimable quantitative information merely because the ultimate impact of adoption may differ, since that information may be relevant to investors even while lacking complete certainty. Second, I would encourage a registrant to disclose known or reasonably estimable quantitative information even if it’s only for a subset of the registrant’s arrangements — for example, one product category or revenue stream (accompanied by the appropriate disclosure, of course) — rather than waiting until all of the impacts are known. Third, these disclosures should be consistent with other information provided to the Audit Committee and investors, and they should be subject to effective internal control over financial reporting. As management completes portions of its implementation plan and develops an assessment of the anticipated impact, effective internal control should be designed and implemented to timely identify disclosure content and ensure that appropriately informative disclosure is made.”

With regard to implementation of the new standard, Bricker noted that “clear progress has been made by preparers, but there is more to do. For example, in a recent survey of public companies released in October, eight percent of respondents still had not started an initial assessment of the new revenue recognition standard, while the others were still assessing (75%) or implementing (17%). Particularly for companies where implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why and provide informative disclosures to investors about the status so that investors can assess the implications of the information. Successful implementation requires companies to allocate sufficient resources and develop or engage appropriate financial reporting competencies.”

With regard to the possible further use of IFRS for domestic issuers, Bricker advised that, “for at least the foreseeable future, the FASB’s independent standard setting process and U.S. GAAP will continue to best serve the needs of investors and other users who rely on financial reporting by U.S. issuers.” So much for that.

Establishment of grant dates for share-based payment awards was a topic addressed by Sean May, Professional Accounting Fellow. Topic 718 defines a grant date, in part, as the date at which an employer and an employee reach a mutual understanding of an award’s key terms and conditions, which, he noted,“could be part of a written agreement, an oral agreement, or the entity’s past practice.” The grant date is important because, generally, the compensation cost related to the award is based on the grant-date fair value of the equity instruments issued. Some awards, he observed, include terms that permit a clawback of all or a portion of the award. To the extent that a key term, such as a clawback, is subject to the exercise of discretion, “then a registrant should carefully consider whether a mutual understanding has been reached and a grant date has been established. When making that determination, a registrant should also assess the past practices exercised by those with authority over compensation arrangements and how those practices may have evolved over time. To that end, registrants should consider whether they have the appropriate internal control over financial reporting to monitor those practices in order to support the judgment needed to determine whether a grant date has been established.”