BoardMatters Quarterly, January 2013

Financial reporting and regulatory update

Preparing for year-end reporting

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Heading into year-end financial reporting season, companies and their audit committees need to have a clear understanding of current reporting matters and pay close attention to the current focus of the Securities and Exchange Commission (SEC) and standard setters.

In recent meetings with the SEC staff, users of financial statements focused on their ability to understand uncertainty in a company’s financial statements.

The SEC’s current hot topics

In recent comment letters, the SEC staff has questioned disclosures that may conflict with SEC rules or accounting requirements, as well as disclosures the SEC staff believes could be enhanced or clarified. The resolutions vary; for example, some registrants sufficiently support their existing accounting or disclosures, and others agree to expand disclosures in future filings or amend previous filings.

Revenue recognition: gross versus net
Reporting revenue on a “gross” or “net” basis relates to whether a company should report revenue based on:

  • The gross amount billed to a customer because it has earned revenue from the sale of the goods or services
  • The net amount retained (i.e., the amount billed to a customer less the amount paid to a supplier) because it has earned a commission or fee

The issue often arises with companies that sell goods or services over the internet, but it can also be found in many other business models.

The SEC often questions how companies determine whether to present revenue on a gross or net basis. The staff frequently requests that companies provide their analyses supporting their conclusions on gross or net reporting.

Revenue recognition: multiple-element arrangements
The SEC requests that companies expand their accounting policy disclosures on multiple-element arrangements to provide more information about certain types of contracts or transactions. Companies also should discuss whether the multiple-element arrangements guidance applies to their transactions.

The overall disclosure objective of the multiple-element arrangement accounting guidance is to provide qualitative and quantitative information about the significant judgments and the changes to those judgments that affect the timing or amount of revenue recognition.

The SEC staff frequently requests that companies expand their disclosures to provide a detailed explanation of how estimated selling price is determined, including a discussion of any factors, trends, inputs, techniques or assumptions used in the company’s analysis. Companies also must disclose how consideration is allocated to the separate units of account within multiple-element arrangements.

Income taxes
The SEC asks companies about the realizability of deferred tax assets and the related disclosures in both the financial statements and MD&A. In particular, the SEC staff often questions the realizability of deferred tax assets recorded by companies that have recognized consecutive annual losses or a significant loss in the current year.

The SEC staff also frequently asks questions about the positive and negative evidence that was considered during a reporting period when a valuation allowance was initially recognized, reversed or significantly changed, as well as the reason why such a change was not readily apparent.

Management’s Discussion and Analysis (MD&A)
In recent meetings with the SEC staff, users of financial statements focused on their ability to understand uncertainty in a company’s financial statements. Many pointed to the critical accounting estimates as the best place to obtain that information.

The SEC expects companies to provide analysis of the uncertainties involved in making the accounting estimates as of the financial reporting date, including the variability that is reasonably likely to result until the uncertainty is resolved.

Other areas
Segment reporting continues to be an area of focus in SEC comment letters. The SEC staff often considers disaggregated information to be better for users of financial statements, frequently questioning registrants about their conclusions that operating segments are economically similar so that they can be aggregated into reportable segments.

For registrants with foreign operations, the focus on disclosure continues. In particular, the SEC has been questioning the tax effects of operating in foreign jurisdictions, including the effects on liquidity of indefinitely reinvesting foreign earnings. Registrants also have been asked to provide more detailed disclosures about their exposure to European debt and debt issued by municipalities.

Joint projects update

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) continue to work on their joint projects. The Boards completed several projects in 2012 (e.g., balance sheet offsetting, fair value measurement, other comprehensive income, IASB consolidation guidance) and are focusing on their major projects of financial instruments, revenue recognition and leases. Final standards on revenue recognition are expected in the first half of 2013, as is a second exposure draft on leases.

The Boards also are jointly re-deliberating the insurance contracts project. While consolidation accounting was once a joint project, the FASB proposed only limited changes to its consolidation guidance. Accordingly, certain differences between US generally accepted accounting principles and International Financial Reporting Standards will not be eliminated.

 Questions for the audit committee to consider

Questions for the audit committee to consider

  • Has the audit committee reviewed sensitive year-end accounting and reporting matters with management and the auditors?
  • Are the company’s publicly available communications about the business consistent with its segment disclosures in the financial statements?
  • Does the company have all of the resources that it needs to analyze and begin to implement the new guidance expected from the Boards’ joint projects?
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