2013 AICPA National Conference on Current SEC and · PDF fileDisclosure overload ... Accounting and auditing standard-setting ... Mr. Golden said foundational projects are those that

Summary Representatives of the Securities and Exchange Commission (SEC or Commission), the Public Company Accounting Oversight Board (PCAOB), the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) shared their views on various accounting, auditing and reporting issues at the three-day AICPA National Conference on Current SEC and PCAOB Developments (Conference) last week in Washington, DC.

Highlights included:

Disclosure overload — SEC representatives stressed the importance of addressing disclosure overload in financial reporting. The SEC will soon issue its Jumpstart Our Business Startups Act (JOBS Act) study of Regulation S-K disclosure requirements for emerging growth companies that SEC Chair Mary Jo White has said will be the first step in a broader review of SEC disclosure requirements. In the meantime, the SEC staff offered suggestions about what registrants can do this reporting season to address disclosure overload and provide more effective disclosures to investors.

Accounting standard simplification — SEC and FASB representatives discussed their desire to simplify accounting standards. However, they said that changes to reduce complexity would not be made to the detriment of the information needs of investors.

Internal control over financial reporting — SEC representatives discussed internal control over financial reporting (ICFR) and stressed management’s responsibility to maintain and appropriately assess ICFR. They suggested that some of the deficiencies that PCAOB inspections have identified in audits of ICFR likely indicate deficiencies in internal controls and in management assessments of ICFR. SEC staff members also noted that they will question registrants about management’s annual assessment of ICFR and quarterly disclosures of

16 December 2013

Compendium of significant accounting and reporting issues

Contents Summary ................................................ 1 Remarks of senior representatives ........ 2 Accounting and auditing standard-setting update ......................... 5 Division of Corporation Finance rulemaking initiatives ............................. 9 Accounting, disclosure and reporting ... 10 Internal control over financial reporting .. 10 Implementing the new COSO internal control framework ............................... 10 SEC staff focus areas ........................... 11

Disclosure overload.......................... 11 Income taxes ................................... 12 Defined benefit pension and OPEB accounting and disclosures .............. 13 Goodwill ........................................... 14 Business combinations ..................... 14 Segment reporting ........................... 15 Non-GAAP financial measures.......... 15 MD&A — Disclosure of metrics .......... 16 Guarantor financial information ....... 16 China-based issuers ......................... 17 Industry considerations .................... 17

Current practice issues panel ............... 18 Communications with the SEC staff ..... 19

International matters ........................... 20 Remarks of SEC enforcement representatives .................................... 24 Appendix — Quoted speeches ............... 26

2013 AICPA National Conference on Current SEC and PCAOB Developments

EY AccountingLink | www.ey.com/us/accountinglink

2 | 2013 AICPA National Conference on Current SEC and PCAOB Developments 16 December 2013

material changes in ICFR if disclosures elsewhere in the registrant’s SEC filings indicate potential material weaknesses in ICFR.

PCAOB rulemaking — PCAOB representatives discussed recent rulemaking efforts to improve the auditor’s report and transparency about key participants in the audit. They noted that the current auditor’s reporting model doesn’t communicate the true value of an audit and that the proposed addition of critical audit matters (CAMs) would allow investors to focus on aspects of the audit that the auditor found to be particularly challenging. They also provided updates on audit inspections and enforcement matters, as well as an initiative to measure and communicate audit quality.

Remarks of senior representatives Remarks by Paul Beswick, SEC Chief Accountant The FASB outreach process SEC Chief Accountant Paul Beswick praised the FASB for focusing on outreach, particularly outreach to the investing community. Improved outreach has driven significant changes in several current projects, and Mr. Beswick said it could help the FASB in other areas such as its agenda-setting process. He commended the FASB for recently adding staff to conduct agenda research.

Simplification of accounting standards Mr. Beswick said the FASB should simplify current and future standards for all companies, not just for private companies. Investors often complain that financial statements are too complex, making it hard for them to understand the information provided. He said standard-setting projects often result in the development of new accounting models that simply replace existing complexities with new ones. Instead of making wholesale changes, Mr. Beswick suggested that the FASB focus on specific problems in existing standards and make targeted improvements to address them.

GASB standards and municipal issuers The SEC recently brought several enforcement cases alleging fraudulent or misleading reporting by state and local governments, including several involving disclosure related to municipal pension obligations. In June 2012, the Governmental Accounting Standards Board (GASB) issued two standards on pension accounting that should result in state and local governments more faithfully reporting their pension obligations. Mr. Beswick reminded investors and auditors to pay particular attention to assumptions used by issuers of municipal securities in reporting their pension obligations and said that this matter will continue to be an area of focus for the staff.

Valuation standards As valuation becomes more integral to financial reporting, Mr. Beswick stressed the need for improvements in the valuation profession. He noted that some valuation professionals such as those working in real estate are required to earn credentials and are subject to regulatory oversight, but others working in areas such as financial instruments are not subject to similar requirements. Mr. Beswick urged the valuation profession to commit to improving standards and practices in a way that would enhance the confidence of investors and others that rely on valuations.

Audit committee responsibilities Mr. Beswick said that while audit committees are in the best position to evaluate whether an auditor is performing a high-quality audit, that task has become increasingly difficult. He

‘There are certainly areas of current GAAP that could be simplified without a loss of the quality of information provided to investors.’

— SEC Chief Accountant Paul Beswick

http://www.ey.com/UL/en/AccountingLink/Accounting-Link-Home



praised the PCAOB’s project to identify audit quality indicators, which should help audit committees evaluate the performance of auditors. Mr. Beswick also cautioned audit committees to not compromise audit quality by placing too much focus on fees when considering whether to hire or retain an auditor. An audit failure that occurs after an audit committee changes auditors because it is “fee hunting” could raise doubts about the audit committee’s faithful discharge of its responsibilities, he said.

Auditor independence and audit quality As he did last year, Mr. Beswick observed that some accounting firms are actively expanding their non-audit services. He again expressed concern about whether that trend could adversely affect audit quality by distracting firm leadership, impairing auditor independence or diverting resources from the audit practice. Mr. Beswick again suggested that accounting firms reflect on how these business developments may shape the public’s views of the firms and the profession.

Internal control over financial reporting Mr. Beswick said financial reporting has improved as a result of an increased focus on internal controls following the Sarbanes-Oxley Act of 2002. He said maintaining and evaluating internal control over financial reporting are ongoing activities, and he urged auditors and preparers to remain focused and not give ground.

Remarks by Russell Golden, Chairman of the FASB FASB Chairman Russell Golden echoed Mr. Beswick’s comments, saying that improving the FASB’s agenda-setting process and reducing complexity in existing and future accounting standards are priorities for the FASB.

To improve its agenda-setting process, the FASB will carefully review the mix of projects to strike a balance between major, long-term projects and narrow ones on specific issues that address more immediate investor concerns. Pre-agenda research is critical to identifying the issue that needs to be addressed so that the solution addresses it. Mr. Golden said future standard-setting projects should fall into three categories: (1) foundational projects, (2) those that promote transparency and (3) those that reduce complexity.

Foundational projects Mr. Golden said foundational projects are those that have a pervasive and long-lasting effect on US GAAP and should be carefully selected and subjected to extensive pre-agenda outreach. He said the conceptual framework project was a foundational project that should be revived because a robust conceptual framework will help resolve accounting debates, keep the standard-setting process neutral and achieve principles-based standards, all of which should help reduce complexity. He believes other foundational projects should address existing measurement and presentation requirements to reduce complexity and further the convergence of US GAAP and IFRS.

Mr. Golden also cited the FASB’s disclosure framework project, which is intended to make financial statement disclosure more effective, as a foundational project. The project has two components: a framework to help the Board make decisions about disclosures and a framework to provide more flexibility by helping companies evaluate which disclosures are relevant in their circumstances. Input from investors and other stakeholders will be essential, and the FASB staff is currently conducting field tests to identify the best approach to such a framework for companies, Mr. Golden said.




Promoting transparency The Board also plans to pursue projects aimed at improving recognition, measurement and presentation to provide greater transparency in financial reporting. Mr. Golden said the FASB needs to respond to changes in the business environment by considering whether improvements in US GAAP can be made. The FASB has already performed some pre-agenda research on accounting for pensions and government grants, two topics that the Board may address.

Reducing complexity Mr. Golden said the FASB is looking at ways to reduce complexity in financial reporting. He noted that complexity can result from standards that are very dense and complicated to apply and from standards that, while clear, result in compliance costs that far outweigh their benefits.

He cited the accounting literature for liabilities and equity as an example that is overly detailed and can result in different accounting treatments for economically similar instruments. He also cited the complexities of the current accounting for goodwill impairment, including the subjective nature of the evaluation and the cost to comply. The FASB recently added a project to its agenda to look at improving the accounting for goodwill impairment.

Mr. Golden also said the FASB is in the final stages of developing an internal policy under which the FASB, before voting on a new standard, would evaluate whether the standard will reduce or increase complexity and explain how the new standard reduces complexity in its basis for conclusions.

Mr. Golden added that any final decisions on reducing complexity will weigh investor needs. That is, the Board would not consider changes to reduce complexity at the expense of the informational needs of investors.

How we see it • We have encouraged the FASB to study how to reduce cost and complexity before

adding additional projects to its agenda and welcome the Board’s initiative on pre-agenda research.

• We recommended that the FASB use its disclosure framework project to directly address the disclosure overload that we believe has resulted from adding new requirements over time.

• We support the FASB’s plan to complete the major convergence projects and its plans, as Mr. Golden outlined at the Conference, to address implementation issues before the effective dates of the new standards.

PCAOB Chairman Doty emphasizes importance of the audit in capital formation PCAOB Chairman James Doty discussed various PCAOB initiatives and emphasized the role the auditor plays in facilitating capital formation. He noted that the cost of capital is influenced by the confidence investors have in the information provided by companies and that markets and the economy depend on trust. He explained that the PCAOB is focused on increasing awareness of the importance of the audit to the success of the US capital markets and on enhancing investor interest and confidence in the audit.

Emphasis on economic analysis Noting the importance of economic analysis to capital formation, Mr. Doty provided an overview of the PCAOB’s new Center for Economic Analysis, led by University of Chicago economist Luigi

The FASB plans to focus on reducing complexity in financial reporting.




Zingales. Mr. Doty said he hopes the center can increase the effectiveness of PCAOB processes and promote further economic research on the role of the audit in the capital markets. Initial areas of focus include developing a baseline analysis of the role of the audit in today’s financial markets, including the role of the audit in promoting access to public markets for smaller enterprises, as well as the effects of audit and financial reporting failures on financial markets.

Resurgence of consulting practices at audit firms Like Mr. Beswick, Mr. Doty expressed concerns about the recent growth in consulting practices at audit firms and the potential implications for auditor independence and audit quality. Mr. Doty suggested that the PCAOB focus the “best minds on these types of issues,” and said task forces and roundtables may be formed to provide perspective on the matter.

Inspection initiatives and observations Mr. Doty noted that the PCAOB has focused on improving the usefulness of its inspection reports and deepening its analysis of inspection findings. Mr. Doty noted that the PCAOB has changed the format and organization of the public portion of its inspection reports for the largest firms to make them easier to read. The PCAOB also has started identifying the accounting and auditing standards involved in the deficiencies cited in large firm inspection reports. As for analyzing inspection findings, Mr. Doty noted that the PCAOB recently issued reports on the implementation of the auditing standards on engagement quality review and broker-dealer audits. He noted that, in both cases, the PCAOB cited deficiencies in a number of areas that require improvements by audit firms.

Standard-setting developments Mr. Doty noted that the Board is reviewing the processes it uses to develop standards in an effort to think strategically about the “future shape of the audit function and the future role and features of the audit profession in performing the audit.” He said this review would include a focus on outreach and economic analysis.

Mr. Doty also summarized PCAOB standard-setting initiatives, including the transparency proposal released earlier this month. He said the proposal would help drive further accountability in the audit, similar to objectives underlying the Sarbanes-Oxley requirements for management to certify the financial statements and internal control over financial reporting.

Accounting and auditing standard-setting update FASB standard setting and other initiatives Susan Cosper, FASB Technical Director, and Alan Teixeira, IASB Senior Director–Technical Activities, summarized the Boards’ joint projects on revenue recognition, leases, financial instruments (i.e., credit impairment and classification and measurement) and insurance contracts. They also discussed other initiatives, including the plan to form transition resource groups to address issues in implementing new standards, as well as activities at the Private Company Council (PCC), which recommends standards to the FASB that would apply to private companies.

Transition resource group In his remarks, Mr. Golden said the FASB plans to form transition resource groups on a project-by-project basis to focus on education, interpretation and potential amendments. Members of the transition resource groups are expected to include representatives from the preparer, auditor and investor communities, both domestic and international (including the IASB).

Mr. Doty stressed the importance of high-quality audits and said audits serve an important role in capital formation.

EY resources

► To the Point, Boards to redeliberate key aspects of lease accounting again (SCORE No. BB2657)

► To the Point, It’s time to start preparing for the new revenue standard (SCORE No. BB2667)

► Technical Line, Considerations for determining whether to elect PCC accounting alternatives (SCORE No. BB2664)


http://www.ey.com/Publication/vwLUAssetsAL/TothePoint_BB2657_Leases_21November2013/$FILE/TothePoint_BB2657_Leases_21November2013.pdf



http://www.ey.com/Publication/vwLUAssetsAL/TothePoint_BB2667_RevenueTransition_5December2013/$FILE/TothePoint_BB2667_RevenueTransition_5December2013.pdf




http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_BB2664_PCC_26November2013/$FILE/TechnicalLine_BB2664_PCC_26November2013.pdf






The revenue recognition transition resource group will be the first to be formed once the Boards issue their final revenue recognition standard in early 2014. The resource group is expected to begin work during the transition period with a term that is not expected to extend beyond the effective date of the new standard. Ms. Cosper acknowledged constituents’ concerns about implementation of the standards. She said the group will solicit and discuss implementation issues and provide information that the Boards can use to determine what action, if any, is needed. That is, the transition resource group will not issue any authoritative guidance.

SEC Deputy Chief Accountant Daniel Murdock supported the FASB’s efforts and cautioned against industry groups’ developing their own conclusions to address revenue recognition implementation issues. He said industry groups may do a good job of identifying issues, but they shouldn’t reach conclusions without consulting with the SEC staff or the FASB because the goal is to have similar transactions across industries be accounted for similarly. He also said that the SEC staff will actively monitor implementation of the revenue recognition standard and would be happy to discuss implementation issues with constituents.

Private Company Council Ms. Cosper discussed the work of the PCC. She said the FASB will consider extending to public companies the alternatives it provides for private companies, as part of its efforts to simplify accounting. Therefore, public companies may want to monitor the progress of alternatives the FASB provides for private companies under US GAAP. The FASB has endorsed the first two accounting alternatives for private companies under US GAAP that will allow private companies to simplify their accounting for certain interest rate swaps and amortize goodwill acquired in a business combination.

When the FASB endorsed the goodwill alternative for private companies, it added a goodwill project to its agenda to explore several approaches to simplify goodwill accounting for public companies. Regarding the simplified hedge accounting approach provided to private companies, the FASB will consider extending that approach to public companies as part of its broader hedging project.

Ms. Cosper said that when the FASB considers allowing public companies to use private company alternatives, the Board will consider whether the alternatives were developed to address differences in the needs of users of public and private company financial statements or to reduce cost and complexity. She said that PCC alternatives intended to reduce cost and complexity should be considered for public companies as well. Mr. Golden noted that the FASB has been working to understand the differences in investor needs between private and public companies.

PCAOB standard setting and other initiatives Martin Baumann, PCAOB Chief Auditor and Director of Professional Standards, discussed proposed changes to the auditor’s report and other aspects of the PCAOB’s 2014 standard-setting agenda. Greg Jonas, PCAOB Director of Research and Analysis, provided an update on the PCAOB’s Audit Quality Indicators project.

2014 standard-setting agenda Mr. Baumann discussed a number of standard-setting projects intended to improve the relevance and reliability of the audit. He said one of the most compelling issues is the global effort to enhance the auditor’s report, because the current report doesn’t reflect the true value of the audit and most investors give it only a casual glance. He hopes the proposed changes to the auditor’s report will increase users’ understanding of the audit and the usefulness of the report.

EY resources

► To the Point, Sweeping changes to auditor’s report may be on the horizon (SCORE No. EE0928)


http://www.ey.com/Publication/vwLUAssetsAL/TothePoint_EE0928_AuditorReportingModel_26September2013/$FILE/TothePoint_EE0928_AuditorReportingModel_26September2013.pdf






Mr. Baumann discussed the following projects:

• Auditor’s reporting model: Mr. Baumann said the PCAOB’s proposal to significantly change the content of the auditor’s report by adding a discussion of CAMs would provide investors with valuable information to analyze a company’s financial statements. PCAOB Board Member Jay Hanson encouraged companies, audit committees and auditors to consider field testing the proposal to better understand the effort that would be required to implement reporting of CAMs and how useful the information would be to investors.

Mr. Baumann also discussed the proposed requirement to disclose the length of the audit relationship in the auditor’s report, noting the PCAOB does not intend to imply that there is a correlation between auditor tenure and audit quality. As for the proposed changes to the auditor’s responsibility for other information accompanying audited financial statements, Mr. Baumann said the proposal was intended to improve the auditor’s procedures, enhance the auditor’s responsibility for such information and enhance users’ understanding of the auditor’s responsibilities for other information as well as the results of the auditor’s procedures.

• Auditor transparency: Mr. Baumann said the PCAOB’s proposal to identify the engagement partner responds to investors’ comments that knowing the name of the engagement partner would help them evaluate the audit. He said identifying other audit firms that participate in the audit will help investors understand which firms are participating in the audit and whether those firms are subject to PCAOB inspection. Mr. Hanson expressed concerns about the need to obtain and file consents from individuals and other audit firms named in the auditor’s report and whether this consequence would make it difficult to meet reporting deadlines. He also suggested that the name of the engagement partner may be better disclosed in the audit committee report in the proxy statement or the audit firm’s annual report on PCAOB Form 2.

• Going concern: Mr. Baumann said the financial crisis demonstrated a need to improve the going concern auditing standard and a need for improved reporting by issuers. However, he said the PCAOB won’t revise its auditing standards on going concern until it has a clearer understanding of the FASB’s plans for its own going concern project.

• Issued projects: Mr. Baumann noted that in 2013, the PCAOB approved attestation standards related to broker-dealer compliance and exemption reporting and issued Auditing Standard No. 17, Auditing Supplemental Information Accompanying Audited Financial Statements, both of which are currently subject to SEC approval. He also said Staff Audit Practice Alert No. 11, Considerations for Audits of Internal Control Over Financial Reporting (Alert), should be mandatory reading for all auditors who audit internal control over financial reporting, and he hopes the Alert will improve audit quality.

• Other projects: Mr. Baumann said the PCAOB plans to adopt an auditing standard on related parties, propose changes to its interim standards related to the auditor’s responsibilities with respect to other accounting firms, individual accountants and specialists, and propose amendments necessary to implement the reorganization of its standards in the first half of 2014. In late 2014, the PCAOB plans to issue concept releases related to auditing estimates and fair value measurements, as well as proposed enhancements to its quality control standards. Messrs. Baumann and Hanson reiterated that the PCAOB currently doesn’t intend to pursue rulemaking on mandatory audit firm rotation.

• Audit quality indicators: Mr. Jonas discussed the PCAOB’s project to identify audit quality indicators (AQIs), noting that the PCAOB plans to issue a concept release in the first quarter of 2014 seeking feedback on how AQIs could be used by investors, audit committees, auditors and the PCAOB. He said one of the project’s goals is to improve




each group’s understanding of audit quality and enhance the consideration of audit quality within the audit market.

How we see it The PCAOB has a broad standard-setting agenda with an aggressive timetable for 2014. While the projects on the agenda will have significant implications for auditors, a number of them also will have a significant effect on companies, audit committees and investors.

SEC staff views on PCAOB initiatives PCAOB matters SEC Deputy Chief Accountant Brian Croteau, whose group in the Office of the Chief Accountant (OCA) oversees the PCAOB, said he believes investors have benefited from the rules implemented since the enactment of the Sarbanes-Oxley Act in 2002. He said the SEC is very interested in feedback on the PCAOB proposal to change the auditor’s report. He also encouraged the PCAOB to move ahead with proposals to amend audit standards involving auditing estimates, fair value and the use of other auditors and specialists, which have been on the PCAOB’s agenda for several years and have the most potential to improve audits. Mr. Croteau also noted the PCAOB has made progress in 2013 on a number of the near-term priority projects announced during 2012, primarily related to improvements in the timeliness of inspection reports, the timeliness of remediation determinations, and the development of a concept release on audit quality indicators that is expected to be released in the first half of 2014. However, he said the PCAOB still has work to do on priorities such as improving the content of inspection reports, audit committee outreach and standard setting.

Continued focus on the importance of auditor independence to auditor objectivity Mr. Croteau said auditor independence requires attention when selecting an auditor, throughout the entire audit relationship and potentially after the relationship has ended. He said that a company’s responsibility for ensuring auditor independence is as important as ensuring that its revenues and expenses are properly reported and classified. For example, if the auditor’s independence is impaired, Mr. Croteau warned that the company will not have satisfied its requirement to file financial statements audited by an independent accountant. Depending on the facts and circumstances, he cautioned that an independence violation could call into question the reliability of the company’s financial reports and the effectiveness of the audit committee’s oversight of the auditor and could significantly impair the company’s ability to raise capital.

Mr. Croteau said the SEC staff has recently received questions from several companies that operate in certain non-US jurisdictions that have been considering, or that are advancing legislation requiring, mandatory audit tendering or mandatory rotation of audit firms. He noted that such developments could have consequences for foreign companies that list securities in the US and for subsidiaries of US companies. Mr. Croteau said proper planning is necessary any time there is a change in auditor so that any potential independence conflicts are resolved timely.

Inspections and enforcement update Helen Munter, Director of the PCAOB’s Division of Registration and Inspections, said the Division has completed nearly 250 inspections in 2013, including inspections in foreign jurisdictions. She said the number of deficiencies identified continues to be high, which is disappointing in light of the significant remedial actions and investments audit firms have made over the past few years. Ms. Munter said the PCAOB wants to work with firms to improve

‘Investor confidence in financial reporting is supported by high-quality audits that are performed objectively by independent auditors.’ — SEC Deputy Chief Accountant

Brian Croteau




their performance and that, while firms’ investments have not yet resulted in significant reductions in the number of inspection findings, she expects to see improved results in the future.

Echoing remarks made by Mr. Croteau, Ms. Munter said the PCAOB has made significant progress in 2013, particularly in the timeliness of inspection reports and remediation determinations. Ms. Munter said additional work is needed to improve the content of inspection reports and the PCAOB’s analysis of inspection findings across firms.

Ms. Munter explained that the PCAOB uses a risk-based approach to select audits to inspect and the audit areas on which the inspection will focus. She said the PCAOB will continue to focus on the riskiest audit areas, including revenue, allowance for loan losses, inventory and management estimates. Ms. Munter noted that overall inspection findings continue to indicate that improvements are needed in a variety of areas, including the following:

• Internal control over financial reporting — Ms. Munter said the most prevalent finding in 2013 inspections related to the auditor’s consideration of the effectiveness of a company’s ICFR. She noted that findings were concentrated in the auditor’s testing of controls, particularly management review controls and included the following:

• Failure to understand and adequately evaluate whether review controls were designed to operate at a level of precision that was sufficient to detect a material misstatement

• Failure to obtain sufficient evidence that a management review control operated effectively

• For example, Ms. Munter stated that reading the minutes of a meeting where a management review took place would not generally be sufficient evidence that the control was operating effectively. An auditor would need to consider performing additional procedures, such as shadowing management to observe the control operating in practice.

• Management estimates — Lack of sufficient analysis, or documentation of such analysis, of critical assumptions underlying management’s estimates, including consideration of evidence that may contradict assumptions used by management in making the estimates

Ms. Munter said the PCAOB has invested in enhancing its ability to identify the root causes of deficiencies, including identifying indicators of audit quality and developing methods to objectively measure those indicators. The goal is to identify traits associated with high-quality audits to inform PCAOB actions to enhance audit quality more broadly.

Division of Corporation Finance rulemaking initiatives The staff of the SEC’s Division of Corporation Finance (the Division) discussed the Division’s rulemaking in 2013. Consistent with SEC Chair White’s priorities, these efforts primarily pertain to mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and the JOBS Act.

Future rulemaking The Division staff said the Commission will soon propose “Regulation A+” to allow exempt public offerings of up to $50 million over a 12-month period, as required by the JOBS Act.

EY resources

► Technical Line, Implementing the JOBS Act (SCORE No. CC0363)

► Comment Letter, Section 108 of the JOBS Act — Regulation S-K Review


http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_CC0363_JOBSAct_7November2013/$FILE/TechnicalLine_CC0363_JOBSAct_7November2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_CC0363_JOBSAct_7November2013/$FILE/TechnicalLine_CC0363_JOBSAct_7November2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/SECAnnualReports10K_CC0360_November2012/$FILE/SECAnnualReports10K_CC0360_November2012.pdf

http://www.ey.com/Publication/vwLUAssetsAL/CommentLetter_CC0356_EGCRegulationS-K_11September2012/$FILE/CommentLetter_CC0356_EGCRegulationS-K_11September2012.pdf





The Division staff said other proposals also are in the works, including (1) conforming SEC regulations to Exchange Act Section 12(g), as amended by the JOBS Act, (2) enhanced compensation disclosure about executive pay for performance, (3) disclosures about hedging by employees and directors and (4) “clawback” of executive incentive-based compensation.

Regulation S-K study The Division staff said it plans to issue its study of Regulation S-K disclosure requirements for emerging growth companies, as required by the JOBS Act, very soon. Chair White has indicated that the study will be an important first step in addressing disclosure overload for investors. Commissioner Dan Gallagher also discussed disclosure overload in a recent speech1 in which he recommended making incremental improvements rather than fundamentally reengineering the SEC disclosure framework.

In discussing the issue, Mark Kronforst, Chief Accountant of the Division, encouraged registrants to think about their current disclosures and be proactive in reducing the volume of their filings by removing immaterial disclosures and making existing disclosures more effective and concise (see below for more discussion of this topic).

Accounting, disclosure and reporting Internal control over financial reporting Mr. Croteau said he remains convinced that at least some of the PCAOB’s inspection findings related to the audits of ICFR are likely indicators of similar problems with management’s evaluations of ICFR, and therefore indicate there is a risk of unidentified material weaknesses. Noting that some have suggested that auditors and the PCAOB have higher expectations than management about the extent of evidence needed to support the effectiveness of internal controls, particularly entity-level controls, he said the SEC and the PCAOB worked together in 2007 to ensure that the SEC’s guidance for management and Auditing Standard No. 5 are fully aligned.

Mr. Croteau also questioned whether all material weaknesses are being identified. He said it is surprisingly rare to see management identify a material weakness without a material misstatement. Mr. Croteau said this phenomenon might suggest that deficiencies are not being identified or that the severity of deficiencies is not being evaluated appropriately. He said OCA plans to continue to work with the Division, the PCAOB and the SEC’s Division of Enforcement to address these matters in 2014. Members of the Division also reminded registrants that, if there are indicators of control deficiencies in filings, registrants may be asked to explain whether those deficiencies were identified by management and, if so, their severity, including whether the deficiencies should be considered material weaknesses. Examples of indicators that the staff discussed include the correction of errors and disclosures of changes in ICFR.

Implementing the new COSO internal control framework Robert Hirth, Jr., Chairman of the Committee of Sponsoring Organizations of the Treadway Commission (COSO), summarized the 2013 COSO framework, significant changes from the 1992 framework and the intended effect on organizations. He encouraged users to transition to the updated framework as soon as feasible and reiterated that COSO will consider the 1992 framework superseded by the 2013 framework after 15 December 2014. He also quoted recent SEC staff statements that the longer issuers continue using the 1992 framework, the more likely they are to receive questions from the staff about whether the issuer’s use of the 1992 framework satisfies the SEC’s requirement to use a suitable, recognized framework. He also said that during the transition period, organizations with external reporting responsibilities should disclose which framework they have used.

Management should review the SEC’s 2007 interpretive guidance to determine whether it needs to improve its evaluation of ICFR.




In his remarks, Mr. Croteau said the updated COSO framework provides an opportunity to improve ICFR. Staff in the Division reminded registrants that any improvements could require disclosure under Item 308 of Regulation S-K if they represent material changes to a company’s ICFR.

SEC staff focus areas The SEC staff from the Division discussed common themes in the filing review process and questioned whether preparers are paying less attention to disclosures than to measurement and recognition matters. Disclosures should help investors understand the “full story” because financial statements reflect a point estimate that is subject to judgment, estimation and uncertainties, they said. The SEC staff discussed the following examples that preparers should consider to improve the effectiveness of disclosures:

• Accounting policy alternatives — The SEC staff said that a clear description of significant accounting policies is particularly important for areas such as revenue and pensions, for both of which several alternatives are available under US GAAP.

• Trends and uncertainties — Management’s discussion and analysis (MD&A) should identify and discuss trends and uncertainties that have had or could have a material effect on the financial statements, including goodwill impairments, expected return on plan assets for pension obligations and valuation allowances on deferred tax assets.

• Interrelatedness of disclosures — MD&A should “connect the dots” for investors, stating, for example, how key performance metrics, including non-GAAP measures, correlate to the company’s results of operations.

• Context and balance — Effective disclosures are balanced and provided clearly and in context. Some examples include the discussion on the realizability of deferred tax assets and how key operating metrics relate to financial performance.

• Emphasis on material matters — The SEC staff urged preparers to focus on material matters and to not let immaterial matters obfuscate information that is important to investors. For example, disclosures related to the valuation of equity awards issued before an initial public offering (IPO), as well as risk factors, should focus only on the information that is material to investors.

• Use of precise and defined language — The SEC staff said that using words that are not defined or understood in US GAAP could confuse users and result in differing interpretations, such as items labeled in the income tax rate reconciliation or a non-GAAP reconciliation.

Disclosure overload The SEC staff referred to a recent speech2 by Chair White on the state of corporate disclosures in which she called for the “need to review our disclosure regime to ensure that it is delivering the most meaningful information to investors.” At the Conference, Mr. Murdock, Deputy Chief Accountant in OCA, said that focusing on material disclosures will result in financial statements that are more transparent and meaningful. Mr. Kronforst said that companies should remove disclosures they made in response to earlier SEC staff comment letters if those issues are no longer material. Other members of the SEC staff said it would not challenge registrants on why certain disclosures, if no longer material, were removed from filings. The SEC staff also said that preparers should not assume that all of its comments require more disclosure. Instead, the staff said, registrants should revise their disclosure to make it more effective.

EY resources

► 2013 SEC Comments and Trends Supplement (SCORE No. CC0376)

► 2012 SEC Comments and Trends, An analysis of current reporting issues (SCORE No. CC0357)

► 2012 SEC annual reports — Form 10-K (SCORE No. CC0360)

► Vision and priorities of Mary Jo White (SCORE No. JJ0005)

► To the Point, Now is the time to address disclosure overload (SCORE No. BB2367)


http://www.ey.com/Publication/vwLUAssetsAL/SECCommentsTrends_CC0376_September2013/$FILE/SECCommentsTrends_CC0376_September2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/SECCommentsTrends_CC0376_September2013/$FILE/SECCommentsTrends_CC0376_September2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/SECCommentsTrends_CC0357_October2012/$FILE/SECCommentsTrends_CC0357_October2012.pdf





http://www.ey.com/Publication/vwLUAssets/EY_-_SEC_vision_and_priorities/$FILE/EY-Vision-and-priorities-of-Mary-Jo-White.pdf

http://www.ey.com/Publication/vwLUAssets/EY_-_SEC_vision_and_priorities/$FILE/EY-Vision-and-priorities-of-Mary-Jo-White.pdf

http://www.ey.com/Publication/vwLUAssetsAL/ToThePoint_BB2367_DisclosureOverload_21June2012/$FILE/TothePoint_BB2367_DisclosureOverload_21June2012.pdf





The SEC staff challenged preparers to reconsider duplicative disclosures. For example, significant accounting policies in the notes to the financial statements should not be repeated as critical accounting policies discussed in MD&A. Registrants also should reconsider disclosures about legal proceedings and not duplicate the same disclosures in Risk Factors, Legal Proceedings, MD&A and the notes to the financial statements.

In addition, while the SEC staff expects disclosures about the estimates of fair value of equity securities underlying awards issued in the 12-month period before an IPO when the value is significantly less than the anticipated IPO price (i.e., cheap stock), the staff challenged preparers to make such disclosures more concise and focus on the judgments made by management in determining fair value.

How we see it The SEC staff challenged preparers to provide effective but concise disclosures and meet the needs of investors without overwhelming them with superfluous information. While preparers may struggle to find the right balance, they should identify disclosures that are immaterial and can be deleted and take a fresh look at other disclosures that could be streamlined.

The SEC staff from the Division also discussed specific areas that it commonly focuses on in filing reviews where it believes disclosures could be improved. The topics discussed included:

Income taxes The SEC staff said registrants should continue to focus on the quality and clarity of key income tax disclosures, including those related to the income tax rate reconciliation, valuation allowances and assertions of indefinite reinvestment of foreign earnings.

Income tax rate reconciliations The SEC staff reminded registrants to clearly label items in the income tax rate reconciliation. Registrants are required to provide a reconciliation between the amount of reported total income tax expense (benefit) and the amount computed by multiplying the income (loss) before tax by the applicable statutory federal income tax rate, showing the estimated dollar value of each of the underlying causes for the difference. Reconciling items that are individually less than 5% of the computed amount may be combined in the reconciliation.

For material rate reconciliation items associated with foreign jurisdictions, the SEC staff said that registrants should disclose the identities of specific jurisdictions that materially affect the effective tax rate, their tax rates and information about the effects of such foreign jurisdictions (e.g., magnitude, mix) on the effective tax rate. The SEC staff also indicated that it may question whether large “provision to return” or “true-up” adjustments included in the rate reconciliation reflect the correction of prior-year errors rather than changes in estimates. Finally, they reminded registrants to determine that information in the income tax rate reconciliation is consistent with disclosures elsewhere in the filing (e.g., MD&A or valuation allowance disclosures in the notes to the financial statements).

Valuation allowances The SEC staff said it continues to encounter boilerplate disclosures related to the realizability of deferred tax assets. The SEC staff stated that disclosures about the realizability of deferred tax assets should address the following:

• The four sources of taxable income, including the prominence of each source and the material uncertainties, assumptions or limitations associated with each source

Preparers should take a fresh look at their disclosures to provide the right level of information to investors.




• Foreign tax credits and net operating loss (NOL) carryforwards, including the period over which credits and carryforwards are expected to be realized or otherwise expire unused

• The positive and negative evidence and their relative magnitude in support of the registrant’s conclusion about the need for a valuation allowance

Indefinite reinvestment assertions about foreign earnings When a registrant has unremitted foreign earnings and asserts that those earnings are indefinitely reinvested, the SEC staff has focused on the accounting and disclosure requirements. The SEC staff reminded registrants of the GAAP requirement to disclose the cumulative amount of temporary differences related to indefinitely reinvested foreign earnings, as well as either the amount of unrecognized deferred tax liability (DTL) or, if applicable, a statement that the disclosure of the amount of unrecognized DTL is impracticable. Registrants also should disclose the types of events or circumstances that would cause such unrecognized DTLs to become taxable (i.e., the events that would cause repatriation of foreign earnings). The SEC staff indicated that it continues to challenge registrants when their indefinite reinvestment assertions appear inconsistent with the parent’s liquidity needs or disclosures elsewhere in the registrant’s filing.

Defined benefit pension and OPEB accounting and disclosures Significant accounting policies The SEC staff discussed its focus on financial statement disclosures for defined benefit pension and other postretirement benefit (OPEB) plans. Because registrants can make policy elections on the accounting for defined benefit pension and OPEB plans, registrants must provide clear disclosures about their accounting policies and elections. Such disclosures should include, among other things:

• Whether expected return on plan assets is determined using fair value or calculated value of plan assets, and, if calculated value is used, how that value is determined

• The period and methodology used to amortize actuarial gains and losses, and, if a “corridor” approach is used, the methodology to determine the corridor

Expected return on plan assets assumption The SEC staff reminded registrants to provide robust disclosures about defined benefit plan assumptions. Specifically, ASC 715 requires a narrative description of the basis used to determine the expected long-term rate of return on plan assets. This disclosure should discuss:

• The general approach used

• The extent to which the overall expected return was based on historical returns

• The extent to which adjustments were made to those historical returns to reflect expectations of future returns and how those adjustments were determined

The SEC staff also expects registrants to provide enhanced MD&A disclosures about the effect of a reasonably possible change in the expected return on plan assets. Such disclosures should include:

• How a reasonably possible change in the return on plan assets could affect the results of operations (i.e., sensitivity analysis), addressing the full range of the possible change and quantifying the effect

• Historical performance of plan assets (recent individual years and over time) and limitations on the predictive value of this data (e.g., changes in asset allocation)




The SEC staff noted that when a company provides historical returns over time, those returns may be calculated using an arithmetic mean (simple average) or a geometric mean (changes compounded over time). Significant differences may exist between the two measures if there is significant variability in the registrant’s asset returns. If material differences exist between the two methods, both measures should be disclosed.

If the expected return on plan assets has changed or is expected to change in the future and the effect in future periods will be material, companies should discuss the reasons for the change and its effects in MD&A.

Other MD&A disclosures The SEC staff also said that significant income statement effects related to contributions to benefit plans should be disclosed and discussed in MD&A. For example, a company’s contribution to plan assets would decrease periodic pension cost due to the expected return on the contributed assets.

Noncash contributions (e.g., contributions of assets or company stock) to a defined benefit plan should be classified as noncash financing or investing activities, as appropriate, in the statement of cash flows. The SEC staff expects registrants to disclose this funding approach in MD&A so that investors can understand its effect on liquidity.

Goodwill Factors giving rise to goodwill The SEC staff reminded registrants to disclose in the notes to the financial statements the qualitative factors giving rise to goodwill recognized in a business combination and to avoid the use of boilerplate language, which the staff has observed in practice. The SEC staff stated that when factors giving rise to goodwill are not obvious, registrants should provide additional detail to give investors insight into the reasons for the premium paid to acquire the business. If the goodwill is attributed to synergies expected from the acquisition, registrants should clearly disclose the source of those synergies (e.g., a particular product line, industry, geography, elimination of duplicate facilities, reduction in costs from increased purchasing power, enhancement of operational efficiencies).

Goodwill impairment SEC staff members noted that they often inquire about impairment considerations when the registrant has experienced adverse events or the registrant’s market capitalization has declined below its book value. The SEC staff reminded registrants of the disclosure guidance in Section 9510 of the Division’s Financial Reporting Manual (FRM) when there is significant uncertainty about the recoverability of goodwill. The staff specifically highlighted the importance of disclosing the specific percentage by which the fair value exceeded the carrying value of reporting units that are “at-risk” of impairment.

The SEC staff also reminded registrants of its continued focus on the timing of goodwill impairment charges and related disclosures in MD&A. The SEC staff emphasized that registrants should disclose why an impairment charge was recognized in a specific period, including whether it was a result of events occurring in the period (i.e., trends) or a change in future projections (i.e., uncertainties).

Business combinations Asset acquisition vs. business combination The SEC staff acknowledged that the definition of a “business” in ASC 805 requires judgment. The determination of whether an acquired set of assets and activities constitutes a business is




critical because the accounting for a business combination differs significantly from that for an asset acquisition. The SEC staff stated that it may question a registrant’s conclusion when the difference in accounting could be material, such as in transactions involving significant premiums, transaction costs or contingent consideration. In the real estate industry, the SEC staff particularly focused on acquisitions of single-family homes and health care facilities.

Measurement period adjustments The SEC staff said registrants should carefully consider whether adjustments to initial or provisional amounts recognized for assets acquired or liabilities assumed in a business combination qualify as measurement period adjustments. Such adjustments result in retrospective changes to the provisional amounts recorded in the business combination. The SEC staff observed that companies, on occasion, have inappropriately characterized changes to the initial amounts recognized in the acquisition as measurement period adjustments rather than error corrections. The measurement period, which cannot exceed one year, ends when a registrant obtains the additional information that it was seeking about facts and circumstances that existed as of the acquisition date or it concludes that such information is not obtainable. If an adjustment does not meet these criteria, the registrant should evaluate whether it is a correction of an error or an item that should be recognized in the current period.

The SEC staff also asks registrants to disclose that the initial measurement of provisional items is incomplete.

Segment reporting The SEC staff emphasized its focus on segment disclosures, including the aggregation of operating segments into reportable segments based on similar economic characteristics. For example, operating segments in disparate geographies (e.g., Asia and North America) may have some similarities, but registrants must consider all characteristics in reaching conclusions about aggregating operating segments. Registrants also must evaluate both projected and historical financial information to assess the long-term economic similarities. The SEC staff indicated it has issued comments when the historical results of aggregated operating segments have not been similar and it is not evident that the future results will be similar.

In identifying operating segments, registrants must consider any component for which discrete financial information is available and regularly reviewed by the chief operating decision maker (CODM). The SEC staff reminded registrants that financial information reviewed by the CODM may indicate that a component is an operating segment even if shared costs of the company are not allocated to the component’s discrete financial results.

Non-GAAP financial measures The SEC staff reminded registrants to provide sufficient disclosure and clear labeling of the adjustments reflected in non-GAAP financial measures. Registrants also are required to clearly disclose why these measures are useful to investors.

The SEC staff reiterated its concerns related to non-GAAP financial measures that reflect adjustments for pension benefits. Because there are many components of pension expense, registrants should clearly label and disclose what the adjustments represent in the non-GAAP presentation. For example, if the non-GAAP financial measure includes an adjustment for the difference between the expected and actual returns on pension plan assets, registrants should disclose the returns reflected in the GAAP results as well as the total pension expense and the amount of returns reflected in the non-GAAP measure. The SEC staff also noted that




a reconciling item labeled “noncash pension expense” might be confusing because, typically, pension liabilities are ultimately settled in cash.

The SEC staff cited other examples of non-GAAP financial measures commonly used in certain industries that may confuse investors when there is misleading terminology or insufficient context and disclosure. For example, oil and gas enterprises often present non-GAAP financial measures that include adjustments for derivative gains and losses. The wording of the adjustment may indicate that the measure excludes all derivative gains and losses, when it does not (i.e., the non-GAAP financial measure includes the realized, and excludes any unrealized, portion of derivative gains or losses). In another example in the mining industry, registrants may disclose non-GAAP cost-per-ounce measures that reflect by-product revenues as a reduction of the production costs. Registrants should provide additional transparency by disclosing the cost-per-ounce measures including and excluding by-product revenue, and the total amount of by-product revenue, if material.

MD&A — Disclosure of metrics Registrants commonly discuss key metrics that are used by management in evaluating results of operations. These key metrics vary by industry. For example, retail companies use metrics such as same-store sales and store openings and closings to assess results of operations. Social networking and online gaming companies typically use average monthly or daily users.

Therefore, when a registrant uses a key metric to discuss operating results in MD&A, the registrant should:

• Define the metric

• Discuss how the metric is calculated

• Discuss any limitations on the metric’s calculation (e.g., whether an average monthly users metric might count individuals more than once)

• Clearly explain how the metric or period-to-period change in the metric links to the financial statements (e.g., average monthly users may be used to illustrate revenue per average user and to help explain a change in sales)

SEC Chair White has said that registrants must provide context about key metrics so that their disclosure is not misleading. For example, if a company discloses that it has 10 million total users with an expected annual growth rate of 12%, but the majority of users are non-paying, investors may incorrectly expect a direct correlation between total user growth and profitability.

In another example, a retail registrant may disclose significant growth in online sales. As in the example above, discussing a high growth rate with no context of the materiality of online sales may be misleading. To provide a basis for investors to understand the effect of such growth on operations, the registrant should quantify the amount of online sales and describe why online sales are experiencing significant growth.

Guarantor financial information The SEC staff shared some observations related to the application of Rule 3-10 of Regulation S-X (Rule 3-10). Rule 3-10 allows for condensed consolidating financial information or, in certain instances, disclosure only in the parent company’s financial statements in lieu of separate financial statements for each subsidiary issuer and guarantor of registered debt.

One of the conditions for relief under Rule 3-10 is that the guarantee must be full and unconditional. When there are customary release provisions pertaining to subsidiary guarantees, registrants are not disqualified from relying on the relief in Rule 3-10. However, in

MD&A disclosures should define and explain how key metrics drive operating results.




each filing for as long as the debt is outstanding, registrants should disclose the circumstances whereby the subsidiary guarantor could be released. If subsidiary release provisions are not customary in nature, the subsidiary may not qualify for Rule 3-10 relief. Furthermore, if the customary release provisions pertain to the parent’s guarantee of registered subsidiary debt, the relief under Rule 3-10 would not apply to the subsidiary issuer. In those cases, the subsidiary issuer would be required to file separate, audited financial statements.

China-based issuers The SEC staff has focused on the disclosures by certain registrants that are primarily holding companies with substantially all of their operations in the People’s Republic of China (PRC). Specifically, the SEC staff is focused on circumstances in which the PRC government limits the registrant’s direct ownership in a significant operating entity, and the registrant enters into contractual arrangements that give it the power to control the entity. In these circumstances, the registrant would consolidate the operating entity under the Variable Interest Model, if it determines the entity is a variable interest entity (VIE) and the registrant is the VIE’s primary beneficiary.

In these circumstances, the SEC staff said that it expects registrants to disclose risk factors similar to the following:

• Substantially all operations of the registrant are concentrated in China.

• The registrant is a holding company that does not own the assets or operations of the consolidated VIE, and may have to deconsolidate the VIE if the contractual arrangements expire or terminate.

• The legality of the VIE structure is uncertain, and the registrant may lose control or face significant penalties if the PRC government disapproves of the structure.

• The holders of the direct ownership interest in the VIE have significant involvement with its operations that could result in conflicts of interests with the registrant.

• The legal protections available to both the registrant and its investors are more limited or uncertain under Chinese law than under US law.

• There are restrictions on the registrant’s ability to transfer cash in or out of China that may constrain its liquidity.

The SEC staff indicated that registrants should continue to disclose sufficient details about the terms of the contractual arrangements and the judgments made by the registrant that lead to consolidation of the VIE. Furthermore, registrants should disclose quantitative and qualitative information to allow readers to understand the nature, purpose and size of the VIE operations. For example, disclosures may include the VIE’s revenue (to external and related parties), net income, and cash flows, as well as the nature and classification of its assets and liabilities (including intercompany payables with PRC subsidiaries).

MD&A also should discuss the restrictions on transferring cash into and out of China, the amount of cash held in China (separately by equity-owned subsidiaries, if any, and controlled VIEs), and the foreign currency of the cash held. If the holding company is conducting its IPO in the US, it should disclose the restrictions on transferring the IPO proceeds into China and continue to include those disclosures in periodic filings until the proceeds are fully used or applied.

Industry considerations The SEC staff highlighted other areas of frequent comment for certain industry sectors, including the technology, oil and gas, real estate, and utility industries.




Technology With a growing market for virtual goods sold by companies that operate gaming or social network sites, the SEC staff clarified its expectations on the accounting and disclosure for these transactions. Companies often process sales of virtual goods on their network platform, but the software is housed and maintained by developers, who may act as the primary obligor in the transactions. The SEC staff said it expects disclosures about whether revenue is recognized by the developer on a gross basis (the total fee paid by customer) or a net basis (the total fee less the amount retained by the platform). Registrants also should expand their accounting policy disclosures to define and describe the type of virtual goods sold (e.g., consumable or durable virtual goods), the time period over which they are recognizing revenue from the sale of a virtual good, and the methodology and assumptions used to determine the estimated time period.

Real estate and oil and gas The SEC staff summarized recent updates of the Division’s FRM, which affect registrants in the real estate and oil and gas industries.

The SEC staff revised its guidance on Rule 3-14 of Regulation S-X, which requires registrants to present the audited financial statements of significant consummated or probable acquisitions of real estate operations. The revisions affect the scope of Rule 3-14 of Regulation S-X, the significance tests of acquired properties, and the financial statement requirements for acquired properties subject to triple net lease arrangements.

The SEC staff also included new guidance in the FRM that registrants acquiring oil and gas properties no longer need to request relief from the staff to present abbreviated financial statements, rather than full financial statements under Rule 3-05 of Regulation S-X, if the acquired property constitutes only a portion of the assets of the seller and certain conditions are met. However, registrants must continue to seek pre-clearance from the SEC staff before presenting abbreviated financial statement of acquired carve-out businesses in other industries.

Utilities The SEC staff noted that certain regulated utility registrants have used regulatory or predecessor cost bases to value and record tangible fixed assets acquired in a business combination. However, ASC 805 requires that such assets be recognized at fair value. In these cases, the SEC staff has asked registrants how these amounts comply with US GAAP. The SEC staff commonly requests supplemental disclosure of (1) market participant assumptions, (2) discount rates and (3) cash flows to support a registrant’s conclusions.

Current practice issues panel Representatives from several of the large accounting and consulting firms discussed challenges preparers and auditors face when addressing complex accounting areas involving significant estimation and judgment. No SEC staff members participated.

Challenges cited by the group included:

• Revenue recognition — Considerations when using a range for a best estimate of selling price for individual deliverables within a multiple-element arrangement, challenges related to gross versus net reporting for service entities and companies that sell virtual goods, as well as related disclosure considerations

• Goodwill — Considerations when a registrant changes its annual goodwill impairment testing date, factors to consider when performing a qualitative goodwill impairment assessment

EY resources

► Technical Line, Recognizing revenue on the sale of virtual goods (SCORE No. BB2325)

► Technical Line, How to apply S-X Rule 3-14 and the latest SEC staff guidance to real estate acquisitions (SCORE No. CC0373)

EY resources

► Financial Reporting Developments, Multiple- element arrangements — Revenue recognition (SCORE No. BB1843)

► Financial Reporting Developments, Intangibles — Goodwill and other (SCORE No. BB1499)

► Financial Reporting Developments, Income taxes (SCORE No. BB1150)

► Financial Reporting Developments, Issuer’s accounting for debt and equity financings (SCORE No. BB2438)


http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_BB2325_RevRecVirtualGoods_22March2012/$FILE/TechnicalLine_BB2325_RevRecVirtualGoods_22March2012.pdf

http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_BB2325_RevRecVirtualGoods_22March2012/$FILE/TechnicalLine_BB2325_RevRecVirtualGoods_22March2012.pdf


http://www.ey.com/Publication/vwLUAssetsAL/TechnicalLine_CC0373_SXRule314_7November2013/$FILE/TechnicalLine_CC0373_SXRule314_7November2013.pdf






http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB1843_RevenueRecognition_MultipleElement_May2012/$FILE/FinancialReportingDevelopments_BB1843_RevenueRecognition_MultipleElement_May2012.pdf




http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB1499_Intangibles_7November2013/$FILE/FinancialReportingDevelopments_BB1499_Intangibles_7November2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB1499_Intangibles_7November2013/$FILE/FinancialReportingDevelopments_BB1499_Intangibles_7November2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB1150_IncomeTaxes_19September2013/$FILE/FinancialReportingDevelopments_BB1150_IncomeTaxes_19September2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB1150_IncomeTaxes_19September2013/$FILE/FinancialReportingDevelopments_BB1150_IncomeTaxes_19September2013.pdf

http://www.ey.com/Publication/vwLUAssetsAL/FinancialReportingDevelopments_BB2438_DebtandEquity_12June2013/$FILE/FinancialReportingDevelopments_BB2438_DebtandEquity_12June2013.pdf






• Income taxes — Evaluating the appropriate accounting model for tax credits and incentives and evaluating deferred tax asset valuation allowances

• Noncontrolling interests — Complexity in evaluating the appropriate accounting for puttable noncontrolling interests

Communications with the SEC staff The SEC staff from the Division noted that its filing review process is intended to assess whether registrants comply with accounting and disclosure requirements and whether the filings are useful and relevant for investors. The SEC staff also reviews filings for consistency with other information, such as earnings releases, analyst reports and content on the registrant’s website. However, the SEC staff reminded registrants that it does not evaluate the merits of transactions or guarantee that all disclosure is complete or accurate. The staff also reminded registrants that while other public comment letters and responses may be a useful resource when responding to staff comments, specific facts and circumstances can differ, so those comment letters and responses should not be relied upon.

With respect to confidential submissions of draft registration statements by emerging growth companies under the JOBS Act, the SEC staff noted that the review process is otherwise the same as the process for public filings. The draft registration statement must be substantially complete when submitted (e.g., the audit report is included). The SEC staff also reminded registrants that response letters related to draft registration statements will eventually become public, and registrants must follow Rule 83 procedures to request confidential treatment.

Mr. Kronforst discussed his desire to improve the timeliness of filing reviews through greater coordination between the Division and OCA. He also expects the Division to work with the Division of Enforcement’s Financial Reporting and Audit Task Force and consider data gathered from the Division of Economic and Risk Analysis’ Accounting Quality Model in staff comment letters when it is available.

The SEC staff provided guidance on submitting waiver requests and other interpretive requests on complex SEC reporting matters. Such requests should be emailed to the SEC staff at [email protected] and include the following information:

• Background on the registrant and transaction

• Summary of the issue and rules involved

• The relief sought and reasons needed, if applicable

• Description of proposed presentation or disclosures

• Analysis about why the result of strictly following SEC rules is anomalous and why the request for relief is not material and/or why the proposed presentation is appropriate for investors

Registrants also can pre-clear conclusions on the application of US GAAP (or IFRS) with OCA.3 In addition, the Division frequently discusses accounting issues identified in its review process with OCA. As a result, OCA may become actively involved in complex accounting matters that have not been pre-cleared and are later identified by the Division during its review process.

Mr. Murdock said the following topics were the top areas of consultation in OCA over the past year:

• Accounting for financial assets, including allowances of loan losses, impairment and valuation matters




• Purchase accounting issues, including the definition of a business and application of pushdown accounting

• Consolidation issues, including the determination of the primary beneficiary of VIEs

• Revenue recognition matters, including gross versus net presentation and the accounting for multiple-element arrangements

Mr. Murdock said OCA’s pre-filing consultations from registrants declined by about 40% from the prior year but consultations arising from the Division’s review process have increased. He expressed concern and speculated that the decline in registrant pre-clearance consultations may stem from registrants’ and accounting firms’ focusing more on the operating effectiveness of ICFR than on technical accounting matters. He reminded registrants and auditors that accounting and financial reporting matters should continue to receive appropriate attention.

How we see it We encourage registrants to consider the benefits of pre-clearing complex accounting and SEC reporting conclusions with OCA and the Division, respectively. By doing so, registrants can avoid the risks of amendment or restatement and delays that occur when such matters are challenged as part of the staff review process.

International matters The IFRS footprint and outlook for interactions between the IASB and the FASB Hans Hoogervorst, IASB Chairman, said the IASB had a number of important accomplishments in 2013, including:

• Completing a study showing that the transition costs from Canadian GAAP to IFRS were manageable and could serve as a data point for potential transition costs from US GAAP to IFRS

• Completing research into IFRS adoption that indicated that of 122 countries surveyed, more than 100 countries have adopted IFRS for most or all listed companies, while 21 countries permit some listed companies to use IFRS

• Forming the Accounting Standards Advisory Forum (ASAF) to deepen the cooperation between the IASB and national standard-setting bodies including the FASB, with a goal of ensuring that IFRS meets the needs of the world’s capital markets

• Agreeing with the International Organization of Securities Commissions (IOSCO) to work together to promote more consistency in the implementation and enforcement of IFRS in capital markets

Mr. Hoogervorst said jurisdictions that have adopted IFRS have generally done so with few, if any, modifications. He said the formation of the ASAF and the agreement with IOSCO show the IASB’s continued commitment to promoting adoption and use of IFRS.

Mr. Hoogervorst also discussed the outlook for the IASB’s standard-setting interactions with the FASB. He said he expects the IASB and the FASB to work closely in the near term to finalize their joint projects. However, he said the nature of the Boards’ future interactions after those projects are completed rests with the FASB. Mr. Hoogervorst said he expects the growing IFRS footprint and the “enlightened self-interest” of US standard setters and




regulators to inform their activities with respect to future IFRS developments. Mr. Golden and Mr. Hoogervorst both expressed support for continued collaboration.

International financial reporting matters IFRS reporting by US companies Mr. Beswick said that determining whether and, if so, when and how to incorporate IFRS into the US financial reporting system remains a priority of the SEC. Given the resources dedicated to address rulemaking and other activities required by the Dodd-Frank and JOBS Acts, the Commission has not had the “bandwidth” to take up a decision on IFRS, he said. However, he said the staff is continuing to work on a recommendation for the Commission.

The role of international standards Julie Erhardt, International Deputy Chief Accountant in OCA, provided her thoughts about the role of international accounting, auditing and disclosure standards in the global capital markets. She said that when evaluating the role of international standards it may be helpful to consider how capital markets operate in other jurisdictions and how investors participate in those markets. Structural differences among the capital markets can influence the decision whether to adopt international standards. However, investors in national markets share common views when analyzing financial statements and about the importance of assurance provided by auditors. The decision whether to incorporate international standards in a particular jurisdiction may ultimately depend on the range of alternatives available in that jurisdiction and the need or problem being addressed.

Foreign private issuers and IFRS considerations Craig Olinger, Deputy Chief Accountant of the Division, said about 500 of the approximately 950 foreign private issuers (FPIs) registered with the SEC prepare their financial statements in accordance with IFRS and more than 400 prepare their financial statements in accordance with US GAAP. The remaining FPIs prepare financial statements in accordance with local country GAAP reconciled to US GAAP.

Confidential draft submissions Mr. Olinger noted that foreign private issuers may submit confidential registration statements if they qualify to use the approach as a dual-listed company or an emerging growth company. The SEC staff recently released a guide4 for foreign companies considering registration that provides an overview of the relevant laws and regulations governing the US securities markets.

Review of IFRS filers The SEC staff reiterated that the financial statements of all SEC registrants are subject to the same review process, regardless of whether they are prepared in accordance with US GAAP, IFRS or home-country GAAP. As a result of its review process, the SEC staff identified several common themes in comment letters issued on IFRS financial statements that generally are consistent with the themes in comment letters issued to US GAAP filers. These themes include the following:

• Income taxes — The SEC staff asks registrants to explain the nature of items disclosed within the income tax rate reconciliation. The SEC staff also asks registrants to provide disclosures about deferred tax assets for which a valuation allowance was not recognized and whether those deferred tax assets were evaluated at the end of the year.

• Contingencies — The SEC staff asks registrants to provide disclosure about the risks of losses and uncertainties related to contingencies (e.g., the expected amount and timing of cash outflows).




• Operating segments — The SEC staff asks registrants to provide profit/loss information by operating segment with reconciliation to consolidated results. The SEC staff also asks registrants to include or expand IFRS 8, Operating Segments, disclosures, particularly entity-wide disclosures about products and services.

• Accounting policies — The SEC staff reminded registrants to provide clear disclosures of accounting policies to help investors understand how transactions are measured and recognized and the significant estimation uncertainty inherent in the policy. Examples include the source of discount rates and valuation assumptions for asset impairments, the level at which goodwill is measured and factors considered in deciding whether to consolidate entities.

• Revenue recognition — The SEC staff has focused on gaining a better understanding of the different revenue streams of a registrant. The SEC staff said it reviews other publicly available information (e.g., earnings call, analysts’ reports) and asks questions to clarify the material terms and details of revenue streams that are growing.

IFRS reporting matters The SEC staff has been monitoring disclosures and compliance with SEC reporting requirements and highlighted some common practice issues.

• Statement of compliance — An FPI may omit the reconciliation to US GAAP only if it states unreservedly and explicitly in an appropriate note to the financial statements that its financial statements are prepared in accordance with IFRS as issued by the IASB. Also, the independent auditor must opine in its report that the financial statements comply with IFRS as issued by the IASB. The SEC staff noted that when the compliance statement was improperly excluded from the notes or audit report, registrants have had to amend their filings.

• Going concern language — The SEC staff said some auditors of FPIs reporting under IFRS improperly included a conditional statement of substantial doubt in the PCAOB audit report when going concern uncertainties existed.

• Opening balance sheet audit — The SEC staff noted that in certain cases an opening balance sheet included upon adoption of IFRS or the retrospective application of accounting principles was not covered by the auditor’s report resulting in registrants having to amend their filings.

• Transition to new IFRS standards — The SEC staff reminded registrants to consider unexpected reporting requirements in connection with adopting new accounting standards (e.g., IFRS 10, Consolidated Financial Statements; IFRS 11, Joint Arrangements and IFRS 12, Disclosure of Interests in Other Entities) for annual periods beginning on or after 1 January 2013. For example, under IFRS 11, entities that were previously proportionately consolidated may be accounted for using the equity method. This approach may trigger the requirement, absent relief from the SEC staff, to file separate financial statements of the equity method investee in the Form 20-F if significance thresholds in Rule 3-09 of Regulation S-X are exceeded in any period presented.

• Effect of retrospective changes to financial statements included in registration statement — When a registration statement is filed later in the year and includes interim financial statements that reflect a retrospective application of a change in accounting principle or discontinued operations, the annual financial statements must be recast to reflect the change. Questions have arisen about whether it is acceptable to file financial statements that have been recast under IAS 10, Events after the Reporting Period, without




reconsidering subsequent events. The IFRS Interpretation Committee considered the issue and concluded that IAS 10 does not address the presentation of reissued financial statements in a registration statement that may be a requirement of the securities laws in a particular jurisdiction (such as the US). The SEC staff noted that, as a result, issuers have been able to fulfill the requirements of the US securities laws by having the auditor’s opinion dual-dated and not reconsidering subsequent events for recognition.

• XBRL tagging — The SEC staff said the Commission has not adopted a taxonomy for IFRS and FPIs using IFRS will not need to comply with XBRL tagging for 2013.

Common issues and best practices related to foreign transactions Members of the SEC staff participated in a panel discussion with others that covered some common areas that are challenging in cross-border merger transactions. The panel highlighted the following reporting considerations for transactions that will be registered with the SEC:

• Filing status — When contemplating a foreign transaction, it is important to understand whether each entity (i.e., registrant and target) is a US domestic filer or an FPI. This distinction is important in understanding the financial information to be presented in the registration statement. Companies also need to continue to monitor their filing status and consider the effect on ongoing reporting requirements if they cease to qualify as FPIs.

• Pro forma presentation in offering document — Companies should be aware of the differences in pro forma requirements (e.g., periods, adjustments, age of information) among the jurisdictions involved in the transaction. The SEC staff observed that the pro forma information must be presented using the basis of accounting of the registrant.

• Auditor reporting framework — In an SEC filing, the panel observed that a target’s financial statements must be audited under AICPA standards or PCAOB standards and that audits performed under International Standards of Auditing are not acceptable. Also, certain disclosures required by IFRS (e.g., market risks and critical accounting estimates) may be disclosed in MD&A and incorporated by reference in the notes to the financial statements. As a result, the audit report on IFRS financial statements must extend to those disclosures.

• Other reporting considerations — In addition to evaluating the financial statement requirements of the target and the acquirer, the company needs to evaluate the requirements for other entity financial statements in SEC-registered transactions. For example, the filing may need to include, for both the target and the acquirer, financial statements of probable or consummated acquisitions in accordance with Rule 3-05 of Regulation S-X and separate financial statements of significant equity method investees in accordance with Rule 3-09 of Regulation S-X.

Mr. Olinger encouraged registrants to identify issues early and pre-clear transactions that are complex with the SEC staff. The SEC staff also will consider providing relief in certain limited circumstances.




Remarks of SEC enforcement representatives Financial Reporting and Audit Task Force Andrew Ceresney, Co-Director of the SEC’s Division of Enforcement, and David Woodcock, a regional director in the Division of Enforcement and Chairman of the Financial Reporting and Audit Task Force, discussed the SEC’s effort to combat financial fraud.

Mr. Ceresney said that the SEC has renewed its focus on financial reporting and auditing violations and as part of this process has created the Financial Reporting and Audit Task Force (Task Force). The Task Force is comprised of approximately 12 attorneys and accountants. David Woodcock, who chairs the Task Force, provided additional insights into its activities and discussed five key objectives of the Task Force:

• Developing a deep understanding of financial reporting fraud and how it happens, including emerging areas where fraud could occur

• Developing a state-of-the-art methodology for identifying and investigating financial reporting fraud, including using new technologies such as the SEC’s Accounting Quality Model and other tools that use data analytics to assess the degree to which aspects of a company’s financial statements appear anomalous

• Sharing information with other offices and divisions within the SEC to leverage additional expertise and resources

• Collaborating and coordinating across the SEC and with other regulatory and law enforcement agencies

• Engaging public, academia and whistleblowers in combating, detecting and reporting fraud

Mr. Woodcock said he expects issues to be brought to the Task Force through different channels, including internal referrals and analyses, tips and complaints from other agencies as well as from whistleblowers and investors. In addition to focusing on accounting fraud in the application of US GAAP, the Task Force will focus on the inappropriate use of non-GAAP measures, omitted or misleading disclosure in MD&A and matters related to ICFR and disclosure control and procedures.

Mr. Croteau said OCA continues to spend time with the SEC’s Enforcement Division on investigations that involve internal control considerations. He cautioned that financial reporting and disclosure investigations are likely to continue to include a close look at the adequacy of internal accounting controls, as well as evaluations and conclusions about both the effectiveness of the company’s ICFR reporting and its disclosure controls and procedures.

Accounting Quality Model Craig Lewis, Chief Economist and Director in the SEC’s Division of Economic and Risk Analysis, said the SEC staff is developing an Accounting Quality Model to provide quantitative analytics to help flag unusual items in a company’s financial statements. For example, the tool would flag areas that may indicate earnings management by comparing period-over-period changes in certain accruals with similar changes made in the past or by other registrants in the same industry.




Foreign Corrupt Practices Act (FCPA) Kara Brockmeyer, Chief of the Foreign Corrupt Practices Unit in the SEC’s Division of Enforcement, noted that the SEC continues to focus on this area as “an issue of public trust.” The staff assesses whether public companies are appropriately accounting for their assets and disclosing the risks that they face related to foreign operations and business practices. She noted the importance of internal controls in combating FCPA violations. Many of the internal controls that help address bribery risks are the same controls that companies have for financial statement purposes, such as cash disbursements and reimbursement of expenses.

Ms. Brockmeyer also discussed the FCPA practice aid the SEC and the Department of Justice released in November 2012.5 The guide addresses a wide variety of topics including who and what is covered by the FCPA’s anti-bribery and accounting provisions, the definition of a “foreign official” and the 10 hallmarks of an effective corporate compliance program, among other topics.

Endnotes: _______________________ 1 Commissioner Gallagher’s speech is available on the SEC’s website at http://www.sec.gov/News/Speech/Detail/

Speech/1370540462287. 2 The speech “The Path Forward on Disclosure” to the National Association of Corporate Directors — Leadership

Conference on 15 October 2013 is available at http://www.sec.gov/News/Speech/Detail/Speech/1370539878806. 3 Pre-clearance letters should be emailed to OCA at [email protected] and guidance for consulting with OCA is available

at http://www.sec.gov/info/accountants/ocasubguidance.htm. 4 The SEC’s guide “Accessing the US Capital Markets — A Brief Overview for Foreign Private Issuers” is available at

http://www.sec.gov/divisions/corpfin/internatl/foreign-private-issuers-overview.shtml. 5 The resource guidance to the US FCPA is available at http://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf.

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http://www.sec.gov/News/Speech/Detail/Speech/1370540462287



mailto:[email protected]

http://www.sec.gov/info/accountants/ocasubguidance.htm

http://www.sec.gov/divisions/corpfin/internatl/foreign-private-issuers-overview.shtml

http://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf


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Appendix — Quoted speeches

Speech and link to source

SEC Chief Accountant, Paul Beswick

• Speech by SEC Chief Accountant: Remarks at the AICPA 2013 Conference on Current SEC and PCAOB Developments http://www.sec.gov/News/Speech/Detail/Speech/1370540488257

SEC Deputy Chief Accountant, Brian Croteau

• Speech by SEC Deputy Chief Accountant: Remarks Before the 2013 AICPA National Conference on Current SEC and PCAOB Developments — Audit Policy and Current Auditing and Internal Control Matters http://www.sec.gov/News/Speech/Detail/ Speech/1370540472057

SEC Deputy Chief Accountant, Julie Erhardt

• Speech by SEC Deputy Chief Accountant: Remarks at the AICPA Conference on Current SEC and PCAOB Developments http://www.sec.gov/News/Speech/Detail/Speech/ 1370540472145

FASB Chairman, Russell Golden

• Speech by FASB Chairman: Remarks to the American Institute of Certified Public Accountants National Conference on Current SEC and PCAOB Developments http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176163675405

IASB Chairman, Hans Hoogervorst

• Speech by IASB Chairman: Opening remarks, AICPA 2013 Conference on Current SEC and PCAOB Developments http://www.ifrs.org/Alerts/Conference/Documents/2013/ Hans-Hoogervorst-AICPA-SEC-speech-December-2013.pdf

PCAOB Chairman, James Doty

• Speech by PCAOB Chairman: Enhancing Capital Formation, Investor Protection and Our Economy — AICPA National Conference on Current SEC and PCAOB Developments http://pcaobus.org/News/Speech/Pages/12092013_Doty_AICPA.aspx

PCAOB Chief Auditor and Director of Professional Standards, Martin Baumann

• Speech by PCAOB Chief Auditor: Update on PCAOB Auditing Standard Setting — AICPA National Conference on Current SEC and PCAOB Developments http://pcaobus.org/News/Speech/Pages/12102013_AICPA_Baumann.aspx







http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176163675405

http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176163675405

http://www.ifrs.org/Alerts/Conference/Documents/2013/Hans-Hoogervorst-AICPA-SEC-speech-December-2013.pdf

http://www.ifrs.org/Alerts/Conference/Documents/2013/Hans-Hoogervorst-AICPA-SEC-speech-December-2013.pdf

http://pcaobus.org/News/Speech/Pages/12092013_Doty_AICPA.aspx

http://pcaobus.org/News/Speech/Pages/12102013_AICPA_Baumann.aspx