Major accounting updates, global developments, and accounting industry trends are converging in 2019. At a recent public company conference, one message came through loud and clear: public companies need to be prepared for change.
The AICPA’s December 2018 conference on SEC and PCAOB developments highlighted a number of internal and external factors that could affect the operating environment for public companies, from Brexit to preparing for the leasing standard. Public companies should keep the following items on their radar to help with navigating what could be a very dynamic year.
Blockchain, artificial intelligence, and other technological developments present opportunities for efficiencies. Companies need to start treating technology as an ally rather than an opponent. Automation can help improve quality by diminishing the potential for human error, but it won’t be a replacement for staff. Human intelligence will continue to play a vital role in strategy and execution of business processes.
One of the biggest concerns SEC leadership voiced at the conference involved the fate of Great Britain’s exit from the European Union, currently set for March 2019. The business community has yet to understand the impact that the so-called Brexit could have on the global market. As of the date of this publication, Great Britain has yet to approve an exit plan for its Brexit, which could result in abrupt, “hard” Brexit.
American companies need to be focused on the potential risks of a hard Brexit. They should evaluate how much of their supply chain is flowing through Great Britain. If significant, the company will need to be prepared to identify Brexit risk factors and make related disclosures. Language in the disclosures should not be boiler plate; it should specifically spell out how Brexit could have a material impact on the business.
From Panera Bread to Delta Airlines and Facebook, 2018 provided plenty of examples of the importance of protecting sensitive customer information. The SEC encourages public companies to put the necessary expertise in place to protect the company from cybersecurity risks. At the conference, SEC staff stressed that public companies need to be taking a “forward-looking” approach when it comes to managing their cyber risks rather than making changes once a breach has happened.
The SEC wants to see detailed cybersecurity disclosures, including information about how a company would respond to a breach. Information should include the design of the controls and how people outside of the finance function communicate breaches. Companies should also keep in mind how cybersecurity affects trading practices.
Boards play an active role in cyber risk management, and regulators also expect to see clearly articulated information about the board’s role in cybersecurity.
Trends in Transparency
Investors want to know detailed information about the companies they invest in, which may require public companies to enhance their disclosures on non-GAAP measures and key performance indicators (KPIs). The information on non-GAAP measures and KPIs should be presented with a similar level of attention and care as the disclosures required by GAAP; these disclosures should be subjected to rigorous controls to ensure completeness and accuracy.
Boards and audit committees should be involved in the compilation of non-GAAP measures and KPIs.
Companies should be prepared to communicate why the information in their non-GAAP disclosures is useful to investors and company’s management teams.
Public companies will want to be particularly mindful of individually tailored accounting principles. Regulators see that section as one of biggest areas of misuse. Answering the following can help organizations ensure that their individually tailored accounting principles are being employed appropriately:
- Does the adjustment shift from accrual basis to cash or other modified basis?
- Does the adjustment add transactions reflected on another company’s books?
- Does the adjustment reflect parts but not all of an accounting principle?
- Does the adjustment render the measure inconsistent with the economics or terms of the arrangement?
Revenue Recognition Risks
The SEC comment letters have provided some insight into the core reporting risks with the new revenue recognition standard, which public companies adopted for their 2018 financial reporting.
Regulators want to see more clear and transparent disclosures about how a company identified performance obligations. There were a lot of questions about the evaluation of whether a performance obligation was highly interdependent or highly interrelated with another performance obligation.
Comment letters also requested more information on:
- How a company determined whether to recognize revenue at a point in time or over time;
- Principal versus agent analysis, particularly in scenarios where physical control is never obtained;
- Disaggregation of revenue; and
- The purpose of upfront payments or payment plans if other than for financing arrangements
Over the next year, public companies will be gearing up for the changes under the new leasing standard. There are several lingering questions, including accounting for minimum lease payments, how to calculate payments tied to an index, whether to use the initial rate or the rate at transition, accounting for costs to put a leased asset into use, and the accounting for costs to fulfill a lease.
Lingering Questions for Credit Losses
Public companies are also gearing up to adopt the new credit loss impairment standard starting in the 2020 calendar year. More guidance is needed for whether write-offs occur at the individual loan level or the portfolio level. Public companies are also looking for more information about how to determine when a loan is uncollectible and the interaction between credit losses and subsequent events.
The Fate of LIBOR
Hedging and interest rate swaps rely on the use of benchmark interest rates, and it is expected that one benchmark interest rate, the London Interbank Offered Rate (LIBOR) will be phased out. It is uncertain what will replace LIBOR, and what that would mean for debt and hedging strategies that use LIBOR. If your debt or hedging arrangement is impacted by LIBOR, you should read your agreements to understand backstop, conduct an internal risk assessment, and draft a disclosure to provide investors with information about what the fall out for the dissolution of LIBOR would be for your company.
In October, the Financial Accounting Standards Board (FASB) added the Secure Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate to its list of accepted benchmark interest rates for hedge accounting in anticipation of LIBOR going away.
Internal Controls Trends
Regulators want more insight into operating effectiveness. Companies should ensure their internal controls over financial reporting interplay with their risk assessments.
Public companies should also have a robust process in place to evaluate control deficiencies. Reporting on control deficiencies won’t be enough; regulators want to see that an official within the organization monitors for these deficiencies, and that the company understands the potential magnitude from a control failure and has compensating controls in place to mitigate that risk. When there is a material weakness identified, companies should have a disclosure that goes further than explaining what the material weakness is; the disclosure should also explain the why.
Start Your Reporting Evaluation Early
Companies that put a plan in place that incorporates the key internal and external trends may have an easier time working through the changes coming their way. For more information, please contact us.
Published on December 19, 2018