By Erik Bradbury
Auditor independence, revenue recognition, SAB 74 disclosures, ICFR, and non-GAAP were top of mind for the SEC’s Office of the Chief Accountant during a roundtable discussion at FEI’s Current Financial Reporting Issues (CFRI) conference.
Wesley R. Bricker, Interim Chief Accountant, and Kevin Stout, Senior Associate Chief Accountant, both of the Office of the Chief Accountant (OCA), participated in a panel discussion moderated by Daniel C. Murdock, former Deputy Chief Accountant at the SEC and current Corporate Controller at Comcast Corporation, to discuss SEC priorities and other financial reporting issues.
Speaking to the preparer audience, Bricker noted the U.S. has 42 percent of global bond activity and 40 percent of global equity market capitalization. “Therefore, confidence in financial reporting is not something we take for granted, or that you take for granted,” he stated. “Rather it is something we remain focused on for high quality accounting standards, high quality audits, and the underlying ICFR that contributes to the reports that you produce as a matter of your reporting routines.”
Consultation Uptick
Consultation activities are up slightly for existing standards and application of new standards. Since 2014, OCA has consulted with 4 of 10 Fortune 10 registrants, for instance, while 14 of the Fortune 100 have consulted directly with OCA. Topic areas, in order of frequency, include:
- Revenue recognition
- Financial assets
- Business combinations
- Consolidations
- Debt/equity classification
Independence
Acknowledging recent high-profile actions against certain accounting firms for breaches of auditor independence, Bricker and Stout provided their insights on the topic while noting consultations in the professional practice group around auditor independence remains significant. The SEC receives 300-400 consultations on independence per year. Some of the topics discussed include:
- Partner rotation
- Bookkeeping
- Non-audit services
- Personal lending and business relationships (a more recent occurrence)
Stout noted questions tend to be unique and facts-and-circumstances-based, but cautioned that registrants and auditors should keep in mind independence rules around non-audit services that are not explicitly prohibited by asking four questions:
- Does it create a mutual or conflicting interest with the audit client?
- Does it place the auditor in the position of auditing its own work?
- Does it result in the auditor acting as management or an employee of the audit client?
- Does it place the auditor in a position of being an advocate for the audit client?
He further noted recent enforcement activity highlights auditor independence is not just an issue for auditors to think about, but a shared responsibility for client management as well.
Revenue Recognition
Acknowledging some companies are making good progress, Bricker remains concerned with others who have yet to crack open the new revenue standard. Initial surveys last year highlighted a significant gap in registrant readiness. And while a significant amount of constructive work occurred this year, clearly more work is needed.
In fact,
recent surveys highlight that roughly 22 percent of companies had not yet started their adoption process. This is concerning to Bricker in the context of a standard that addresses the top line of the income statement, and feeds into key analytical ratios about a company’s performance while also affecting a company’s bottom line. The new standard provides significant new disclosures on revenue streams that will be useful to investors in understanding a company’s performance.
For those who have not started, “a significant amount of effort is ahead” said Bricker. “When you contrast the level of work between a company that hasn’t started compared to the work leading companies have done and the kind of issues that they’ve needed to understand and evaluate, it certainly amplifies and underscores the risk of financial reporting for some,” Bricker noted.
While some in the 22 percent may choose to go to their auditors for help, it’s important to start with the premise that management leads the implementation efforts as required by books and records and internal accounting controls provisions of federal securities laws, noted Stout. Auditors will obviously have to provide feedback and evaluate appropriateness of application of new standards by management. However, investor confidence depends on the auditor’s commitment to maintain independence in fact and appearance, while respecting boundaries that should be followed. Auditors can still be helpful as long as the auditor is not making the final determination of the analysis.
SAB 74 disclosures
SAB 74 addresses disclosure of the impact recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. The SEC delivered an announcement during its Sept. 22, 2016, EITF meeting that underscored the Staff’s expectations for transition disclosures for new accounting standards.
If that disclosure only states management has evaluated and does not yet know the anticipated effects, the Staff announcement said, that’s not enough. According to Bricker, registrants need to provide qualitative information about the status of work in developing the anticipated effect, even if directional. This may include information about the status of a registrant’s work and any anticipated accounting policy positions. The goal is to identify for investors the kinds of information they will learn when the new standard is applied.
OCA Consultations on New Standards
According to Bricker, “We are open for business on consultations of all sorts including interpretation of new accounting standards. Revenue recognition is at the top of that list.” However, the consultation process tends to be fact-and-circumstances-based, and preparers should not assume their fact pattern is similar to other registrants.
In terms of the consultation process, Bricker cautioned the SEC is not looking to force prescriptive answers, but rather will respect judgments, views and interpretations that may be different among preparers. However, the Staff will look for rigorous and robust analysis of the issues. Bricker acknowledged they have objected to certain views but encouraged registrants to bring their positions to the Staff.
ICFR
OCA and the Division of Corporation Finance participated in a number of outreach efforts with preparers that culminated in a panel discussion on ICFR at the AICPA conference last year, where the SEC and PCAOB encouraged preparers and auditors to engage in further dialog to enhance the communication and better understand and reconcile differences in perspective. More recently OCA participated in additional outreach efforts to understand what progress has been made. FEI’s Committee on Corporate Reporting (CCR) participated in these outreach efforts.
Stout noted he continues to believe the steps outlined at the AICPA conference are important but acknowledged the full benefit of enhanced communication has yet to be realized fully. “Open and timely communication is critical” Stout noted.
While certain issues remain, it was Stout’s view that progress has been made around the design and reliance of management review controls, which appears to have been addressed with “some success” as it has been raised less frequently in more recent meetings with stakeholders. However, other challenging matters have been highlighted more prominently, including varying perspectives between preparers and auditors around appropriate risk assessments. Stout encouraged preparers and auditors to continue the dialog around risk assessments to bridge the difference to ensure an effective and more efficient audit.
Stout and Bricker further cautioned it’s important for these discussions to occur at the appropriate level of detail and specificity to have an impact. “Don’t delay the conversation now because it’s difficult,” Bricker stated.
While less frequent in occurrence, OCA is also open to discuss ICFR matters, with Bricker and Stout encouraging preparers and auditors to consult with the Staff as questions or issues arise. “We do answer ICFR questions,” noted Stout. “It’s okay to not be fully aligned,” he went on to say, “but where you should be aligned is on the population of relevant controls that need to be relied upon.”
Non-GAAP
“We’re not anti-non-GAAP,” was the headline from Bricker. “However, it’s important to understand the objective and the purpose of non-GAAP.”
GAAP reporting is designed to provide a standardized presentation for users to compare performance with other registrants. It’s in that context that the rules require non-GAAP reporting to be no more prominent than GAAP. Non-GAAP reporting serves a purpose in providing clear analytical description of the performance of a business that, in an appropriate context, can convey meaningful analytical information to investors. The concern around non-GAAP is that it is “supplanting” not “supplementing” GAAP performance, stated Bricker. For example, a company that individually tailors an accounting principle where the non-GAAP measure is perhaps accelerating revenue and recharacterizing the definition of earnings, is not appropriate and highlights the SEC’s concerns over the “supplanting” of GAAP.