The Securities and Exchange Commission’s pledge to simplify its disclosure regime gets plenty of attention these days. That project, alas, while welcome, may seem like a consolation prize for companies facing a complex and evolving financial reporting landscape.
In response, the SEC’s Division of Corporation Finance and the Office of the Chief Accountant have taken steps, both internally and through issuer outreach, to address questions and concerns they see emerging in the months ahead—and, lord knows, financial reporting executives will have plenty of questions in the months ahead.
Most pressing are the substantial changes to revenue recognition standards that take effect in 2018, moving away from the rules-based approach of U.S. Generally Accepted Accounting Principles toward a more principles-based standard that will require much more judgment. The SEC now clearly wants companies to disclose at least something about their adoption efforts so far. Numerous studies suggest that for many companies the answer is some variation of “not much.”
Another hot issue: long-stalled efforts to converge U.S. GAAP with International Financial Reporting Standards. SEC Chief Accountant James Schnurr announced a new plan of attack at the recent Current Financial Reporting Issues Conference in New York. His pending recommendation to SEC Chairman Mary Jo White will be that in addition to filing financials in accordance with U.S. GAAP, domestic companies should be allowed to provide supplemental information in IFRS. The proposal would be formalized through the rulemaking process, he explained. The initiative would be spearheaded by his office and Corporation Finance because it affects the disclosure regime.
Looking for Help
On revenue recognition, Schnurr says he and his staff are available to assist with pre-clearance consultations on company or sector-specific issues. More fundamental issues of implementation, however, might need more help.
He also pointed to a recent survey by PwC and the Financial Education Research Foundation that found 75 percent of companies haven’t completed an initial assessment of the standard’s effect. Nearly 27 percent of respondents haven’t started the assessment process at all. Those results give rise to those who think more guidance will be needed from standard setters.
“Companies should let the auditors be involved and not do a separate process. We’ve seen companies get an answer from an auditor, come to us to get a different answer, and then go back and beat the auditor over the head with it.”
Mark Kronforst, Chief Accountant, SEC Division of Corporation Finance
Earlier this month, the Financial Accounting Standards Board and the International Accounting Standards Board convened the last session of their Transition Resource Group, an effort to smooth revenue recognition implementation pains through policy setting. Count Schnurr among those who say its work should continue.
“My hope is that there are not any more big issues that are going to require standard setting, but there are issues that will need more education to achieve consistency,” he said.
Schnurr’s advice to those seeking guidance from SEC staff is to evaluate whether your question is specific to your company, rather than a question that would apply across an entire industry group. “We will work with a company as it works through the accounting analysis,” he said. “We will certainly respect reasonable judgments. The big issue is that we don’t want to find out two to three years after the standard is implemented that there is substantial diversity in practice to a particular transaction that is material.”
Given the shifting state of disclosure obligations, companies may want to avail themselves of pre-clearance consultations with Corp Fin’s accounting staff or informal phone consultations. The latter comes with a variety of caveats.
“We will talk to anyone, so feel free to call us,” said Mark Kronforst, Corp Fin’s chief accountant, but “phone duty,” as it is known to staff, is intended to be an informal process and should be treated as such. “We usually give a disclaimer that the division is not bound by it. We are not doing any research. It is just a quick answer in contrast to the formal process where the division is bound by the advice.”
REVENUE STANDARD CONCERNS
The following is from a survey by PwC and the Financial Executives Research Foundation of 335 companies and their progress implementing the new principles-based revenue recognition standard Issued by the Financial Accounting Standards Board and the International Accounting Standards Board.
Companies Do Not Yet Have a Complete Understanding of How the Standard Will Affect Them
A majority (75 percent) of respondents have not yet completed their initial impact assessment, and almost 27 percent of respondents have not begun an assessment. Only 5 percent of respondents have started to implement systems, process and controls changes, despite the fact that public companies planning to utilize the full retrospective method of adopting the standard will need 2016 information.
Reasons for Delayed Implementation
Key explanations cited for why companies have not begun to address the standard change include:
Do not believe there will be a significant impact on our company’s financials: 38 percent
Resource constraints: 18 percent
Waiting for clarification on additional accounting topics: 14 percent
Waiting for finalization of the proposed amendments: 13 percent
Expect to initiate efforts now that the FASB and IASB have voted on the effective deferral date: 8 percent
Only 9 percent of survey respondents are planning for adoption prior to 2018, with over 66 percent of respondents indicating that their company plans on taking advantage of the deferral.
Sources: PwC/Financial Executives Research Foundation
Kronforst did warn companies not to use phone consultation as a means to dodge differences of opinion with your audit firm or more formal review of some issue. “Companies should let the auditors be involved and not do a separate process,” he said. “We’ve seen companies get an answer from an auditor, come to us to get a different answer, and then go back and beat the auditor over the head with it.” Corp Fin officials have a term for it: “opinion chomping.”
Opinions may vary with an informal consultation because staff doesn’t have the time or insight to appreciate the subtleties and company-specific facts that underlie an issue. More nefarious, Kronforst said, are intentional efforts to manipulate staff advice by “sanitizing the fact set.” His warning: “Once we figure out this is a difficult question that probably wasn’t intended for a phone review, we will put companies through the formal process.”
Abusing “phone duty” is all too common, said Wayne Carnall, a partner at PwC and the division’s former chief accountant. “What will happen is that legal counsel will say, ‘Well, we just cleared that issue with the division’s Chief Accountants Office, so there is no issue,’ but they omitted significant points that were relevant to the decision,” he explains. “If you have an issue that is a difficult issue, you are much better off going in with a formal consultation.”
Brian Lane, a partner at law firm Gibson Dunn, says planned SEC consultations should start with a review of issues ahead of time with a company’s auditor and legal counsel. This helps to set talking points ahead of the call. Also, he says, keep the histrionics to a minimum—don’t be confrontational or panicked. “The staff doesn’t want to debate the letter on the phone,” he says. “Everyone wants to get Corp Fin on the phone to tell them how wrong they are, but the staff doesn’t want to have that conversation. You have to characterize it as a clarification. You can call to say you don’t understand what they’re getting at and ask them to explain their concerns. Then you can start talking.”
Changes at Corp Fin
Amid the many changes affecting financial disclosures and company reporting, Corp Fin has itself undergone some structural changes. For example, after reviewing the industry-specific examination groups assigned to public companies that file disclosure documents, the division consolidated banking groups that were split in 2010 between large and smaller institutions.
Kronforst sees benefits to this and similar efforts. “We’ve gotten questions about whether that means continuous reviews for large financial institutions will end. That is not the case,” he said. “I don’t think it really means anything from a registrant perspective. But as far as which group to contact there will no longer be confusion.”
Corp Fin is also focusing on technical issues, rather than strictly sector-based reviews by examination groups. “The change aligns us more closely with our colleagues in the Office of the Chief Accountant,” Kronforst said. For example, instead of stock compensation issues that might sporadically emerge within specific industry groups and be reviewed by multiple SEC staff, one point person will now oversee that specific issue.
“One of the challenges the division has always had is having consistency with their comments,” Carnall says. “When you have a focus that is not just by industry groups, but by the topical areas, it will help improve consistency and lead to having better comments going out. I think it is a win-win situation.”