Highlights of the 2015 AICPA National Conference …...2015/12/14 · Fill the GAAP • Highlights...

Fill the GAAP • Highlights of the 2015 AICPA National Conference on SEC and PCAOB Developments 1

No. 2015-16

14 December 2015

Highlights of the 2015 AICPA National Conference on

Current SEC and PCAOB Developments

Conference Overview

The 2015 AICPA National Conference on Current SEC and PCAOB Developments (the Conference) was held 9 - 11 December 2015, in Washington, D.C. As in prior years, representatives of the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB) and the Public Company Accounting Oversight Board (PCAOB), along with auditors, preparers, users, and industry experts, met at the Conference to express views on various important accounting, auditing and financial reporting topics. Our publication provides an overview of key topics discussed during the Conference.

Keynote Addresses and Updates from Lead Representatives

Center for Audit Quality Update from Cynthia Fornelli, CAQ Executive Director

Cynthia M. Fornelli, Executive Director for the Center of Audit Quality (CAQ), provided an overview of the CAQ’s vision for the future of the public company audit profession. Ms. Fornelli explained that two surveys conducted by the CAQ indicated that investor confidence in U.S. capital markets held steady at 73% and that independent auditors topped the list of entities of the financial reporting supply chain in which investors were confident. Ms. Fornelli stated that the CAQ is focusing on initiatives that help the profession work on audit quality indicators and on deterring and detecting financial reporting fraud. The CAQ has also focused on engaging with members of academia to generate behavioral research on issues that are relevant for practitioners. In addition, the CAQ will continue to work with audit committees to increase transparency and promote communication between audit committees and independent auditors. Ms. Fornelli discussed the current role of the auditor in cybersecurity, an evolving area in the profession, and the profession’s adaptation to the changing workforce.

SEC Keynote Address by Mary Jo White, SEC Chairwoman

Mary Jo White, SEC Chairwoman, discussed the responsibilities of preparers, auditors, audit committees, standard setters, and regulators. Chairwoman White highlighted the preparers’ responsibilities in internal control over financial reporting (ICFR) and best practices in the use of non-GAAP measures. She explained that the profession’s continued focus on ICFR is important to providing high-quality financial information on which investors can rely. Although a company’s non-

Contents

Conference Overview………….......1

Keynote Addresses and Updates from Lead Representatives……......1

OCA Policy Initiatives and

Current Projects……………..……..6

SEC Enforcement Update…...…..19

Developments in the Division of Corporation Finance……………..20

Current Topics in Assessing ICFR……………………..………..21

PCAOB Auditing Standard-

Setting Update………………........22

Cybersecurity Panel Discussion….23

MD&A Panel Discussion……......24

Revenue Recognition………….….24

Accounting for Leases…………....25

Appendix – Links to Speech Transcripts…………………....…..27


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14 December 2015

GAAP measures are intended to convey information to investors that the issuer believes is relevant and useful in understanding its performance, Chairwoman White indicated that these measures are a potential source of confusion. She explained that finance and legal teams, and audit committees should consider the purpose, usefulness, and completeness and accuracy of using non-GAAP measures.

Chairwoman White summarized the positive direction of auditors, stating that the profession has seen a reduction in the number and severity of restatements of financial statements and high investor confidence in audited financial statements and independent auditors as a result of enhanced audit quality. Chairwoman White also credited the PCAOB’s inspection program and enhancements to auditing standards for the positive impact on the audit responsibilities. Chairwoman White discussed the demands and importance of audit committee directors and indicated that

companies and directors should consider “…those who have the time, commitment, and experience to do the job well…” as growing demands require greater commitment and time from audit committee members. Chairwoman White stressed the importance of the audit committee report in its purpose to serve as a place for engaging with shareholders on important subjects and meeting investors’ ever-changing needs. She also highlighted the progress in the convergence of U.S. GAAP and IFRS by the FASB and IASB in major areas such as the new revenue recognition standard, business combinations, and fair value measurements.

Chairwoman White pointed to the SEC’s disclosure effectiveness initiative, explaining that the Division of Corporation Finance (Corp Fin) is reviewing Regulations S-K and S-X. The SEC issued a request for comments on certain Regulation S-X requirements in September 2015. She anticipates “further output in the coming year on Regulation S-K, as well as on various technical changes related primarily to financial statement disclosures and improvements to the presentation of information and tools on sec.gov.” In conclusion, Chairwoman White noted that “…it is important to keep in mind that regulators are not just preaching to you, although it may seem like that at times. What we are trying to do is engage proactively with you on our shared responsibility for high-quality, reliable financial reporting.”

Remarks of James Schnurr, SEC Chief Accountant

James Schnurr, Chief Accountant of the Office of the Chief Accountant (OCA), discussed the key issues facing the accounting profession, considerations about disclosure effectiveness, the role and communications of audit committees, and the importance of high-quality auditing standards. Mr. Schnurr highlighted the importance of the roles of preparers, auditors, audit committees, standard setters, and enforcement in providing investors with relevant information to allow them to make informed decisions and facilitate capital formation.

Mr. Schnurr pointed to management’s and the auditors’ need to focus on the ongoing maintenance and assessment of ICFR. He highlighted management’s responsibility in the design and effectiveness of ICFR, stating that “…well-designed controls support the process by which those accounting judgments are made and the resulting quality of the financial reporting.” He further emphasized that deficiencies in ICFR audits are one of the most frequent findings in PCAOB inspections, noting that ICFR issues identified by the PCAOB may not only be a problem with audit

“Key to our mutual

success is maintaining

high-quality reporting of

reliable and relevant

financial information

that investors can use to

make informed

investment decisions.”

- Mary Jo White, SEC

Chairwoman

“Audit firms should

compete for work on the

basis of audit quality,

keeping in mind that

their responsibility is

also to the shareholders

rather than management

of the company.”

– James Schnurr, SEC

Chief Accountant


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14 December 2015

execution but an indicator of deficiencies in management’s controls and assessments. Mr. Schnurr also pointed out the importance of auditor independence and concerns that may arise as a result of the growth of consulting practices in accounting firms. Mr. Schnurr encouraged the continued partnership between the FASB and IASB in converging financial account standards. He summarized the SEC Enforcement Division’s cases that were brought against BDO and Grant Thornton during 2015 as a result of violations of professional obligations to investors and commended the PCAOB’s progress in their transparency and reporting initiatives.

Mr. Schnurr also mentioned the SEC staff’s continued work on the disclosure effectiveness initiative and pointed to the efforts of Corp Fin to update the requirements in Regulations S-K and S-X, and the OCA’s coordination with the FASB to improve the effectiveness of financial statement disclosures and minimize

duplication with existing disclosure requirements.

PCAOB Keynote Address by James Doty, PCAOB Chairman

James Doty, PCAOB Chairman, discussed findings and trends of recent work completed by the PCAOB. He mentioned that constituents continue to struggle to see the merits of a robust audit and possibly perceive audits as a regulatory burden. The role of the PCAOB’s oversight is intended to protect investors from the risk of material misstatements and omissions in financial reporting, and promote the interests of investors and the audit profession through informative, accurate and independent audit reports.

Mr. Doty highlighted trends resulting from the PCAOB’s investigations and disciplinary proceedings. He argued that PCAOB remediation efforts have changed audit firms’ conduct across the board through a “spill-over” effect of improved audit

quality when deficiencies were found and remediated in an audit firms’ process. He stated that when the PCAOB identified a significant deficiency in an engagement, such that the audit report should not have been issued when it was, most firms tend to agree with the PCAOB’s finding. Mr. Doty also noted that when the PCAOB inspected an audit and found no significant deficiencies that merited inclusion in Part 1 of their inspection report, then the PCAOB tends to see a statistically significant decrease in effort and increase in restatement rate.

Mr. Doty discussed the increased recognition of the PCAOB abroad and the collaborative efforts with foreign audit oversight bodies to carry out inspections in foreign jurisdictions. There is a continuous effort to gain access to conduct inspections in foreign jurisdictions which currently do not allow PCAOB inspections. Additionally, Mr. Doty highlighted the PCAOB’s current and forthcoming efforts on the oversight of audits of broker-dealers. He specifically mentioned the PCAOB’s

attention on assembling and analyzing information about the state of audits by various types of firms and of various types of brokers and dealers. Increased disclosure requirements are also being deliberated in order to provide investors with useful information for their consideration. Particularly, the PCAOB intends to issue a new proposal for public comment in 2016 on changes to the audit report to include key audit matters, as well as on disclosing the name of the engagement partner and other firms, if any, that participate in an audit.

“We can protect the

public's interest in the

audit as a mechanism to

provide trust only by

recognizing the impact

of incentives, both

systemic and personal,

and implementing

stronger counter-

measures.”

– James Doty, PCAOB

Chairman


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14 December 2015

FASB Address by Russell Golden and FASB Accounting Standard Setting Update

by Susan Cosper, FASB Technical Director and Emerging Issues Task Force

(EITF) Chairwoman

Russell Golden, FASB Chairman, began his remarks by emphasizing the importance of FASB’s independence from political and special interest influence in the standard setting framework. Mr. Golden, along with Susan Cosper, FASB Technical Director and EITF Chairwoman, discussed the progress made to support companies’ implementation of the new revenue recognition standard, and provided an update on upcoming projects, such as impairment of financial instruments, and projects nearing completion, including disclosure framework, hedging, definition of a business, and leases.

Revenue Recognition

Mr. Golden discussed the creation and progress of the Revenue Recognition Transition Resource Group (TRG), which was created to help manage implementation issues and limit the extent to which preparers disagree on how to interpret the standard prior to its effective date. Jointly with the IASB, the TRG involves various stakeholders including preparers, auditors, users, the Private Company Council and the AICPA. He highlighted the usefulness of the TRG discussions which, while non-authoritative, have provided practical expedients that should reduce cost and complexity in implementation and on an on-going basis.

Additionally, Mr. Golden affirmed that the FASB and IASB have converged on all significant issues regarding the new revenue recognition standard. However, he noted the following differences currently exist:

Collectability of consideration must be probable before an organization applies the revenue guidance. “Probable” has slightly different meanings under U.S. GAAP and IFRS.

Public companies applying U.S. GAAP will be required to make quantitative disclosures on a quarterly basis. These disclosures include disaggregation of revenue, contract balances, revenue recognized in the current period that was included in the contract liability at the beginning of the period, revenue recognized in the current period for performance obligations satisfied in previous periods, and remaining performance obligations. Companies applying IFRS will apply the existing interim disclosure guidance to assess what disclosures about revenue may be necessary, without having specific interim revenue disclosure requirements, except for disaggregation of revenue.

It currently is unclear whether the IASB will propose changes similar to what the FASB will propose as part of its Identifying Performance Obligations and

Licensing and Narrow-Scope Improvements and Practical Expedients Exposure Drafts.

Impairment of Financial Instruments

Similar to the Revenue Recognition TRG, the FASB has established a transition group for the standard on the impairment of financial instruments. The major difference in the new impairment of financial instruments standard will be the required use of the forward looking “current expected credit loss” (CECL) model


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instead of the “incurred loss” approach in effect today. The CECL approach is intended to capture lifetime expected losses. Additionally, the standard will provide enhanced disclosures compared to current U.S. GAAP. Mr. Golden addressed concerns regarding the forward looking model, countering the notion that the new standard will require companies to implement costly and complex new systems, to look forward 20 or 30 years, or that the standard will be at odds with how bank examiners review financial instrument impairments.

The FASB expects to publish a final accounting standards update (ASU) on credit losses in early 2016. Public businesses that meet the definition of an SEC filer will be required to apply the new guidance for fiscal years beginning after 15 December 2018, including interim periods within those fiscal years.

Hedging

Mr. Golden discussed that both investors and preparers have raised concerns that current hedge accounting standards do not appropriately reflect potential risk-mitigation strategies into which companies have entered, “…because they are rule-oriented and fairly rigid.” An exposure document was issued by the FASB several years ago, but the project had since been put on hold in order to switch focus to finish classification and measurement, and impairment. The FASB returned to the project in 2015 and expects to issue an exposure draft during the first half of 2016.

Definition of a Business

Mr. Golden discussed the FASB’s issuance of an exposure draft to clarify the definition of a business. The proposed guidance provides a more robust framework to help companies assess whether a transaction should be accounted for as an asset acquisition or a business combination. The proposed guidance is intended to

promote consistency in application, reduce the costs of the accounting assessment, and make the definition more operable. The proposed updated definition of a business would lead to more transactions accounted for as asset acquisitions, which consequently would affect various other areas of accounting, including goodwill, consolidation and disposals.

Disclosure Framework

Mr. Golden and Ms. Cosper both discussed the overall disclosure framework project, which encompasses the FASB’s project on materiality. Two exposure drafts were released in September 2015. The first exposure draft would amend FASB Concepts Statement No. 8, Conceptual Framework for Financial Reporting, which aligns FASB’s

definition of materiality currently used by the SEC and PCAOB. The second exposure draft is the proposed accounting standards update, Notes to the Financial

Statements (Topic 235): Assessing Whether Disclosures are Material. The proposed

accounting standards update is intended to clarify the process that companies and other filers of financial reports follow in assessing the materiality of information included in their notes to financial statements. According to Mr. Golden, “The proposed amendment would not change the legal definition of materiality—the FASB does not have that authority. The amended Concepts Statement would apply only to the Board’s observation of materiality as part of its standard-setting process. The proposed amendment would not apply to preparers and auditors. The proposed ASU would clarify, but would not change what we understand to be the predominant current practice related to the assessment of materiality by companies


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and other filers. The ASU clarifies a longstanding provision of U.S. GAAP that companies need not apply FASB standards to immaterial items. Specifically, the proposed clarification indicates that companies need not include immaterial information in their financial report disclosures. Put another way, failure to disclosure immaterial information is not an accounting error.”

The disclosure framework project includes three phases. The first phase is intended to establish how the FASB considers disclosures in order to promote consistency in standard-setting activity. The second phase promotes better communication by reporting entities when assessing disclosure requirements. Therefore, the proposed accounting standards update on materiality falls into phase two. Lastly, phase three will reevaluate current disclosure requirements for certain accounting standards regarding the disclosure framework. The FASB is currently working on exposure

drafts to reevaluate disclosures for defined benefit plans, fair value measurements, income taxes and inventory.

IASB Chair Address by Hans Hoogervorst, IASB Chairman

Hans Hoogervorst, IASB Chairman, provided an update on key developments from the IASB. Mr. Hoogervorst discussed the improved revenue recognition standard that was initiated as part of the convergence of U.S. GAAP and IFRS. Mr. Hoogervorst noted that the revised revenue recognition standard “… is a huge success for all of us—and especially for investors—that companies around the world will be using essentially the same standard for their top line. Few would have thought this possible ten years ago.” In addition, the anticipated release of an improved lease accounting standard in January 2016 will also converge lease accounting standards between U.S. GAAP and IFRS. Mr. Hoogervorst also highlighted the increased use of IFRS in Asia, including Japan, India, and China. He

highlighted that the growth of IFRS can be seen by the recent high-profile listing of Ferrari on the New York Stock Exchange, which gave Ferrari a platform to attract U.S. investment. Ferrari was able to get listed using their home-country financial statements, which are prepared in accordance with IFRS. In the next year, the IASB plans on completing two consultations on its agenda and the effectiveness of its structures. Mr. Hoogervorst ended his remarks noting that “IFRS strips out significant costs for American investors, multinational preparers and global accounting networks. More generally, the U.S. has a big interest in a strong infrastructure for the global economy, of which IFRS is an important part.”

OCA Policy Initiatives and Current Projects

Remarks on OCA Policy by Brian Croteau, Deputy Chief Accountant

Brian Croteau, Deputy Chief Accountant for the OCA, indicated that ICFR continues to be an area of focus for the OCA. Mr. Croteau stressed the importance of properly identifying and describing the nature of control deficiencies and understanding the complete population of transactions that a control is intended to address in advance of assessing the severity of any identified deficiencies. Mr. Croteau stressed that “The evaluation of whether it is reasonably possible that a material misstatement could occur and not be prevented or detected on a timely basis requires careful analysis that contemplates both known errors, if any, as well as


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potential misstatements for which it is reasonably possible that the misstatement would not be prevented or detected in light of the control deficiency.”

Mr. Croteau discussed the Concept Release on Possible Revisions to Audit Committee Disclosures, which was released by the SEC earlier this year. Mr. Croteau noted that “…the staff has observed a growing desire by some investors to hear more from audit committees about how they perform their role as gatekeepers for the benefit of investors. The staff also has observed that many audit committees have enhanced their public reporting to investors by including disclosures that go beyond those required by today’s rules.” Comment letters received from investors on the Concept Release suggest there is a significant interest in hearing more from audit committees, particularly for “…audit committees’ work in areas such as the selection and appointment of auditors, evaluation of the qualifications and work of the audit

team, and the determination of auditor compensation.” Mr. Croteau then discussed the OCA’s focus on auditor independence issues. He stressed it is particularly important for management and audit committees “…to have policies and procedures for ongoing monitoring of the provision of non-audit services during their execution to address the risk of ‘scope creep’ that could result in a service becoming impermissible and impairing the auditor’s independence. When that happens, unplanned changes in auditors and potential re-audits may be necessary which can be costly and distracting to the company and its shareholders and could interfere with capital raising plans.”

Remarks on OCA Policy by Wesley Bricker, Deputy Chief Accountant

Wesley Bricker, Deputy Chief Accountant for the OCA, began his remarks by noting that one of the single most important measures used by investors, regardless of a company’s industry, the nature of its securities, or the capital markets it accesses, is revenue. He cautioned that a majority of companies had not completed their initial impact assessment of the new revenue recognition standard. As companies prepare their annual financial statements in the next few months, he anticipates that organizations will disclose in detail the expected effects that the new revenue recognition standard will have of their financial statements. Alternatively, if the effects are still unknown, in addition to a statement in that regard, registrants should consider disclosing when the assessment is expected to be completed.

Mr. Bricker further highlighted the recent trend in accounting restatements. The accounting topic areas most commonly identified in restatements included debt/equity accounting, statement of cash flows classification, and income tax accounting. He suggested an increased focus on financial reporting competencies and other internal controls over preparation and review processes concentrating in these

areas before financial statements are provided to investors. He recommended that companies, including management and their audit committees, continually assess whether they have sufficient training and competence available to support high quality financial reporting.

Remarks on OCA Policy by Julie Erhardt, Deputy Chief Accountant

Julie Erhardt, Deputy Chief Accountant for the OCA, discussed her observations on aspects of the U.S. engagement with IFRS and the goal of a single set of high-quality global accounting standards. Firstly, Ms. Erhardt noted that the U.S. was a strong


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supporter and active participant in the global accounting profession’s decision to convert the former volunteer-based International Accounting Standards Committee into the permanently-staffed IASB and that “…we in the U.S should continue to be actively involved with IFRS.” Additionally, she remarked that the U.S. is perceived as a perennial leader on financial reporting policy matters, possessing extensive historical perspective as well as current real world experience, which should be harnessed to support the work of the IASB. Ms. Erhardt noted that benefits to the U.S. actually arise as a consequence of the IFRS policy decisions made by other countries. For example, U.S. companies and investors now encounter and use the more recognizable IFRS financial reporting framework as they evaluate the financial prospects of cross-border acquisition, investment, joint venture, and trade opportunities. Further, U.S. issuers that have overseas operations are more likely to be able to use a common IFRS-based accounting platform to meet statutory financial

reporting requirements in several countries; audit firms benefit from this aspect as well.” Lastly, Ms. Erhardt conveyed her impressions of the perspectives of some in the accounting profession overseas on how the U.S. might engage with IFRS in the future. She believes that some constituents overseas do not anticipate that the U.S. will adopt IFRS for financial reporting by domestic public entities. Additionally, Ms. Erhardt noted that “If U.S. involvement with IFRS is now to come in a completely ad hoc manner, this could give rise to concerns that there is no memorialized intention or longer term plan for parties from the U.S. to stay engaged with and be supportive of IFRS.”

SEC Staff Remarks on OCA Current Projects OCA Auditor Independence Consultation Process

Michael Husich, OCA Senior Associate Chief Accountant, discussed auditor

independence, including the consultation process in the OCA. He noted that the OCA has an experienced team available to respond to independence consultations. In many cases, the calls received by the OCA can be resolved by directing someone to the relevant Commission or staff guidance. However, consults may also be interpretive in nature, and some may require a much deeper analysis, if the existing guidance is not exactly on point. Regardless of the nature of the independence question, the staff generally encourages the inquirer to communicate in writing to help the OCA better understand the facts. It may be difficult for the staff to provide definitive views for certain types of questions. For example, non-audit service questions generally tend to be very fact specific and frequently those facts may be only partially known or still evolving. Moreover, a description of the service by itself may not provide the full picture regarding the manner in which the service may ultimately be performed. However, the staff nonetheless will generally provide

feedback or observations with consideration to any written analysis provided by the caller. Lastly, to the extent an independence question is posed to the SEC staff as a result of an ongoing PCAOB inspection, the OCA expects the inquirer to be transparent, as discussions with the PCAOB staff may be warranted in order to determine an appropriate response to the question.

Mr. Husich clarified that the staff does not have the statutory authority to waive an independence violation because the company and its accountant cannot be relieved of the obligation to file audit reports certified by an independent public accountant.


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While there is no requirement under the Commission’s rules for issuers and their accountants to self-report independence violations, the staff expects that any potential violation of the independence rules has been appropriately evaluated by the accountant and the Company and its audit committee, to determine the potential regulatory implications. In addition, the accountant should also consider whether potential improvements to its quality control system are necessary to avoid similar future occurrences. When in doubt, the OCA encourages issuers and accountants to consult with the staff on these matters. Mr. Husich also discussed that a company should consider, as appropriate, the extent of its policies and procedures in place to promote compliance by its accountant with SEC and PCAOB independence rules. For example, the accountant must be independent of its audit client and its affiliates and should have an effective

system in place to identify affiliates accurately and in a timely fashion. Management should have its own records concerning affiliates, which the accountant could refer to in determining if its list of affiliates is complete and accurate. The OCA suggests that management and audit committees, along with its accountant, regularly review their current practices in this area. Mr. Husich noted that the issuer is in a position to supplement the accountant’s independence procedures by requiring management, officers and directors to disclose potential conflicts or other relationships with its accountant that could be problematic. The OCA staff encourages issuers, in consultation with their accountant, to evaluate the sufficiency of their monitoring processes, as appropriate, to reduce the likelihood of entering into prohibited business relationships.

Partner Rotation

Mr. Husich referenced the FAQs issued to help address some common questions

received by the OCA about the application of current partner rotation rules. He noted, however, that it is impractical to address the full range of fact patterns and permutations that could arise in a series of FAQs or other staff guidance. The staff would thus prefer to respond to rotation questions on a case-by-case basis, so that it can give due consideration to the particular facts and circumstances. One reminder provided is that quarterly reviews should not be overlooked in complying with partner rotation requirements. For example, even if a partner only served as the lead partner for one quarterly review during the year, that year would count as one year toward the total number of years that partner served as the lead partner on the engagement.

Presentation of Discontinued Operations

An SEC staff member discussed the FASB’s new guidance on reporting discontinued

operations, which is meant to address concerns that too many disposals were qualifying for discontinued operations presentation. The guidance introduced new terminology into the judgment of determining whether the presentation of discontinued operations is appropriate, such as strategic shift and major effect. Under

the new guidance, to present a disposal as a discontinued operation, a component (or group of components) that is disposed of or classified as held for sale must represent “a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The SEC staff member observed that the standard requires judgment to determine whether a disposal meets the revised definition for a


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discontinued operation. Accounting Standards Codification (ASC) 205-20 examples of what may constitute a strategic shift that will have a major effect on operations and financial results include a sale of a product line that represents 15% of total revenue; the sale of a geographic area that represents 20% of total assets; and the sale of all stores in one of two types of store formats that historically provided 30-40% of net income and 15% of current net income. The SEC staff member refuted that the quantitative factors included in the examples are meant to create thresholds by which to determine whether a disposal represents a strategic shift that has a major effect on the entity’s operations and financial results and noted that in the SEC staff’s view, the thresholds are illustrative and do not establish bright lines or safe harbors. The SEC staff member believes that judgment is required to determine which financial results are indicative of a strategic shift that has a major effect, and that

certain “primary” metrics that are prominently presented in the financial statements and communicated to investors, such as revenue, total assets and net income are items that the SEC staff would clearly consider to be relevant metrics. In the SEC staff member’s view, the guidance indicates a need to evaluate the totality of the evidence, and there is no single financial metric that is determinative in concluding that a disposal had a major effect on the entity’s operations and financial results. While the guidance does not provide quantitative bright lines in determining whether a disposal is a strategic shift that has a major effect, the less significant a financial impact the disposal has on an entity, the stronger the qualitative evidence would need to be. In evaluating whether the qualitative evidence supports a strategic shift that has a major effect, the SEC staff member notes that it is important to consider the prominence and consistency with which the disposed component and related qualitative factors have been discussed within periodic filings.

Post-Vesting Restrictions

An SEC staff member provided observations regarding the impact of post-vesting restrictions on the measurement of share-based awards. The measurement of share-based awards impacts compensation cost. Post-vesting restrictions, such as transfer or sale restrictions, are a common feature of many share-based payment arrangements. ASC 718 provides guidance on the accounting for share-based awards when the sale of the underlying shares is prohibited for a period of time subsequent to the awards vesting date. The post-vesting restrictions should be considered when estimating the grant-date fair value of the award. The SEC staff member noted that it is expected that a post-vesting restriction may result in a discount relative to the market value of common stock to reflect that the market shares can be freely traded while restricted shares cannot. The 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, rather than an attribute related to the individual holding the award. The SEC staff member also noted that some market participants have indicated that post-vesting holding restrictions on share-based payment awards can result in significantly lower stock compensation cost. The SEC staff member cautioned that although post-vesting restrictions should be considered in estimating the fair value of share-based payments, when evaluating the appropriateness of measurement in this area, the staff 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


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restrictions may have little, if any, effect on the amount at which the shares being valued would be exchanged.”

Staff Accounting Bulletin No. 102 Reminders

An SEC staff member provided reminders regarding Staff Accounting Bulletin (SAB) No. 102 and noted that for financial services companies, the allowance for loan losses represents one of the most significant estimates in the financial statements. For auditors, the risk of material misstatement for the allowance for loan losses often represents a significant risk due to the degree of complexity and judgment involved in the measurement of the allowance. SAB No. 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 U.S. GAAP. The SEC staff member highlighted a few excerpts

concerning data reliability and documenting adjustments, as follows:

Data-reliability: SAB No. 102 speaks to the expectation that management provide written documentation on certain decisions, strategies, and processes for its allowance for loan loss methodology. One of these processes relates to the accumulation of relevant, sufficient, and reliable data on which to base the allowance estimate. Source data is subjected to management’s selected methods and judgments to ultimately arrive at a recorded estimate. SAB No. 102 provides for tailoring aspects of the allowance process to the size and complexity of the registrant and its loan portfolio. The SEC staff member believes, as a general rule, an allowance for loan loss process that would meet the expectations of SAB No. 102 would include effective internal accounting controls designed to ensure the use of relevant, reliable, and sufficient data to develop the estimate. While management reviews certainly have a place in the process of developing an accounting estimate, transaction level controls would typically be needed in order to satisfy SAB No. 102’s expectations surrounding data relevance and reliability. Registrants should consider the sufficiency of controls and documentation related to the aggregation and evaluation of the data itself to assert the relevance, sufficiency, and reliability of the data used.

Documentation of adjustments: The SEC staff members noted that adjustments are often recorded to capture factors not already included in the entity’s loss estimation model. These factors could include changes in risk selection and underwriting standards, lending policies, and certain economic trends and conditions. SAB No. 102 establishes an expectation that entities consider these types of factors and determine and document which factors were used in the analysis, and how those factors affected the loss measurements. In order to meet these expectations, it would likely be

important that the entity have an adequate understanding of the data currently being used in the loss estimation model, as well as the methods and judgments being applied to that data to ultimately arrive at an estimate. This would likely be important in order to establish the starting point for the allowance calculation, and in turn be able to evaluate the necessity and reasonableness of proposed adjustments. The SEC staff member further noted that in situations where adjustments are recorded, SAB No. 102 establishes the expectation that management maintain sufficient, objective


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evidence to support the amount of the adjustment, and explain why the adjustment is necessary.

Consolidation – Risk Retention

An SEC staff member addressed recent consolidation questions received by the OCA related to certain special purpose entities. Since the adoption of the final rules to implement the Dodd-Frank credit risk retention requirements for asset-backed securities, the OCA has received accounting consultations related to the application of ASC Topic 810 to a registrant’s involvement with a so-called collateralized manager vehicle (CMV). CMVs are designed to sponsor various types of securitization transactions. By way of example, the SEC staff member provided one particular fact pattern whereby “the CMV itself was required to hold an ownership interest in the underlying securitization to which it acted as a sponsor. The registrant

made an initial equity contribution to the CMV, and obtained one of three seats on the CMV’s board of directors. The remaining equity capital was funded by third party investors, several of which were individually significant. The registrant also entered into a services agreement to provide certain support functions to the CMV, including middle and back office operations, investment research, and other administrative activities. An aspect of the registrant’s consolidation analysis related to whether the CMV was a voting interest entity under Topic 810. The analysis focused heavily on the ownership of the CMV and the role of the CMV’s board of directors. The equity holders of the CMV, as represented by the board of directors, had power over the most significant activities of the CMV, including the development of the investment strategy, the hiring and firing of service providers, and the appointment of individuals to the CMV’s investment committee.” The SEC staff member noted that based on these factors, the OCA did not object to the conclusion that the CMV was a voting interest entity under Topic 810 and the staff understand that many variations of this type of entity exist in the marketplace. Therefore, it is possible that several of the most significant factors to the analysis may vary greatly from CMV to CMV, and therefore may result in different accounting conclusions. As a result, it would not be appropriate to analogize their conclusions to other fact patterns that involve a CMV.

Segment Identification and Disclosure

An SEC staff member highlighted some observations around the identification of operating segments and aggregation into reportable segments. The SEC staff member noted that as business operations evolve, how management organizes the entity for purposes of making operating decisions and assessing performance will also likely evolve. As such, registrants should periodically reassess their identification of operating segments, in particular after a change in organizational structure, key

personnel changes, or significant acquisitions and dispositions. Further, the SEC staff member discussed relevant guidance which notes that an operating segment is a component of the entity for which operating results are regularly reviewed by the chief operating decision maker (CODM) for the purpose of allocating resources and assessing performance. Registrants should consider whether their identified operating segments are consistent with these sources of information. At times, application of the guidance will result in identification of a single operating segment. When such identification is consistent with the guidance, it can be a significant signal to investors about how management has allocated resources. Upon arriving at this


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conclusion, registrants should disclose that they allocate resources and assess financial performance on a consolidated basis and should explain the basis for that management approach. The SEC staff member further noted that it would seem counter to the objectives of segment reporting if the business description indicates the entity is diversified across businesses or products, yet is not managed in a disaggregated way.

The SEC staff member noted that the OCA has also spent significant effort in evaluating registrants’ application of the guidance for aggregation of individual operating segments into one or more reportable segments. While the identification of operating segments is done under the management approach, the determination of reportable segments is a modified management approach. This approach incorporates both aggregation criteria and quantitative thresholds to determine which

subset of operating segments should be reported in order to meet the objectives of segment reporting without reporting overly detailed information. Two or more operating segments may be aggregated into a single reportable segment when all of the following are true:

1) aggregation is consistent with the objectives and principles of the standard, 2) the operating segments have similar economic characteristics, and 3) the operating segments are similar with respect to five qualitative criteria.

The SEC staff member discussed that in determining whether two operating segments are “similar” with respect to the economic characteristics and each of the qualitative criteria, the guidance notes the evaluation should be made relative to the range of the entity’s business activities and the economic environments in which it operates. For example, some entities operate within a single industry segment but may have multiple product lines by which it has defined its operating segments.

Under the guidance, the entity would need to consider the range of those product lines and the characteristics of each that drive economic performance when evaluating aggregation. In doing so, it may be helpful to consider whether a reasonable investor would consider the two operating segments to be similar. Often, publically available industry reports and other analyses by users will indicate the key characteristics by which a reasonable investor may analyze the entity. Once the registrant has identified those segments that meet the quantitative tests or are otherwise qualitatively material and require separate reporting under the guidance, there is additional guidance for combining any remaining segments. The SEC staff member noted that in performing this analysis, registrants should consider what additional level of detail would be useful to users of the financial statements for purposes of understanding the entity’s performance, assessing its prospects for future cash flows, and making more informed judgments about the entity as a whole. As a good check, registrants may also want to consider whether their reportable segments facilitate a consistent description of the entity in its annual report and other published information, such as its earnings release filings, investor presentations, and financial information on its website.

Customer Incentives

An SEC staff member discussed the application of the customer payments and incentives guidance in ASC Subtopic 605-50, which provides that all payments to customers should be considered, and that the scope does not stop at the vendor’s


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direct customer, but explicitly includes other parties in the vendor’s distribution chain. The SEC staff member noted that questions have arisen in practice regarding how the customer incentive guidance should be applied when evaluating whether payments made by a vendor outside the distribution chain should be considered to be net against revenue, specifically due to the proliferation of intermediaries in the technology sector that serve to connect vendors of goods or services with consumers which resulted in business models that did not exist when the customer incentive guidance was originally established. The SEC staff member provided an illustrative example whereby a vendor develops a technology platform to facilitate its direct customer’s provision of revenue generating services; while the direct customer’s customer may also receive some benefit from the technology platform, that customer might not be considered in the distribution chain of the vendor because the direct customer does not pass along the services associated with the vendor’s technology

platform to its own customer. The SEC staff member cautioned that careful consideration should be taken in similar arrangements to determine which party or parties would be considered the vendor’s customer. In a similar fact pattern to the example provided, the staff has not objected to a view that payments made to customers and potential customers of the vendor’s direct customers would be classified as an expense and not be evaluated under the customer payments and incentives guidance. In reaching this conclusion, careful consideration was given to whether:

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

2) there was a contractual requirement to pass along consideration to a direct customer’s customer; and

3) the vendor was acting as an agent of its customer in passing through

consideration to a direct customer’s customer.

Application of ASU No. 2015-02 – Consolidation

The next topic addressed by the SEC staff member was the evaluation of whether a decision-maker’s fee constitutes a variable interest under the FASB’s updated consolidation guidance. The SEC provided an illustrative example whereby an entity has four unrelated investors with equal ownership interests, and a manager 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. In this simple 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. The guidance to consider interests held by related parties when evaluating whether a fee is a variable interest specifically refers to instances where a decision-maker has an indirect economic interest in the entity being evaluated for consolidation. However, the SEC staff member noted, in the instance where a controlling party in a common control group designs an entity in a way to separate power from economics for the purpose of avoiding consolidation in the separate company financial statements of a decision-maker, the OCA has viewed such separation to be non-substantive. In the SEC staff member’s example, if the manager determines that its fee is not a variable interest the amendments in ASU


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No. 2015-02 are not intended to subject the manager to potential consolidation of the entity. In other words, a decision-maker would not be required to consolidate through application of the related party tiebreakers once it determines that it does not have a variable interest in the entity.

The SEC staff member also addressed the evaluation of whether a decision-maker’s fee arrangement is customary and commensurate. The SEC staff member noted that this evaluation is done at inception of a service arrangement or upon a reconsideration event, such as the modification of any germane terms, conditions or amounts in the arrangement. The determination of whether fees are commensurate with the level of service provided often may be determined through a qualitative evaluation of whether an arrangement was negotiated on an arm’s length basis when there are no obligations beyond the services provided to direct the activities of the

entity being evaluated for consolidation. This analysis requires a careful consideration of the services to be provided by the decision-maker in relation to the fees. The SEC staff member noted that the evaluation of whether terms, conditions and amounts included in an arrangement are customarily present in arrangements for similar services may be accomplished in ways such as benchmarking the key characteristics of the subject arrangement against other market participants’ arrangements negotiated on an arm’s length basis, or in some instances against other arm’s length arrangements entered into by the decision-maker; there are no bright lines in evaluating whether an arrangement is customary, and reasonable judgment is required in such an evaluation.

Foreign Exchange Restrictions

An SEC staff member discussed that in the past year, the OCA has observed registrant disclosures indicating a loss of control of subsidiaries domiciled in

Venezuela. Disclosures indicate that these conclusions have been premised on judgments about lack of exchangeability being other than temporary and, also in some instances, the severity of government-imposed controls. The SEC staff member noted that the application of U.S. GAAP in this area requires reasonable judgment to determine when foreign exchange restrictions or government imposed controls or uncertainties are so severe that a majority owner no longer controls a subsidiary. In the same way, a restoration of exchangeability or loosening of government imposed controls may result in the restoration of control and consolidation. In other words, the SEC staff member would expect consistency in a particular registrant’s judgments around whether it has lost control or regained control of a subsidiary. In addition, the SEC staff member would expect registrants in these situations to have internal controls over financial reporting that include continuous reassessment of foreign exchange restrictions and the severity of government-imposed controls. The SEC staff member highlighted that, to the extent a majority owner concludes that it no

longer has a controlling financial interest in a subsidiary as a result of foreign exchange restrictions and/or government-imposed controls, careful consideration should be given to whether that subsidiary would be considered a variable interest entity upon deconsolidation because power may no longer reside with the equity-at-risk holders. As a result, registrants should not only think about clear and appropriate disclosure of the judgments around, and the financial reporting impact of, deconsolidation but also of the ongoing disclosures for variable interest entities that are not consolidated.


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Identifying Principal or Most Advantageous Market

An SEC staff member discussed some considerations for a company when identifying the principal or most advantageous market. The guidance in ASC Topic 820 states that a fair value measurement assumes that the transaction to sell an asset or transfer a liability takes place either in the principal market or, in the absence of the principal market, the most advantageous market for the asset or liability. The principal market is defined as the market with the greatest volume and level of activity for the asset or liability. The most advantageous market is defined as the market that maximizes the amount that would be received to sell the asset or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and transportation costs. The fair value measurement guidance also indicates a reporting entity must have access to the principal or most advantageous market at the measurement date. 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. The SEC staff member pointed that being able to transact in a market on the measurement date is something that may need to be considered even when relying on observable pricing as an input into a fair value measurement; an entity may need to consider any different characteristics associated with its asset or liability being measured at fair value and the observable pricing. Different characteristics may prevent an entity from accessing the observable market on the measurement date at the price observed within the market and may lead to a different principal or most advantageous market for fair value measurement purposes. Some observations regarding common characteristics that may prevent an entity from accessing a particular price within a market include, but are not limited to, the following:

1) a reporting entity’s need to transform the asset or liability in some way to

match the asset or liability in the observable market; 2) restrictions that may be unique to the reporting entity’s asset or liability that

are not embedded in the asset or liability in the observable market; and 3) marketability or liquidity differences between the asset or liability in the

observable market relative to the reporting entity’s asset or liability.

The SEC staff member noted that a reporting entity may not be precluded from using observable prices from a particular market as one input into its fair value measurement (even if the market does not constitute the principal market); however, an entity may need to make appropriate adjustments to the fair value measurement for any differences in the characteristics of the asset or liability being measured and the price observed within a market. Based on the example provided by the SEC staff member, an entity that is measuring the fair value of a loan may look to the securitization market when measuring the value of the loan, but would need to make

appropriate adjustments to the observed securities prices to reflect the fact that the loan has not been securitized as of the measurement date. For purposes of determining the reporting entity’s principal or most advantageous market, the SEC staff would consider starting with the initial transaction. There may be situations when the market in which the initial transaction occurs is different than the principal or most advantageous market. In those situations, a reporting entity may need to consider whether it is able to access the principal or most advantageous market for the asset or liability on the measurement date.


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Use of Cost Basis as Fair Value

An SEC staff member discussed some entities’ use of the initial cost basis of certain illiquid assets or liabilities (including any capitalized transaction costs) as its fair value measurement for a period of time following an initial transaction and provided some thoughts when considering adjustments to an initial cost basis of an asset or liability to determine fair value, as follows:

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. The reference to current market conditions at the measurement date is a key concept in measuring fair value because it is likely that a measurement date’s current market conditions differ from the market conditions

when an initial investment was made. Market conditions may evolve over time due to various factors. These factors may include changes in general macro-economic conditions, such as changes in interest rates. Other factors may include changes in the makeup of the market participants or changes in the principal or most advantageous market. In addition, there may be factors specific to the performance of the asset or liability that explains a change in fair value, such as a change in the expectation of cash flows. Even if none of the aforementioned factors exist, the fair value may differ, depending on the nature of the asset or liability, due to changes in time value from the initial transaction to the measurement date or the initial cost basis included any capitalized transaction costs. Each of these factors influences a fair value estimate and may provide evidence that the fair value of an asset or liability has changed from the initial cost basis for subsequent measurement periods.

In measuring fair value, an entity may consider incorporating observable market

pricing for its asset or liability or incorporating comparable assets or liabilities with observable market prices. Specifically, an entity should support its fair value measurement assumptions that a market participant would consider in measuring fair value. An entity may employ the evidence directly into the valuation technique as an assumption or indirectly by using the evidence or changes in the evidence to support the fair value measurement conclusion. By providing the quantitative evidence, an entity may be able to better assess and support its fair value estimate as to why the initial cost basis approximates fair value or why the fair value may have changed from the initial cost basis.

Changes in Key Assumptions to Certain Pension Accounting Measurements

Companies are recently considering different approaches to developing the discount rates used to compute the interest cost component of a sponsor’s net benefit cost for a single-employer defined benefit pension plan. An SEC staff member discussed the

OCA’s staff recent consultations with companies and accounting firms on two approaches to developing the key discount rate assumptions – a single weighted-average approach and a disaggregated approach, referred to as the “spot rate” approach.

The single weighted-average approach that is based on developing a single discount rate is permitted in the accounting guidance and is commonly applied in practice for pension plans under ASC 715. Under this approach, a single weighted-average rate is determined at the pension plan measurement date based on the projected future


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benefit payments used in developing the pension benefit obligation (PBO). The single discount rate represents the constant annual rate that would be required to discount all future benefit payments related to past service from the date of expected future payment to the measurement date, such that the aggregate present value equals the benefit obligation.

The spot rate approach uses individual, duration-specific spot (discount) rates from the yield curve that was used in the most recent measurement of the PBO for purposes of computing the interest cost component of net periodic benefit cost. The use of individual (disaggregated) discount rates results in a different amount of interest cost as compared to the use of a single weighted-average discount rate because of the different weightings given to each subset of cash flows.

However, in both approaches, the source data about market interest yields used in

estimating a discount rate was the same – it was taken from the measurement of the pension benefit obligation. In a recent consultation, the OCA did not object to a registrant changing from the use of the single-weighted average approach to the spot rate approach, and the OCA 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.

The approaches to estimating appropriate discount rates described above use the same yield curve data embedded in the measurement of the pension benefit obligation. Some registrants, however, may use a different method of measuring the obligation – a hypothetical bond matching methodology, which is based on identifying a portfolio of bonds expected to generate cash flows similar to the estimated benefit payments of the pension plan. The SEC staff member noted that some registrants have asked whether it would be permissible to change their methodology for measuring the pension obligation from using a hypothetical bond matching methodology to a yield curve methodology, since a spot rate approach for computing interest cost can be generated directly from the yield curve model. While the OCA has not consulted with individual registrants on this question, the SEC staff member noted that under the accounting guidance, the measurement of the pension obligation and the determination of interest cost are integrated concepts; that said, the measurement of the pension obligation is the relevant starting point in applying the pension accounting model. As a result, the SEC staff member remarked, a company should evaluate the basis for its current selection of the market information, and it should change its methodology only if, and to the extent that, the alternative market information results in better information to be used in measuring the pension obligation; that is, a company’s decision to select, or to change the selection of, a particular methodology should align with the requirement to select the

best rate(s) for which the obligation could be effectively settled.

Implementation of the New Revenue Standard

An SEC staff member provided detail about the OCA staff efforts in monitoring of the transition period activity relating to the new revenue recognition standard. The SEC staff member noted that because the measurement and recognition of revenue will be governed by a principles-based standard that replaces nearly all existing guidance, including industry-specific guidance, all companies will experience some degree of change. That change may include the creation of new business processes,


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systems and controls; the need to make additional estimates and judgments; and a requirement to provide expanded disclosures. As a result, a change management project plan should be a high priority for management teams and companies’ audit committees to make progress during this transition period; successful implementation of the plan will require the allocation of sufficient resources with the appropriate skill sets across the relevant areas of the business. The SEC staff also noted that some companies are taking a bottoms-up approach when assessing the effect of Topic 606, with good results, which typically involves:

1) identifying each of the different revenue arrangements and contracts, 2) taking a fresh look at historical accounting policies and practices, and 3) identifying any differences that may result from applying the requirements

of the new standard to those arrangements.

The SEC staff member commented that upon taking a “fresh look,” management may discover that its accounting policies result in different accounting conclusions from that of other companies, despite the existence of similar facts and circumstances. One of the objectives of Topic 606 was to enhance revenue standards by establishing broad principles and concepts that should result in improved comparability in the accounting for similar fact patterns. The SEC staff further noted that though similar diversity may exist under application of Topic 605, they are focused on achieving more consistent interpretation and application of the principles as part of the transition to Topic 606; as differences regarding the implementation of Topic 606 are identified, it is important for management to raise those viewpoints – whether that is through the joint TRG, AICPA industry task forces, or to the OCA – so that diversity among companies may be resolved during the implementation phase. Resolution of differences sooner rather than later is preferable from a comparability standpoint, and it could save companies from incurring additional costs associated with changing after the initial implementation date.

SEC Enforcement Update

Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, highlighted the Division’s continued focus on financial reporting and audit. Mr. Ceresney noted there was a significant increase of cases over the last few years. Violations were discovered through traditional methods, such as external and internal tips, as well as through the use of analytical tools to identify and analyze unusual trends within companies’ reported results that are not in line with other companies in the same industry. Mr. Ceresney specifically complimented the SEC’s whistleblower program created under the Dodd-Frank Act, which led to enforcement investigations and which he believes will continue to serve as a deterrent of future violations. Mr.

Ceresney specifically mentioned that the SEC prosecutes both registrants and audit firms. Audit firms and individual auditors are scrutinized to determine if they failed to comply with professional standards.

Michael Maloney, SEC Chief Accountant in the Enforcement Division, highlighted several trends noted in recent financial reporting and audit violation cases. He noted that financial reporting trends included poor tone at the top, rapid growth of companies that overwhelms their accounting systems and internal controls, earnings management to meet or exceed earnings expectations, and violations involving


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revenues recognition, complex financial instruments, valuation issues, and inadequate or misleading disclosures. Major audit violations included overreliance on management representations, insufficient professional skepticism, failure to use due professional care, independence violations and failure to sufficiently document audit results to support conclusions.

Developments in the Division of Corporation Finance

Keith Higgins, Director of SEC’s Division of Corporation Finance, along with a panel of other staff discussed Corp Fin’s developments and recent activities. Corp Fin recently finalized its rulemaking on crowdfunding and Regulation A+ and is in the process of finalizing rulemaking for executive compensation, including hedging, pay-for-performance, and clawback provisions in the event of an accounting

restatement.

Mr. Higgins highlighted changes to securities laws based on the recent enactment of the Fixing America’s Surface Transportation (FAST) Act. Changes included:

Allowing emerging growth companies (EGCs) to submit for confidential, non-public staff review of draft registration statements for an initial public offering. Section 6(e) of the Securities Act previously required issuers to publicly file the registration statement and all previously submitted drafts no later than 21 days before the date on which the issuer conducts a road show. Section 71001 of the FAST Act shortens that period to 15 days.

Amending Section 6(e)(1) to provide that an issuer that qualifies as an EGC at the time it initiates the registration process, either by submitting a draft registration statement for confidential review or by filing it publicly, but

which subsequently ceases to be an EGC, will continue to be treated as an EGC until the earlier of the date on which the issuer (1) consummates its initial public offering, or (2) the end of the one-year period beginning on the date the company ceases to be an EGC.

Requiring the SEC to revise the instructions on Form S-1 and Form F-1 to simplify disclosure requirements for EGCs to permit the omission financial information for historical periods otherwise required by Regulation S-X if the issuer reasonably believes that the omitted information will not be required to be included in the filing at the time of the contemplated offering.

Permitting issuers to include a summary page on Form 10-K which must include cross-references to the relevant information.

Mr. Higgins then discussed the Disclosure Effectiveness Project, which is intended to increase the effectiveness of disclosures provided to stakeholders. The project is currently reevaluating whether existing disclosure requirements are outdated, whether quantitative threshold are outdated given new guidance on materiality, whether certain disclosures should be more principle-based instead of prescriptive, and whether there should be scaled disclosure for smaller reporting registrants. Further, Mr. Higgins noted that Corp Fin is reviewing existing industry guidance and is considering updates to its industry guides and to the SEC’s website to make information available to stakeholders through the website’s search function.


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Mr. Higgins also provided guidance on certain financial statement and disclosure areas, specifically noting the following:

Segment determinations drive reporting in the financial statements, including the MD&A section, and companies should carefully evaluate the designated CODM to arrive at the appropriate conclusion. Also, there are no “bright-lines” in metrics used to determine segments as there is variability between industries.

Companies should carefully consider whether their fair value disclosures specifically address methods and inputs for each type of instrument presented, and be advised that aggregating fair valuing techniques for different instruments is not permitted.

Companies should disclose whether they hold large cash balances in foreign jurisdictions, which may be subject to tax regulations.

Companies are expected to disclose their conclusions regarding the implementation of the new revenue recognition standard. These disclosures should not be boiler plate and are expected to become more refined as the companies’ analyses continue.

Current Topics in Assessing ICFR

A panel of speakers consisting of preparers, regulators, and auditors discussed key developments and current topics in assessing ICFR. The panel encouraged a continued focus by management and auditors on management review controls and reminded the audience of the auditors’ and management’s role in evaluating whether controls are designed and operating effectively. In regard to review controls, the panel discussed the evaluation of control precision, predictability of an error, and

objectivity of the reviewer. In order to assess the risk of material misstatement and identify key controls, panelists discussed that auditors should understand the flow of information related to transactions. Without a clear understanding of the flow of transactions, auditors may not appropriately evaluate how existing controls operate and they may not obtain sufficient evidence to support their opinion which may allow for deficiencies in ICFR to not be identified.

The panelists also stressed the importance of open dialogue between management and their auditors to gain an understanding of company processes, risks, and key controls. Auditors should work with management to identify any differences in management’s and the auditors’ understanding of the control environment in order to enhance their evaluation of controls. The panel discussed the importance of identifying the relevant suite of controls and how such controls address risks; specifically, the panel recommended the testing of both lower level and higher level controls by auditors. Auditors should remember that higher level controls may rely on lower level controls to operate effectively; such as controls over inputs and spreadsheets that are reviewed by management.

The panel reminded the audience that auditors should use a top-down approach to evaluating ICFR. Panelists explained that the top-down approach allows the auditor to identify accounts, disclosures, and assertions that present a risk of material misstatement to the financial statements and disclosures. Very importantly, the panel


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noted that management should be willing to make modifications to ICFR to facilitate the audit process and, in response, to deficiencies identified by auditors.

PCAOB Auditing Standard-Setting Update

Marty Baumann, PCAOB Chief Auditor and Director of Professional Standards, provided and update on specific PCAOB auditing standard-setting projects. Mr. Baumann discussed the reorganization of the auditing standards using a topical structure and a single, integrated numbering system for easier navigation, noting that this reorganization was done without redrafting or making substantive changes to the existing auditing standards. The auditing standards reorganization is effective as of 31 December 2016, with early use permitted. Mr. Baumann also provided an overview of reporting standards with near-term action planned and others requiring

further research, including:

Transparency – naming of the engagement partner and participation of other accounting firms: Based on comments on its proposal, which would require the names of the engagement partner and other participants in an audit to be disclosed in the auditor’s report, the PCAOB is considering an alternative approach whereby the name of the audit engagement partner would be available in a searchable database. The PCAOB will hold an open meeting on 15 December 2015 to further deliberate on this matter.

Auditor’s reporting model: The PCAOB proposed to make the audit report more informational to stakeholders and, thus, recommended the inclusion of critical audit matters in the report; this proposal will be re-opened for discussion during 2016.

Supervision of other auditors: The PCAOB is working on a proposal

regarding new rules for the supervision of other auditors whose work is used to support the audit opinion of a chief audit firm. The proposal is expected to provide for guidelines for the assessment of qualifications of other auditors.

Auditing accounting estimates, including fair value measurements and the use of specialists: Mr. Baumann stated this is a significant focus area for the PCAOB as it plans to release a proposal during the first half of 2016 which would replace AU No. 328, Auditing Fair Value Measurements and Disclosures,

and AU No. 342, Auditing Accounting Estimates.

Mr. Baumann also provided a list of emerging issues identified by the PCAOB, as follows:

Whistleblower activity

Economic developments

Use of data/data auditing

Non-GAAP measures

Impact of FASB’s materiality proposal

Revenue recognition

Cybersecurity

Jay Hanson, PCAOB Board Member, separately provided his commentary on a few aspects of the PCAOB standard setting activities and the audit quality indicators


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project. Mr. Hanson noted that the proposal on the auditor’s reporting model received broad commentary from constituents expressing concerns with the scope of the proposal to identify and disclose critical audit matters. As a result, the PCAOB has modified the proposal and it will be re-opened for commentary during 2016. Regarding the PCAOB’s project on auditing of accounting estimates, Mr. Hanson noted that he encourage preparers “…to follow these projects closely since the ultimate result may require auditors to perform more work and therefore may affect the amount of time preparers spend gathering information for their auditors. The specialist consultation paper includes some provocative questions about whether all information that management provides to the auditor should be treated the same, regardless of whether it was prepared by accountants employed by the company or by a specialist, such as an actuary, who relies on historical data provided by the

company, along with assumptions about the future.” Regarding the PCAOB’s inspection activities, Mr. Hanson said that the results of inspections show that all engagement teams do not execute required audit procedures equally well. According to Mr. Hanson, many firms have developed tools, checklists and templates to drive more consistent execution and, while these tools overall are successful, they are not substitutes for an auditor's understanding of the business, the controls and why specified audit procedures are necessary.

Mr. Hanson also discussed the PCAOB’s efforts on audit quality indicators (AQIs), noting that the overwhelming feedback has been that exploring AQIs is a worthwhile effort. However, he notes that there is a sharp divergence in the role of the PCAOB in setting these AQIs. Some advocate that the PCAOB should move quickly to require the use of certain defined indicators by audit firms and individual

engagement teams and that such indicators be made publically available for all investors to consider. Many others have argued that the best use of AQIs is in a discussion between the engagement team and audit committee, focusing on indicators that best capture the relevant considerations for that audit. Mr. Hanson’s personal opinion is that the PCAOB needs to further its efforts to validate which AQIs have the strongest correlation to high quality audits. Mr. Hanson believes the PCAOB should refine the list of 28 indicators included in the concept release to ten or fewer and make that list public, along with clear definitions for each indicator to encourage consistency in its use. The PCAOB should continue to collect and analyze information, through its inspection process and other outreach efforts, about what indicators audit committees and engagement teams find most valuable and provide transparency about the findings and conclusions. After a few years, the PCAOB can reassess the need, if any, for rulemaking to mandate the use, discussion or disclosure of quality indicators.

Cybersecurity Panel Discussion

A panel of executives, governmental experts, and accounting firms discussed the rising importance and risks associated with cybersecurity. The panel strongly recommended investments in people and processes to proactively minimize the risk of cyberattacks. Highlights of the panel discussion included:


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Some companies and their board of directors are making progress on

addressing cybersecurity issues, however, much work remains to limit the risks associated with cybersecurity issues and to bring the necessary focus to the issue of cybersecurity.

All companies have to manage cybersecurity and cyberattacks pose the risk of compromising confidentiality and directly or indirectly disrupting business operations.

Understanding a company’s flow of transactions is equally important in ICFR as it is in managing cybersecurity.

The panel cautioned companies on making cyberattacks disclosures as they occur or risk potential repercussions from regulators and the market in the event significant security breaches occur.

To contain cyberattacks and security breaches, companies are well served by network segmentation.

Assessing the impact that breaches of cybersecurity have on ICFR.

Companies should regularly examine their “cyber-hygiene” including access to password management, key documents or files, and other IT processes.

Cybersecurity is not a one-time problem; business risks relating to cyberattacks needs to be managed proactively and continuously over time.

MD&A Panel Discussion

A panel representing preparers, auditors, and corporate attorneys discussed the importance of the management discussion and analysis (MD&A) as a part of an SEC filing to “tell the story of the company” to stakeholders. The panelists recommended describing the key drivers of a company and carefully evaluate whether material

information may have been excluded. The panel explained that there is a continued focus on MD&A as it is a bridge to the future for investors. The panelists also noted that the MD&A and financial statements are key parts of the Form 10-K; therefore, the SEC staff will continue to focus on MD&A and issue comments, and that MD&A should include any matters that “keep the CEO up at night.” Preparers were encouraged to call the SEC staff and request clarification when receiving comments from the SEC instead of rushing to respond to the staff’s correspondence. The panelists also urged prepares to ensure that all disclosures and communications made by a company, including through press releases, analyst calls, financial statement footnotes, and MD&A, are verified for consistency.

Revenue Recognition

A panel of preparers and auditors discussed the implementation and current issues

related to ASU No. 2014-09, Revenue from Contracts with Customers. The new standard

eliminates the transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replaces it with a principle based approach for determining revenue recognition. This standard has the potential to affect every entity’s day-to-day accounting and, possibly, the way business is executed through contracts with customers. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the new revenue standard to annual reporting periods beginning after 15 December 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual


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reporting periods beginning after 15 December 2016, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU No. 2014-09 to annual reporting periods beginning after 15 December 2018, and interim reporting periods within annual reporting periods beginning after 15 December 2019. All other entities may apply the guidance in ASU No. 2014-09 earlier as of an annual reporting period beginning after 15 December 2016, including interim reporting periods within that reporting period.

Although the revenue recognition adoption date was deferred, panelists stressed the importance of companies starting their implementation process imminently. The panel noted that the AICPA organized 16 industry task forces, consisting of preparers and auditors, to develop implementation issues. Currently, approximately 150 issues (topics) were identified and are in various stages of progress, and nine

issues were posted to the AICPA website for comment. The industry task forces encompass the following industries: aerospace & defense, airlines, broker dealers, construction contractors, depository institutions, gaming, healthcare, hospitality, insurance, asset management, not-for-profit, oil & gas, power & utilities, software, telecommunications, and time share. The panelists provided the following recommendations to companies evaluating the new revenue standard:

Assess the impact of the new standard implementation well in advance of the effective date; work with the operations teams, IT, and other parties that may be impacted by the new standard to assess the effect the new standard has on the company.

Review all relevant industry-specific topics related to the new standard.

Focus on any necessary IT system implementation to ensure that systems are properly aligned to address the changes in the new standard; clear

communication between financial statement preparers and their IT teams or software consultants to ensure that IT systems properly apply the revenue standard consistent with management’s interpretation of the standard.

Consider both quantitative and qualitative factors in internal control design for reviewing contracts and ensuring that management’s conclusions are well documented.

Accounting for Leases

A panel representing auditors, preparers, and standard setters discussed the new lease accounting standard. Scott Muir, FASB Practice Fellow, provided an overview of the new lease standard, which is expected to be issued in January 2016 and effective in 2019 for public entities. Mr. Muir highlighted the following changes:

The new standard will require the lessee to recognize most leases on their balance sheet with exception of short-term leases. ‘Short term’ is defined as a lease term of 12 months or less which can be accounted for as an operating lease under the current standard. Lessor accounting requirements are similar to the current requirements in U.S. GAAP for direct financing and sales-type leases. Therefore, for lessors, upfront profit will be recognized for sales-type leases only and deferred for direct financing leases.

A lease will be defined as a contract that involves an identified asset and the right to control the use during the lease term. Mr. Muir explained that,


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“…most leases today will be leases tomorrow.” The changes in the definition of a lease further aligns U.S. GAAP with IFRS.

An entity will also need to determine non-lease components from lease components if it contains more than one leased asset. The new lease guidance will provide an accounting policy election whereby a lessee may elect, by class of underlying asset, not to separate non-lease components from the lease components to which they relate, accounting for the entire combined component as a single lease component. The lessee may also allocate non-lease components based on the relative standalone price basis of the components. Lessors are required to separate leases from non-lease components in accordance with the new revenue guidance.

There are new disclosure requirements for both lessees and lessors to enable the users of the financial statements to assess the amount, timing, and

uncertainty of cash flows arising from leases.

Once the new standard is adopted by a company, the modified retrospective approach will be required for the transition, while the full retrospective approach is prohibited.

Speakers also discussed considerations for preparers when adopting the new standard, noting that adoption of the new standard should be approached as a multistep process that includes understanding lease populations and systems to ensure that the accounting and reporting departments of a company have a complete and accurate population of leases. Companies should analyze the new standard to understand its impact on the entity, and plan and communicate adoption steps across all departments within the entity that are impacted.

Speakers explained the impact that the new standard would have on audits. Auditors

will have to consider lease inventories during the entity’s initial application of the new guidance, impact on materiality due to the change in balance sheet, changes in systems (if applicable), impact on different business processes and its related risk of material misstatement, and training of staff and clients. Auditors should also consider the areas within the new guidance that require management judgment.


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Appendix – Links to Speech Transcripts

Speaker Link to Speech Transcript

Cindy Fornelli, Executive Director, Center

for Audit Quality Center for Audit Quality Update: Focus on the Future

Mary Jo White, SEC Chairwoman Keynote Address at the 2015 AICPA National Conference: "Maintaining High-Quality,

Reliable Financial Reporting: A Shared and Weighty Responsibility"

James V. Schnurr, Chief Accountant, Office

of the Chief Accountant

Remarks Before the 2015 AICPA National Conference on Current SEC and PCAOB

Developments

James Doty, PCAOB Chairman Protecting the Investing Public’s Interest in Informative, Accurate, and Independent Audit Reports

Russell G. Golden, FASB Chairman Remarks of FASB Chairman Russell G. Golden at the 2015 AICPA Conference on Current SEC and PCAOB Developments

Hans Hoogervorst, IASB Chairman IFRS: 2015 and beyond

Brian T. Croteau, Deputy Chief Accountant,

Office of the Chief Accountant

Remarks before the 2015 AICPA National Conference on Current SEC and PCAOB

Developments

Wesley R. Bricker, Deputy Chief

Accountant, Office of the Chief Accountant Remarks before the 2015 AICPA Conference on Current SEC and PCAOB Developments

Julie A. Erhardt, Deputy Chief Accountant,

Office of the Chief Accountant

Remarks before the 2015 AICPA National Conference on Current SEC and PCAOB

Developments

Kris Shirley, Professional Accounting Fellow, Office of the Chief Accountant

Remarks before the 2015 AICPA National Conference on Current SEC and PCAOB Developments

Michael W. Husich, Senior Associate Chief Accountant, Office of the Chief Accountant


Christopher M. Rickli, Professional Accounting Fellow, Office of the Chief

Accountant


Ashley Wright, Professional Accounting Fellow, Office of the Chief Accountant


Christopher D. Semesky, Professional Accounting Fellow, Office of the Chief

Accountant


Courtney D. Sachtleben

Professional Accounting Fellow, Office of

the Chief Accountant


Barry Kanczuker, Associate Chief Accountant, Office of the Chief Accountant


http://www.thecaq.org/docs/default-source/speeches-and-commentary/fornelli_aicpa_sec_2015.pdf?sfvrsn=2

http://www.sec.gov/news/speech/keynote-2015-aicpa-white.html

http://www.sec.gov/news/speech/keynote-2015-aicpa-white.html

http://www.sec.gov/news/speech/schnurr-remarks-aicpa-2015-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/schnurr-remarks-aicpa-2015-conference-sec-pcaob-developments.html

http://pcaobus.org/News/Speech/Pages/Doty-AICPCA-2015-keynote.aspx

http://pcaobus.org/News/Speech/Pages/Doty-AICPCA-2015-keynote.aspx

http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176167706891

http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176167706891

http://www.ifrs.org/Alerts/PressRelease/Pages/IFRS-2015-and-beyond.aspx

http://www.sec.gov/news/speech/croteau-2015-aicpa.html

http://www.sec.gov/news/speech/croteau-2015-aicpa.html

http://www.sec.gov/news/speech/bricker-remarks-2015-aicpa-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/erhardt-2015-aicpa.html

http://www.sec.gov/news/speech/erhardt-2015-aicpa.html

http://www.sec.gov/news/speech/shirley-remarks-2015-aicpa-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/shirley-remarks-2015-aicpa-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/husich-remarks-2015-aicpa-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/husich-remarks-2015-aicpa-conference-sec-pcaob-developments.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-rickli.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-rickli.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-wright.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-wright.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-semesky.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-semesky.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-sachtleben.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-sachtleben.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-kanczuker.html

http://www.sec.gov/news/speech/remarks-at-2015-aicpa-conference-kanczuker.html


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