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AICPA Conference

Highlights of the 2015 AICPA National Conference on Current SEC and PCAOB Developments

At a glance

The 2015 AICPA National Conference on Current SEC and PCAOB Developments was held on December 9, 10, and 11, 2015. The Conference featured representatives from regulatory and standard setting bodies, along with auditors, preparers, securities counsel, and industry experts. Presenters expressed views on a variety of accounting, auditing, and financial reporting topics. Each panel demonstrated support for the differentiated roles that combine to generate financial reporting that provides users with useful information. The title of SEC Chair Mary Jo White’s speech seemed to capture this year’s theme: Maintaining High-Quality, Reliable Financial Reporting: A Shared and Weighty Responsibility.

Overview

.1 SEC Chair Mary Jo White noted that preparers are the lynchpin of high-quality financial reporting, but auditors and audit committees are also critical participants. Later in the Conference, a panel discussion hosted by Cindy Fornelli, Center for Audit Quality (CAQ) Executive Director, focused on the working relationships between and among what she referred to as the “gatekeepers,” consisting of external auditors and audit committees. The emphasis on the role of all parties involved in financial reporting, together with insights on how to enhance such reporting and highlights of several technical accounting topics, served as the foundation for this year’s Conference. The primary focus was on how internal controls over financial reporting and the roles of management, auditors, and audit committees combine to create high-quality, reliable financial reporting.

Regulatory update and financial reporting matters

Internal control over financial reporting (ICFR)

.2 Chair White set the stage by saying in her opening remarks that “it is hard to think of an area more important than ICFR to our shared mission of providing high-quality financial information that investors can rely on.” James Schnurr, SEC Chief Accountant and Brian Croteau, Deputy Chief Accountant, also discussed the importance of ICFR, making it clear this continues to be a key focus area. Croteau commented that there have been some encouraging signs of progress, noting that for the second year in a row, the SEC staff has seen an increase in the number of material weaknesses reported where

No. US2015-13

December 14, 2015 What’s inside:

Overview .......................... 1

Regulatory update and financial reporting matters .......................... 1

Internal control over financial reporting (ICFR) ................................... 1

SEC observations .................... 2 Disclosure

effectiveness ......................... 4 Fixing America’s Surface

Transportation Act (FAST Act) ........................... 5

Standard setting update .................................. 5

Other technical accounting topics .................................... 7

International.......................... 12 Division of

Enforcement ....................... 12 Focus on audit

committees .......................... 12 Cybersecurity ......................... 13

Auditing update............. 13 PCAOB .................................... 13 Audit Quality

Indicators ........................... 14

Appendix ........................ 15

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issuers had not first identified a material misstatement. Despite this movement, Croteau still stressed the importance of a complete evaluation of the severity of the deficiency, including specific consideration of both the magnitude of the actual error and the volume of activity that is reasonably possible to be exposed to the deficiency. .3 The SEC staff reminded registrants of the importance of giving ongoing consideration to implementing or redesigning controls, as necessary, in connection with the application of new accounting standards and policies. They also reminded registrants of the requirement to consider their quarterly obligation to disclose material changes in ICFR. Interim disclosure may be warranted in advance of the adoption of a new accounting standard or policy, or when actions are taken to remediate prior material weaknesses. .4 A panel of representatives from the SEC, PCAOB, public accounting firms, and public companies discussed various hot topics in ICFR, including: the identification of management review controls and how to test them, assessing the population of key controls, and the sufficiency of evidence to satisfy ICFR. The panel stressed the responsibility of management and the auditor to gain an understanding of processes where review controls are operating in order to assess the ability of the control to address the associated risk at the appropriate level of precision.

SEC observations

Non-GAAP disclosures

.5 Chair White observed in her keynote address that the use of non-GAAP measures is an area that deserves close attention. Issuers need to make sure they comply with the current rules, while the SEC should consider whether those rules are sufficiently robust in light of current market practices. Chair White commented that finance and legal teams, along with audit committees, should consider why non-GAAP measures are being used, how they provide investors with useful information, how they are being described, and whether there are appropriate controls over the calculation of such measures. These perspectives were echoed by several other presenters. .6 Adding specificity to Chair White’s remarks, Nili Shah, Deputy Chief Accountant in the SEC’s Division of Corporation Finance, cautioned companies that pension obligations are generally expected to be settled in cash. This means it would not be appropriate to label pension-related adjustments in non-GAAP measures as "non-cash." She also expressed that the SEC staff may ask questions when issuers assert the preferability of mark-to-market (immediate) pension recognition but then adjust the impact of pension expense in their non-GAAP measure. Other presenters mentioned the importance of describing non-GAAP measures in a way that is not misleading. .7 IASB Chairman Hans Hoogervorst discussed the use of non-GAAP measures in IFRS financial statements. While the IASB has no desire to eliminate the use of these measures, the reconciliation to GAAP measures and ensuring GAAP measures have equal prominence is key. Since IFRS contains less specificity regarding the definition and composition of financial statement line items, Hoogervorst acknowledged this can create greater disparity in non-GAAP measures used under IFRS.

Management’s Discussion and Analysis (MD&A)

.8 Cicely LaMothe, Associate Director in the SEC’s Division of Corporation Finance, indicated that the SEC staff is considering whether some of the prescriptive guidance and materiality thresholds in Regulation S-K are outdated. In this regard, the SEC staff is looking at the application of principles-based requirements compared to line item requirements (e.g., MD&A disclosure requirements are principles-based, whereas the need to disclose the number of employees is an objective line item requirement).

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.9 MD&A was also the topic of a panel discussion that included tips and best practices to make MD&A more effective. The panel featured Wayne Carnall (PwC Partner and former Chief Accountant in the SEC’s Division of Corporation Finance), Marty Dunn (Partner, Morrison & Foerster and former Chief Counsel, Deputy Director and Acting Director of the SEC’s Division of Corporation Finance), and Amie Thuener (Chief Accountant, Google Inc.). Carnall highlighted common focus areas in SEC comment letters, including questions regarding the income tax rate reconciliation and the need to quantify each component when multiple items drive a fluctuation, especially when some items offset each other. This discussion was consistent with the comments made by Shah, who highlighted that taxes for most companies are material, and so believes investors are very interested in the related disclosures. Shah noted that one way to improve transparency is by providing the rate reconciliation on a jurisdiction-by-jurisdiction basis, although she acknowledged that she understood many would be reluctant to do so. .10 LaMothe also mentioned that last year, depressed oil prices were generally assumed to be short-term in nature. Given the passage of time and further decline, issuers may need to re-evaluate the extent of their disclosures. While initially focused on the impact to oil and gas companies, she stressed that other industries may be impacted. All issuers should be focused on disclosing significant exposure and possible implications, including the potential for impairments. If the issuer expects the price to rebound, then they should consider disclosing what would happen if it is depressed longer than expected and how it may impact management’s growth plans.

PwC observation: As LaMothe discussed, oil price volatility is impacting companies across all sectors. See our video on the driving forces, potential impacts, and the operational levers you can pull to react in the face of this uncertain environment at: Oil price volatility: are you fit for $50 oil.

.11 While not addressed in his formal remarks, when asked during Q&A, Craig Olinger, Deputy Chief Accountant in the Division of Corporation Finance, suggested issuers consider including a discussion of material operations in Venezuela or other highly-inflationary economies in their discussion of known trends and uncertainties.

Segment reporting

.12 During 2015, the three topics of most frequent consultation with the SEC’s Office of the Chief Accountant related to revenue recognition, business combinations, and segments. Wesley Bricker, Deputy Chief Accountant, commented that some segment consultations are troubling when registrants contend that they should not be required to apply a GAAP standard because the result would be “competitively harmful” or “misleading.” He suggested that a registrant focus instead on what information is useful to investors and determine how that information can be appropriately reported. Bricker also warned against over reliance on benchmarking to other registrants’ disclosures. .13 The SEC staff provided key reminders regarding the identification of the Chief Operating Decision Maker (CODM) and segments, as well as considerations when aggregating operating segments into reportable segments. They also emphasized the need for effective controls specific to segment reporting. .14 When certain criteria are met, two or more operating segments may be aggregated into a single reportable segment. This process involves the application of reasonable judgment along with a thorough understanding of an entity’s specific facts and circumstances. One of the criteria for aggregating operating segments is that the segments are “similar,” which should involve careful evaluation of the company’s product lines. It may also be helpful to consider publicly-available industry reports and other analysis to better understand how a reasonable investor would expect to view operating

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segments. Registrants often focus only on this criterion—sometimes referred to as the qualitative requirement, coupled with the additional quantitative need to demonstrate similar economic characteristics. However, the third requirement—to aggregate segments only if such aggregation is consistent with principles of the standard—is often overlooked. .15 In identifying the CODM, the SEC staff noted that often registrants will indicate that an individual is the CODM because they have the “ultimate decision making authority.” This concept, however, is not included in the standard, and therefore is not determinative in identifying the CODM. .16 Shah specifically noted that in instances where the SEC staff has disagreed with a registrant’s identification of segments, the staff has not typically objected to those registrants presenting segment changes in future filings on a retrospective basis, assuming the change does not have an impact on previous goodwill impairment conclusions.

PwC observation: We have highlighted the areas that received the most comments from the SEC staff and provided examples of recent comments in several industry-specific comment letter trends publications available on CFOdirect: SEC comment letter trends by industry sector In early December, we held two webcasts to discuss comment letter trends. Archived versions can be found on CFOdirect at the following link: SEC comment letter trends webcasts

Disclosure effectiveness

.17 The SEC staff continued to highlight the disclosure effectiveness initiatives underway at the SEC and at the FASB. The SEC staff discussed the comments received in their recent solicitation of public input regarding the financial disclosure requirements in Regulation S-X relating to certain non-registrant entities (e.g., acquirees, equity method investees, and guarantors).

PwC observation: In connection with the SEC’s initiative, PwC offered recommendations and observations regarding specific provisions of the applicable sections of Regulation S-X to improve their effectiveness and in some cases, reduce the cost of compliance. PwC’s response to the SEC’s Request for Comment is available at: Disclosure Effectiveness - comments of PwC

.18 The SEC staff encouraged public companies to continue to provide feedback, even though the formal comment period has closed, and to continue to consider changes that can be made to improve the effectiveness of disclosures even before there is any formal rulemaking. The SEC staff and preparers noted that companies should evaluate the effectiveness of their financial reporting from the perspective of both compliance with the requirements and the extent to which it conveys important information to investors. While there are likely areas where issuers can eliminate redundant, outdated, and immaterial disclosures, the SEC staff cautioned that this analysis should also consider if additional disclosures may be warranted to meet the needs of investors.

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.19 Karen Garnett, Associate Director in the SEC’s Division of Corporation Finance, indicated there has already been progress in improving the effectiveness of disclosures. She acknowledged the recent momentum of companies taking on the challenge to update and improve disclosures. The SEC staff has also seen an increase in the use of tables and graphics, which is often an effective way to present information in a format that is easier to digest. .20 Garnett also challenged the perception that comments issued by the SEC staff always require additional disclosures. The comment process is intended to be a fact-finding exercise, where the staff evaluates whether disclosures are appropriate in light of additional facts obtained. In some cases, the conclusion may be that no incremental disclosure is necessary. In addition, she reminded issuers that disclosures added as a result of prior staff comment letters should be evaluated in the same manner as all disclosures, and may be deleted when the matter is no longer material.

Fixing America’s Surface Transportation Act (FAST Act)

.22 Keith Higgins, Director of the SEC’s Division of Corporation Finance, discussed the rule-making agenda, highlighting the recent passage of the FAST Act. Higgins specifically discussed certain provisions of the FAST Act, which provide for:

a reduction in the timeframe in which emerging growth companies (EGCs) need to file publicly all confidential filings and amendments prior to the commencement of a roadshow (from 21 days to 15 days);

an issuer that initially files for an IPO as an EGC but subsequently loses its EGC status prior to the effectiveness of the registration statement to remain an EGC until the earlier of: (1) the date on which the issuer consummates its IPO or (2) one year from the date that the issuer ceases to be an EGC; and

EGCs to omit financial information (including audited financial statements) from a Form S-1 (or Form F-1) relating to periods that are not reasonably expected to be required at the time of effectiveness of the registration statement.

.23 The FAST Act also directs the SEC to study Regulation S-K further and take action to implement additional reforms to simplify and modernize disclosure requirements in order to reduce the cost and burden on issuers while still providing all material information.

PwC observation: On December 11, PwC issued a summary of the securities-related provisions of the FAST Act. See In brief: FAST Act provisions intended to aid capital formation, simplify disclosure for more information.

Standard setting update

.24 Russell Golden, FASB Chairman, provided context for certain standard-setting projects and described associated Board initiatives. He emphasized the role and responsibility of the FASB in the standard-setting process and the importance of its independence. Sue Cosper, FASB Technical director, detailed several new standards and the Conference included sessions dedicated specifically to the new revenue recognition and leasing standards. Other panels also provided insight on the new revenue standard.

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Revenue recognition

.25 SEC staff discussions on the new revenue recognition standard noted that comparability between registrants, both domestic and international, may be achieved through continued collaboration among a global Transition Resource Group (TRG) process, industry groups (including those formed by the AICPA), and the many other informal groups that have been created. Bricker encouraged inclusive, robust discussion within those groups, but also timely escalation of unresolved questions to the TRG, the audit firms, or the Office of the Chief Accountant, emphasizing that now is the time for companies’ perspectives on implementation questions to be considered. .26 Bricker noted that the staff is looking forward to reviewing more detailed disclosures in the coming months about the effect the new standard is expected to have on financial statements (i.e., Staff Accounting Bulletin (SAB) 74 disclosures). Bricker noted good company practice is to ensure that the audit committee, executive management, and auditor incorporate timely, candid discussions about not only the appropriateness of the design and status of management’s detailed revenue implementation plans and impact assessments, but also the sufficiency of resources needed to complete the work timely. .27 Through the establishment of the TRG, Golden noted that the Board has resolved practice issues related to the new revenue recognition standard in a timely fashion. .28 Certain companies have been identifying practice issues related to the new revenue standard through a bottoms-up approach with good results. This involves reviewing individual revenue streams and contracts, as well as historical policies. Through this process, companies may reach different accounting conclusions from that of other companies, despite the existence of similar facts and circumstances. Panelists reiterated Bricker’s comments that raising issues regarding implementation to the TRG, AICPA industry task forces, or the Office of the Chief Accountant will enable the resolution of diversity during the implementation phase rather than requiring more costly post-implementation changes. .29 Preparers and members of the TRG, the AICPA Financial Reporting Executive Committee (FinREC), and AICPA industry task forces discussed their efforts to facilitate effective implementation. Over the last 18 months, the TRG has reached general consensus on a majority of the almost 50 issues raised by constituents. Panelists advised that an important step in the implementation process is to be aware of the conclusions reached by the TRG and others on these issues. While not authoritative, the basis for conclusions by the TRG can bring further clarity to interpreting the standard. .30 Panelists expressed interest in continuing to have a group in place to address specific implementation issues once companies progress in their implementation, but stressed the need for a stable standard setting environment to finalize their implementation efforts.

PwC observation: Discussions at the Conference made it clear that there is diversity among companies regarding the level of preparedness for the new revenue recognition standard. Some companies have only completed a high-level assessment, while others may only be in the early stages of their analysis. See Point of view: Preparing for the new revenue standard - are you ready? for additional perspectives.

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Leasing

.31 Cosper and Hoogervorst both confirmed that the final leasing standards are expected to be issued in late January 2016. Scott Muir, FASB Practice Fellow, discussed key changes since the last lease exposure draft was issued. .32 Among the most recent conclusions, the Boards have agreed on a 2019 effective date. The FASB will allow private companies to adopt in 2020. The FASB will allow early adoption upon issuance, while the IASB will permit early adoption only concurrent with adoption of the new revenue standard. In another difference, the FASB has approved a single method for transition—the modified retrospective approach—whereas the IASB will permit both retrospective and a simplified retrospective approach. In order to ease the burden of adoption, both Boards have included elements of specific relief to address their particular implementation concerns. .33 Muir acknowledged that ultimately, the FASB and IASB did not completely align on a number of matters due to differing feedback received from the two standard setters’ constituents, perhaps most significantly with regard to the single vs. dual approach for classifying how leases are recorded in the income statement. Similar to current guidance, the new standard will require judgments in a number of areas, including determining when an arrangement is or includes a lease, assumptions related to lease term and discount rate, and the allocation of consideration to lease and non-lease components. The new standard will require lessees to recognize virtually all leases on the balance sheet by recording a right of use asset and liability based on the cash flows associated with the lease. As a result, judgments such as the determination of whether an arrangement is or contains a lease and the applicable discount rate may be more impactful than under current guidance. Muir highlighted that judgments such as those related to inclusion or exclusion of optional renewal periods would need to consider objective evidence and not rely only on management’s historical practices. In addition, he noted that the expanded disclosure requirements will warrant thoughtful consideration. .34 To help preparers make key judgments, Muir noted that the FASB will provide more guidance and examples than exist today. .35 Other panelists described the challenges of implementation and that it will require the involvement of a wide range of individuals within an organization. It will likely also require significant changes to processes, systems, and controls, the extent of which should not be underestimated.

Other technical accounting topics

.36 The FASB’s forthcoming guidance on financial instrument impairment is expected to be released in early 2016. Both Golden and Cosper believe that there are extensive misconceptions about the impact of this standard, chief among them that it will require companies to develop and install costly, complex new systems. Golden said that he would be “very surprised” if lending institution were not already making some type of assessment similar to what is required by the forthcoming impairment model. During his remarks, Golden shared that the FASB leveraged its experiences with the TRG related to the revenue recognition standard, and has established a TRG for the impairment standard. Cosper noted that the FASB staff will be developing education materials to explain the Board’s intent and how certain judgments should be consistent with those considered today. .37 Both Golden and Cosper noted that the recent exposure drafts related to materiality are not intended to change the working definition of materiality. The Board has proposed amendments to both the description of materiality in the Conceptual Framework and ASC 235, Notes to Financial Statements, referring to it as a legal concept. Specifically, the concept statement will serve as a framework for the Board as part of its standard setting process. The proposed Accounting Standards Update is intended to provide a

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framework to guide preparers’ judgments about what information to include in the notes to the financial statements. These exposure documents are part of a broader project to improve disclosure-related guidance, and to make the level of detail required for disclosures more consistent across standards. .38 The Associate Chief Accountant and the SEC Professional Accounting Fellows in the SEC’s Office of the Chief Accountant addressed a number of specific technical questions, detailed below.

Revenue recognition—customer incentives

.39 Christopher Semesky, Professional Practice Fellow, noted that within the current revenue recognition standard, the guidance in Subtopic 605-50, Customer Payments and Incentives, requires that a vendor consider how to account for payments made not only to its direct customers, but also to other parties in its distribution chain, such as its customer’s customers. With a growing number of intermediaries and facilitators through various technologies, questions have arisen regarding how a vendor should account for payments made to parties outside its direct distribution chain. .40 Semesky detailed a specific fact pattern, and indicated that this is an area where judgment is required. In coming to a conclusion, Semesky noted that companies would need to consider the objectives of the payments and whether:

1. the vendor was in substance granting a broad pricing concession to its customers;

2. there was a contractual requirement between the vendor and its customer to make the payment; and

3. the vendor was acting as an agent of its customer in making the payment.

.41 Semesky noted that in a survey of users of the financial statements, there was broad consensus that regardless of how a company reported such incentives or payments, clear disclosure of its policy, assumptions, and alternatives was critical to the decision usefulness of the financial statements.

Discontinued operations

.42 The FASB’s new guidance on discontinued operations states that the disposal of a component or a group of components is a discontinued operation if “the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” Barry Kanczuker, Associate Chief Accountant, observed that judgment will be required when evaluating whether a disposal represents a strategic shift. He does not believe that the detailed examples provided in the guidance were intended to provide bright lines or safe harbors. .43 Entities will also need to exercise judgment when identifying the “financial results” that should be considered when evaluating whether there is a “major effect.” Among other factors, Kanczuker believes issuers should consider the prominence and frequency the applicable financial results or metrics were given in periodic filings. He also noted that “major effect” is not just a numerical assessment. Even if the quantitative financial impact of the disposal is minimal, issuers will need to evaluate the magnitude of other qualitative factors when determining whether to classify a component as a discontinued operation.

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PwC observation: The revised guidance provides examples that may be used by companies to aid in the evaluation of whether an entity has undergone a strategic shift. In considering the examples and their own facts and circumstances, companies should give careful consideration not only to the historic and current actions, but also to the future plans and intentions of the organization.

Revised consolidation guidance—decision maker fees

.44 Semesky addressed specific implementation questions raised by constituents related to the revised consolidation guidance issued in February 2015 and whether decision maker fees should be deemed variable interests. .45 He noted that if a manager’s fee would not otherwise meet the criteria of a variable interest, the fact that an investor under common control with the manager has a variable interest that would absorb more than an insignificant amount of variability would not by itself cause the manager’s fee to be considered a variable interest. .46 Semesky provided an example of an entity that has four unrelated investors with equal ownership interests, and a manager that is under common control with one of the investors. The manager has no direct or indirect interests in the entity other than through its management fee, and has the power to direct the activities of the entity that most significantly impact its economic performance. .47 In this example, if the manager’s fee would otherwise not meet the criteria to be considered a variable interest, the fact that an investor under common control with the manager has a variable interest that would absorb more than an insignificant amount of variability would not by itself cause the manager’s fee to be considered a variable interest. However, Semesky cautioned that when an entity is specifically structured to separate the power from the economics so as to avoid consolidation, he would not consider the separation to be substantive.

PwC observation: Interpretation of this fact pattern has varied. The conclusion described by Semesky provides clarification on this matter and may differ in some respects from how some may have previously interpreted it.

.48 Semesky also discussed the revised consolidation guidance that eliminates three of the criteria that could cause a decision maker fee to be deemed a variable interest. By removing those criteria, the ASU increases the focus on the remaining criteria—specifically on the determination of whether the decision fee is at a market rate and commensurate with the level of services provided. He noted that this analysis requires careful consideration of the services to be provided by the decision maker in relation to the fees. One approach would be to benchmark the arrangement against the arm’s length arrangements negotiated by the decision maker or other market participants. A decision maker should also carefully consider whether any terms, conditions, or amounts would substantively affect the decision maker’s role as an agent or service provider to the other variable interest holders in an entity.

Consolidation guidance—collateralized manager vehicles

.49 In 2014, several federal agencies adopted final rules related to risk retention receivables for asset-backed securities. Christopher Rickli, Professional Accounting Fellow, noted that the SEC staff has received a number of accounting consultations related to collateralized manager vehicles (CMVs), which are designed to sponsor various types of securitization transactions. The consolidation analysis can be complex and the

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most significant factors in arriving at an accounting conclusion may vary greatly from CMV to CMV. As a result, Rickli cautioned against analogizing the conclusions reached in a given circumstance to other fact patterns.

Consolidation guidance—foreign exchange restrictions

.50 Semesky noted that in the past year, certain registrants determined that they no longer controlled, and therefore deconsolidated, subsidiaries domiciled in Venezuela. These conclusions appear to be based on the lack of currency exchangeability being other-than-temporary and the severity of government-imposed controls over the subsidiary’s operations. .51 In such situations, Semesky would expect that after deconsolidation, entities have effective internal controls in place to continue to evaluate the factors that caused deconsolidation. The same parameters used to reach a deconsolidation conclusion should be considered in determining whether the foreign exchange restrictions or government-imposed controls have been sufficiently removed or loosened to once again merit consolidation. Additionally, where equity holders determine that they do not have control, they should consider whether the entity would be deemed a variable interest entity (VIE) and if the additional disclosures for unconsolidated VIEs would be required.

Loan losses

.52 The objective of the allowance for loan losses is to capture management’s best estimate of probable incurred credit losses as of the reporting date. Recent PCAOB inspection findings highlight the need for both auditors and management to consider the guidance in SAB No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues (SAB 102). SAB 102 establishes expectations for management related to the development, documentation, and application of a systematic methodology for determining allowance for loan loss estimates in accordance with GAAP. .53 Rickli noted that to satisfy SAB 102’s requirements, entities should maintain appropriate internal controls, including transaction level controls, designed to ensure the use of relevant, reliable, and sufficient data to develop the estimates of the allowance for loan losses. Additionally, entities often must record adjustments to reflect factors not already included in the entity’s loss estimation model. These adjustments require a sufficient understanding of the data currently being used in the loss estimation model, as well as the method and judgments being applied to arrive at an estimate. SAB 102 establishes an expectation that entities should maintain documentation of the sufficient objective evidence used to support the adjustments made.

Fair value

.54 The determination of fair value involves the identification of the principal or most advantageous market. The fair value measurement guidance indicates that if the reporting entity cannot transact in a particular market on the measurement date, then that market may not constitute the principal or most advantageous market. Kris Shirley, Professional Accounting Fellow, noted certain situations that may prevent an entity from accessing the observable market on the measurement date at the price observed within the market. These generally relate to differences between the reporting entity’s asset or liability and the asset or liability in the observable market. A reporting entity’s principal or most advantageous market will not necessarily be the same as that in which the initial transaction occurred. .55 A reporting entity is not precluded from using observable prices from a market that is not the principal market as one input into its fair value measurement. Shirley noted that appropriate adjustments must be made, however, for any differences in the characteristics of the asset or liability being measured and the price observed within a market.

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.56 Shirley also noted that fair value is an exit price concept. Therefore, an entity’s transaction price, which is an entry price, is not a substitute for a fair value measurement. Notwithstanding, entities may use the transaction price as a starting point when determining the fair value for certain assets or liabilities that do not have readily observable markets, or when the entity does not have access to those markets. .57 The fair value measurement guidance specifies that the assumed transaction for an asset or liability is one that is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date under current market conditions. As such, when using the transaction price as a starting point, entities should consider changes in market conditions since the transaction date (e.g., interest rates or market participants), as well as in the specific asset (e.g., expected cash flows or time value of money). Shirley noted that in all situations, entities should ensure that they not only appropriately support their conclusion of fair value, but also maintain appropriate internal controls over the process. She cautioned that even when third party services are retained to assist with the valuation, management must maintain effective internal controls over the process.

Share-based payment awards—post-vesting restrictions

.58 Share-based payment arrangements may include post-vesting restrictions, such as transfer or sale restrictions, that apply for a period of time after an award vests. ASC 718, Stock Compensation, states that post-vesting restrictions should be considered when estimating the grant-date fair value of an award. Kanczuker noted that assumptions used in determining the value of the share-based award should be attributes that a market participant would consider related to the underlying award. Attributes like the tax position of the employee, however, are related to the individual holding the award, and would therefore not be considered in determining fair value. .59 Kanczuker also noted that while a post-vesting restriction may result in a discount relative to the market value of common stock without a restriction, they continue to look to the guidance in ASC 718-10-55-5, which states that “…if shares are traded in an active market, post-vesting restrictions may have little, if any, effect on the amount at which the shares being valued would be exchanged.” Registrants should consider consulting with the SEC staff when they determine that a post-vesting restriction results in a significant discount being applied to the grant-date fair value of a share-based award.

Defined benefit plan discount rates

.60 Many companies, together with their actuaries, use a weighted-average approach when determining a discount rate. This approach derives a single, constant effective rate from the computation of the projected benefit obligation. This rate is then applied to the calculation of interest and service cost. Ashley Wright, Professional Accounting Fellow, noted that as an alternative, some preparers use a disaggregated approach, referred to as the “spot rate” approach. This involves the use of individual, duration-specific spot rates from the yield curve, which are applied to the present value of projected benefit payments in individual periods. The approach used will impact the amount of interest and service cost. .61 In a recent consultation, the SEC staff did not object to a registrant changing from the use of the single weighted-average approach to the spot rate approach. The SEC staff also did not object to the registrant accounting for the change as either a change in estimate or as a change in estimate inseparable from a change in accounting principle. .62 Wright explained that a number of entities do not use the full yield curve to measure the pension benefit obligation, but use other approaches, such as a bond match approach, which utilizes a hypothetical portfolio of bonds constructed to match the plan’s projected benefit payments. Because this approach does not incorporate a full set of individual

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discount rates, questions have arisen as to whether such companies could adopt a yield curve approach to measuring the projected benefit obligation in order to apply the spot rate approach to determine interest and service cost. Wright noted that the focus of assessing a potential change in approach should be on the measurement of the benefit obligation and determination of the best estimate for settling the obligation, rather than on the calculation of components of net benefit costs. A company must also consider its prior basis and reasons for selecting the bond match approach and whether those are still relevant, and what economic facts and circumstances have changed to warrant a change in approach.

International

.63 Chair White and Schnurr mentioned that the SEC staff was discussing a proposal with the Commission to allow domestic issuers to voluntarily submit IFRS financial information, without reconciliation, in addition to their US GAAP financial statements. Both Schnurr and Hoogervorst noted that even if there was low interest among issuers, investor demand may drive US companies to provide the information. .64 A panel including Craig Olinger, Deputy Chief Accountant in the SEC’s Division of Corporation Finance, Alex Cohen, Partner, Latham & Watkins, and Paul Dudek, Chief, SEC Office of International Corporate Finance, discussed a number of issues impacting both foreign private issuers and domestic companies when dealing with cross-border M&A. The discussion included an overview of financial reporting considerations, auditor reporting, and auditor independence for registrant and non-registrant financial statements. In discussing cross-border M&A transactions, Dudek commented that accountants’ reports prepared under local jurisdiction rules (i.e., non-PCAOB and non-AICPA reports) are not appropriate for inclusion or incorporation by reference in registration statements filed with the SEC. To the extent a company and its counsel conclude that these reports need to be disclosed to investors pursuant to Rule 425, they can be furnished under Item 7.01 of Form 8-K or on a Form 6-K, as applicable.

Division of Enforcement

.65 Andrew Ceresney, Director, and Michael Maloney, Chief Accountant, of the SEC's Division of Enforcement provided an overview of enforcement action trends, noting that fiscal year 2015 set a record for independent actions for violations of the federal securities laws and included a number of first-of-their-kind cases. Financial reporting actions increased 44 percent from the prior year and have more than doubled since 2013, reflecting the focus on this area post-financial crisis. .66 Example financial reporting cases related to a broad range of topics, including contract accounting, valuations, impairments, concealment of covenant breaches, earnings management, and failure to disclose executive perks. Fraud cases may be attributed to poor tone at top, insufficient oversight on multi-locations, and over reliance on processes.

Focus on audit committees

.67 The role of the audit committee received increased focus in this year’s Conference. Chair White discussed her growing concern about the increased work required of some audit committees given their need to focus not just on their core responsibilities and oversight of financial reporting, but also to oversee additional risks in important areas such as cybersecurity. She commented that companies and directors should carefully choose who serves on their audit committees, selecting only those that have the time, commitment, and experience to do the job well. Schnurr echoed this sentiment, emphasizing that audit committees should not lose sight of their key SEC and exchange listing requirements.

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Cybersecurity

.68 A panel of representatives from the Department of Homeland Security and public companies focused on how cybersecurity is considered in organizations. As the use of technology continues to become more ingrained in businesses, the potential for a cybersecurity attack increases. The role of key decision makers in management and the board of directors is also evolving. In the absence of formal guidance or requirements, the panel suggested that management needs to be doing more to understand the cybersecurity risks in their environment, and respond to those risks before a breach occurs.

PwC observation: Our September 2015 Audit Committee Excellence Series publication addresses the role the board plays in the oversight of cybersecurity. Refer to Achieving excellence: Cybermetrics - What directors need to know.

Auditing update

PCAOB

.69 Many presenters expressed their appreciation for the role the PCAOB has played in enhancing audit quality and addressing the needs of the capital markets. PCAOB Chairman James Doty believes the PCAOB has had a meaningful impact on auditor conduct and audit quality. He provided details of the number of US and non-US firms and engagements inspected, noting that abroad, the PCAOB is working jointly with a local audit oversight body in 18 jurisdictions. The PCAOB continues to receive support from the European Commission to work with member state authorities.

.70 Claudius Modesti, PCAOB Director of Enforcement, gave an update on the state of the Enforcement Program and its developments during the year. He noted the following areas of high priority for the Enforcement Program: (1) lack of professional skepticism (2) independence and integrity of the audit, (3) matters threatening or eroding the integrity of the PCAOB’s regulatory oversight process, and (4) cross-border audits.

Standard setting update

.71 Martin Baumann, PCAOB Chief Auditor and Director of Professional Standards, highlighted the status of various standard setting matters. He described some of the requirements of the new Auditing Standard 18 (AS 18), which requires auditors to obtain sufficient appropriate audit evidence to determine whether related party relationships, and transactions with related parties, have been properly identified, accounted for, and disclosed in the financial statements. .72 Several presenters, including Baumann, discussed the proposal to improve transparency by requiring disclosure of the engagement partner’s name and additional information about certain other participants in the audit. The final standard, which will mandate disclosure of this information on a new PCAOB form, Form AP, Auditor Reporting of Certain Audit Participants, is expected to be approved by the Board in the coming week, and then will be subject to approval by the SEC. .73 Baumann also discussed the proposal related to the Auditor’s Reporting Model, and the investors’ desire for improved and expanded descriptions of certain aspects of the audit.

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Inspection results and findings

.74 Helen Munter, PCAOB Director of Registration and Inspections, gave an update on the state of the Inspection Program, highlighting the five areas in which she believes the audit profession has improved: tone at the top, training, new practice aids and checklists, coaching and support, and monitoring. Along these lines, Doty acknowledged that firms that committed to remediating deficiencies and assessing root causes have experienced a decline in inspection findings. He also noted, however, that firms with fewer inspection findings may have a tendency to lessen their focus on audit quality. .75 Munter also discussed the PCAOB's areas of focus for the 2016. Although the overall inspection process will remain consistent, she expects the following areas to receive focus in 2016: (1) technology risks (“cybersecurity”), (2) AS 18 (3) recurring audit deficiencies, and (4) how economic and environmental risks are addressed.

Audit Quality Indicators

.76 During 2015, the CAQ completed its pilots of Audit Quality Indicators (AQIs), quantitative metrics designed to help define audit quality. The findings included: (1) audit committees value engagement-level AQIs more than firm-level AQIs, (2) two-way communication between the audit committee and the engagement team provides context that is critical for a proper understanding of AQIs, and (3) the use and reporting of AQIs should be voluntary and flexible. The CAQ is in the process of completing a new report that integrates the findings from the pilot testing and related roundtables, which it expects to issue in early 2016. .77 Jay Hanson, PCAOB Board Member, discussed the PCAOB’s efforts in this area, noting that very little feedback was received on the specific AQIs discussed in the concept release. He acknowledged that questions have arisen about the role of the PCAOB in this area and how the AQIs should be used.

PwC observation: PwC supports the PCAOB’s efforts to continue discussions regarding the best use of audit quality indicators through their concept release and related efforts, and have included voluntary disclosure of transparency data points in our quality reports since 2013. As part of our continued commitment to provide transparency to our stakeholders, we recently released our 2015 annual quality report.

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Appendix

The text of certain Conference speeches has been made available to the public. Click on the presenter’s name to access his or her speech.

Organization Presenter

CAQ ◆ Cindy Fornelli, Executive Director

FASB ◆ Russell G. Golden, Chairman

IASB ◆ Hans Hoogervorst, Chairman

PCAOB ◆ James R. Doty, Chairman ◆ Jay D. Hanson, Board Member

SEC

◆ Mary Jo White, Chair ◆ James V. Schnurr, Chief Accountant ◆ Wesley R. Bricker, Deputy Chief Accountant ◆ Julie A. Erhardt, Deputy Chief Accountant ◆ Brian T. Croteau, Deputy Chief Accountant ◆ Michael W. Husich, Senior Associate Chief Accountant ◆ Barry Kanczuker, Associate Chief Accountant ◆ Christopher M. Rickli, Professional Accounting Fellow ◆ Courtney D. Sachtleben, Professional Accounting Fellow ◆ Christopher D. Semesky, Professional Accounting Fellow ◆ Kris Shirley, Professional Accounting Fellow ◆ Ashley Wright, Professional Accounting Fellow

Questions?

PwC clients who have questions about this In depth should contact their engagement partner. Engagement teams who have questions should contact Valerie Wieman, Courtney Blum, or a member of the appropriate team in the National Professional Services Group.

Authored by:

Valerie Wieman Partner Phone: 1-973-236-5887 Email: valerie.wieman@pwc.com Nicholas Doland Senior Manager Phone: 1-973-236-5664 Email: nicholas.doland@pwc.com Ryan Hamill Director Phone: 1-973-236-5658 Email: ryan.hamill@pwc.com Kate Sturgess Senior Manager Phone: 1-973-236-5519 Email: kate.sturgess@pwc.com Jessica Zamora Senior Manager Phone: 1-973-236-4356 Email: jessica.zamora@pwc.com

Courtney Blum Senior Manager Phone: 1-973-236-7726 Email: courtney.blum@pwc.com Jamal Douglas Senior Manager Phone: 1-973-236-4382 Email: jamal.douglas@pwc.com Jonathan Rhine Director Phone: 1-973-236-4738 Email: jonathan.rhine@pwc.com Jacob Young Senior Manager Phone: 1-973-236-7351 Email: jacob.r.young@pwc.com

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