- Verify that companies have the processes and controls in place to make sure management can appropriately consider how changes in the economic environment affect their accounting and financial reporting.
- Continue to assess changes in the business, trends or uncertainties and the implications for financial reporting. Known trends or uncertainties may include inflation, rising interest rates, the war in Ukraine, and supply chain disruptions that affect the relationship of costs to revenue.
- Revisit other disclosures included in SEC filings, such as risk factors, critical accounting estimates, liquidity, and capital resources to address certain risk concentrations (e.g., customer, supplier, geographic) and other known trends, events, and risks and uncertainties that have had or are reasonably expected to have a material effect on the business.
- When a company is considering selling or transferring debt securities to meet its liquidity needs, it may have to change the classification of those securities. To classify debt securities as held to maturity, a company has to assess for each reporting period whether it has both the positive intent and the ability to hold them to maturity.
- Companies that assert their intent and ability to indefinitely reinvest foreign earnings should challenge whether they can continue doing so in their operations that have been affected by rising interest rates and inflation. This assertion should be supported by projected working capital and an assessment of long-term capital needs in the locations in which those earnings are generated (or other foreign locations) and by an analysis of why those funds are not needed upstream. The analysis should also consider the increasing cost of capital in today’s high interest rate environment.
- Companies that have reported significant increases in year‑over‑year inventory balances may need to consider whether to record a charge for any decline in value of inventory they cannot sell in the short term. In today’s environment, it is also important to determine which costs can be included in inventory. For example, higher-than-expected inflation in the cost of materials can be included in inventory and capitalized, because cost inflation is an element of actual inventory cost. In contrast, if a variance is driven by excess capacity, rework or other costs that cannot be included in inventory, those costs are accounted for as an expense.
- In addition, companies may need to revise their estimates of how much variable consideration they will be entitled to under a contract with a customer if they change their expectations about returns of goods, contract volume and whether they will meet contractual conditions for performance bonuses or penalties. Companies that accept partial payment or extend payment terms need to consider the implications, such as whether the contract has been modified or includes a significant financing component.
SEC rulemaking and other reporting considerations
While the timing has continued to slip, several rule-related actions are expected in 2023 from the SEC, including a proposed rule on human capital management disclosure and final rules on climate and cybersecurity risk governance and disclosure. Although SEC Chair Gary Gensler faced skeptical questions about the extent of the SEC’s rulemaking agenda by some members of the House Financial Services Committee in an April hearing, he gave no indication that he plans to pull back.
In May, the SEC adopted a final rule on share repurchase disclosures, which requires most issuers to disclose daily quantitative share repurchase information on a quarterly basis. It also requires narrative disclosure to discuss share repurchase objectives, criteria used to determine the amount of the repurchase, and policies and procedures related to trading of securities during a repurchase program by its officers and directors. According to the rule, issuers also must disclose information about their adoption and termination of Rule 10b5-1 trading arrangements.
The SEC remains focused on companies’ use of non-GAAP financial measures in earnings releases and SEC filings and whether such metrics could potentially mislead investors. While no new guidance has been released, the SEC staff updated their Compliance and Disclosure Interpretations on this topic in December 2022 to reflect views the staff had previously communicated. Audit committees should understand the use and purpose of non-GAAP financial measures disclosed in filings with the SEC and review related disclosures in order to confirm that clear explanations of these measures are provided.
Audit committees should also understand management’s plans to update, as necessary, existing policies and compensation plans as a result of the SEC’s final rule on erroneously awarded compensation (also known as clawbacks) issued in October 2022. The final rule requires exchanges to establish listing requirements to mandate that issuers develop, implement and disclose their policies on recovering incentive-based compensation received by current or former executive officers when there is an accounting restatement of the financial statements due to an error. Both the NYSE and Nasdaq have finalized rules to implement the clawback rule which are expected to be approved by the SEC before the end of Q2. Companies are required to adopt a compliant policy no more than 60 days after the applicable listing standards are effective and begin to provide required disclosures. Audit committees should consider how their companies are preparing for potential regulatory changes, which could impact reporting requirements, disclosures, and enforcement trends. Download the full report to find out what actions audit committees may need to take.
