Public company regulators often provide insight into the compliance issues that could be affecting your organization through their comment letters and other feedback. Below is a round-up of some of the areas identified by the SEC and PCAOB as compliance concerns for 2019. Whether your organization is public or private, you will want to ensure that you have these issues well-covered in your financial reporting this year, as auditors and regulators may be on the look for out for the same concerns.
Public companies in particular will want to be careful with their use of non-U.S. Generally Accepted Accounting Principles (non-GAAP) measurements. The SEC noted during a recent industry conference that quarter-to-quarter changes in non-GAAP measurements are not a good practice as they may prevent comparability. All non-GAAP measurements should be fully explained, including the controls your organization has in place around its use of non-GAAP measurements.
Incentive programs are particularly popular among growth-stage companies, but they may need some additional explanation in your financial reporting. The accounting for incentives may be impacted by the nature of the recipient of the incentive. For that reason, it is important to distinguish incentives given to employees from those provided to service providers, customers or others.Public companies will want to disclose, discuss, and quantify their incentive programs’ impact on their operations in their Management Discussion and Analysis (MD&A) report.
Complex Accounting Standards
Not surprisingly, public company regulators took a keen interest in the reporting related to complex accounting standards, including the changes to revenue recognition, leasing, and business combinations.
Comment letters for revenue recognition increased in 2019, and many focused around the determination of performance obligations, the timing of revenue recognition and principle versus agent analysis. Regulators also want to see that the items in the disclosures are meaningful to the understanding of the transaction. For 2019 reporting, companies should ensure their disclosures relate to something that materially affects the transaction treatment, and include a discussion of how materiality was determined in the first round of comments on a transaction. Public companies should not continue the transition disclosures in their 2019 reporting; transition disclosures should only be present in the first year of ASC Topic 606 adoption.
There are no trends in comments on the leasing standard yet identified, but early SEC observations indicate concern related to the amount, timing and uncertainty of cash flows that occurs as a result of adopting the changes in ASC Topic 842. Public companies should be mindful not to use boilerplate disclosures; rather, disclosures should relate to specific assumptions the company used to implement the accounting changes.
Other points companies may want to consider include practices around leasing reassessments. How do you get information from operations to know when a reassessment should occur?
Impairment assessments are also important, and companies should be able to identify how they will factor lease liabilities into their impairment analysis. Companies will account for lease impairment using guidance in ASC Topic 360. The lease asset will generally be included into an existing asset group. Fair value can be particularly challenging for a right of use asset since there is no market for the sale of these, what is the highest and best use? What is the market that should be considered?
Keep in mind that the accounting definition of a business may not be the same as the definition of a business under the rules of the Securities and Exchange Commission. Public companies have also been challenged with identifying the predecessor entity in a business combination transaction. Some points to consider with the predecessor analysis include:
- What order were the entities acquired
- What is the size of the entities
- Financial considerations
- Fair value of the entities
- Management structure
Public Company Material Trends and Uncertainty Disclosures
Regulators voiced concern that public companies were not adequately disclosing how Brexit and the potential loss of the LIBOR affect their organization and financial reporting. Companies should be monitoring for material trends’ impact on a historical and go-forward basis. For example, if the loss of LIBOR affects liquidity or the impending Brexit causes an uptick in supplier finance programs for trade payables, companies should be prepared to disclose those points.
If your company finds that it has a material risk with Brexit, LIBOR or another source, be sure to include how your board helps oversee that risk. Regulators in 2019 also noted that public companies needed to include more discussion around the board’s role in risk management.
Public companies should also note the status of their efforts related to risks that have been identified but not assessed. Management teams should disclose why a risk has not (or cannot) be assessed.
Public Company Compensation Arrangements
Public company regulators wanted to see more transparency surrounding compensation practices. Comment letters asked for more information around how compensation committees account for buy-back provisions of targets acquired. Additional insight into how adjustments are made to earnings-per-share targets when those buybacks occur was also requested.
Even though compensation disclosures and analysis are exempt from non-GAAP measure guidance, companies should still be able to demonstrate how adjusted numbers are reached, including the method of calculation. For example, a number may not be a reconciliation but it may be very close to a reconciliation.
For More Information
If you have specific comments, questions, or concerns about these financial reporting risks, please contact us.
Published on January 21, 2020