SEC Comments and Trends

Transcription

SEC Comments
and Trends
2013 supplement — an update of current reporting issues
September 2013
To our clients and other friends
Every year, we closely monitor the Securities and Exchange Commission (SEC) staff’s comments on
public company filings to provide you with insights on its areas of focus. Although each registrant’s facts
and circumstances are different, the economic conditions in which they operate and the financial
reporting challenges they face are often similar. Understanding the SEC staff’s recent comments can
help you as you head into the year-end reporting season.
In October 2012, we issued our publication SEC Comments and Trends — An analysis of current reporting
issues, which provides insights on frequent areas of SEC staff comments, including matters that could
affect all registrants, as well as topics that are specific to industries and foreign private issuers. The
topics discussed in last year’s publication are still relevant today, and we encourage you to continue
referencing that publication.
This publication highlights areas where we have seen the SEC staff increase its focus over the past year
and where there have been significant developments. Accordingly, this supplement can be read as an
update or along with last year’s publication for a complete analysis of the SEC staff’s focus areas.
The SEC staff continues to focus on many of the same topics that we highlighted last year. The following
chart summarizes the top 10 most frequent comment areas in the current and previous years.
Comment area
Ranking
Twelve months ended 30 June
2013
2012
Comments as % of total
registrants that received
comment letters*
2012 and 2013
Management’s discussion and analysis**
Fair value measurements***
1
2
1
2
51%
25%
Non-GAAP financial measures
Contingencies and commitments
3
4
8
4
16%
19%
Revenue recognition
Income taxes
5
6
6
5
17%
17%
Signatures, exhibits and agreements
Intangible assets and goodwill
7
8
3
10
20%
14%
Segment reporting
Executive compensation disclosures
9
10
9
7
15%
15%
* Based on comment letter topic taxonomy according to research firm Audit Analytics for SEC comment letters issued to
registrants related to Forms 10-K from 1 July 2011 through 30 June 2013
** This category includes comments on MD&A topics, in order of frequency: (1) results of operations (29%), (2) liquidity matters
(22%), (3) critical accounting policies and estimates (15%), (4) business overview (13%) and (5) contractual obligations (4%). Many
companies received MD&A comments in more than one category.
***This category includes SEC staff comments on fair value measurements under ASC 820 as well as fair value estimates, such as
those related to revenue recognition, stock compensation and goodwill impairment analyses. Individual SEC staff comments may
be associated to multiple comment areas in this chart.
As illustrated above, the top areas of focus in SEC staff comment letters have remained generally
consistent over the past two years; however, there have been increases in relative volume of comments
regarding non-GAAP financial measures and intangible assets and goodwill, which are discussed further
in the publication. We also have observed decreases in the relative volume of comments related to
compliance with the executive compensation disclosure requirements and signatures, exhibits and
agreements, which we have not discussed further in this publication because the nature of the comments
SEC Comments and Trends September 2013
To our clients and other friends
is similar to the prior period.
The SEC staff continues to question registrants’ disclosures related to significant judgments and
estimates, including those related to segment reporting, goodwill impairment, loss contingencies, income
taxes and revenue recognition. Registrants are spending significant time addressing SEC staff comments
on these topics. The SEC staff requests additional information to support registrants’ conclusions and
additional disclosures about the facts and circumstances that support significant judgments.
During the past year, we’ve seen an uptick in comments from the SEC staff related to compliance with
Rule 3-10 of Regulation S-X when presenting condensed consolidating information in lieu of separate
financial statements for subsidiary guarantors or issuers. We have seen more comments questioning
whether the form and content of the condensed consolidating information complies with US GAAP,
particularly the classification of intercompany balances. When large errors are identified, the SEC staff
has insisted that registrants amend their filings to revise the condensed consolidating financial
information even if the errors are not considered material to the consolidated financial statements taken
as a whole.
The SEC staff is also focusing on compliance with the disclosure requirements in recent accounting
standards, including the new fair value disclosures in Accounting Standards Update (ASU) 2011-04 and
the presentation of other comprehensive income in ASU 2011-05, as amended by ASU 2011-12.
We believe future areas of SEC staff focus may include:
•
Valuation of equity securities issued shortly before an initial public offering, following the AICPA’s
recent release of an Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity
Securities Issued as Compensation, updating its 2004 Practice Aid that had the same title
•
New presentation and disclosure requirements in ASU 2013-12 to reclassify amounts out of
accumulated other comprehensive income
•
Disclosures about the anticipated effect of new accounting standards (e.g., the expected new
revenue recognition standard) on a registrant’s financial position and results of operations, as
required by SAB Topic 11-M
The main section of this supplement discusses recent matters that relate to all registrants. Appendices A
and B highlight emerging trends related to specific industries and foreign private issuers, respectively,
and should also be read in conjunction with last year’s publication. In addition, Appendix C of our 2012
publication provides an overview of the SEC staff’s filing review process, as well as best practices for
responding to staff comments.
We hope this publication helps you understand recent trends and areas of interest to the SEC staff. EY
professionals are prepared to discuss any concerns or questions you may have.
Contents
SEC reporting issues ....................................................................................................... 1
Guarantor financial information ........................................................................................................1
Management’s discussion and analysis (MD&A) .................................................................................3
Materiality and internal control over financial reporting .....................................................................5
Non-GAAP financial measures ..........................................................................................................6
Pro forma adjustments ....................................................................................................................7
Rule 4-08(e) disclosures ..................................................................................................................8
Consolidation ................................................................................................................ 10
Contingencies ............................................................................................................... 11
Fair value measurements............................................................................................... 12
Goodwill ....................................................................................................................... 13
Income taxes ................................................................................................................ 15
Other comprehensive income......................................................................................... 18
Revenue recognition ..................................................................................................... 20
Segment reporting ........................................................................................................ 22
Statement of cash flows classification and presentation .................................................. 24
Appendix A: Industry sections........................................................................................ 26
Banking industry............................................................................................................................26
Health care industry ......................................................................................................................29
Insurance industry .........................................................................................................................30
Oil and gas industry .......................................................................................................................33
Real estate industry .......................................................................................................................36
Retail and consumer products industry ...........................................................................................39
Appendix B: Foreign private issuers ............................................................................... 40
Appendix C: Abbreviations............................................................................................. 42
SEC reporting issues
Guarantor financial information
Background and summary of issues notes
Debt or preferred stock registered under the Securities Act may be guaranteed by one or more affiliates
of the issuer. It’s common for a parent company to raise capital by offering its own securities that are
guaranteed by one or more subsidiaries or through one of its subsidiaries that are guaranteed by the
parent and/or one or more of its subsidiaries. If certain conditions are met, Rule 3-10 of Regulation S-X
allows for condensed consolidating financial information or, in certain instances, narrative disclosure in
the parent company’s financial statements in lieu of separate financial statements for each subsidiary
issuer and guarantor of registered debt.
As we discussed in our publication last year, the SEC staff frequently comments on compliance with the
relief under Rule 3-10. In its comments, the staff asks registrants to confirm that the subsidiary issuers
and guarantors are 100% owned rather than “wholly owned” and requests that registrants revise their
disclosure in future filings to state that fact. We also continue to see comments seeking clarification that
the guarantee is full and unconditional. In the past year, we have seen a significant increase in comments
related to the form and content of the condensed consolidating financial information.
Analysis of recent trends
Full and unconditional guarantees
One of the conditions for relief under Rule 3-10 is that the guarantee must be full and unconditional. In
our publication last year, we highlighted the SEC staff’s view that certain subsidiary release provisions
would not disqualify the registrant from relying on the relief in Rule 3-10. However, when these
customary release provisions exist, registrants should disclose the circumstances when the subsidiary
guarantor may be released. If subsidiary release provisions are not customary in nature, the subsidiary
may not qualify for Rule 3-10 relief.
At the 2012 AICPA National Conference on Current SEC and PCAOB Developments, the staff
emphasized that when there are customary release provisions, Rule 3-10 relief applies only to
subsidiaries guaranteeing parent debt. If the parent guarantee of registered subsidiary debt contains
customary release provisions, the relief under Rule 3-10 would not apply to the subsidiary issuer. That is,
a subsidiary issuer must file its audited financial statements if the parent’s guarantee is not full and
unconditional. The SEC staff encourages registrants to consult with the Office of Chief Counsel in the
Division of Corporation Finance when parent release provisions exist and the registrant still intends to
apply the relief in Rule 3-10 for a subsidiary issuer.
Example SEC staff comment letter: Guarantor financial information
You disclose that the Senior Notes are fully and unconditionally guaranteed by the company’s wholly
owned domestic subsidiaries. We note that on page XX of the Form S-4, there are provisions under
which the guarantees shall automatically terminate or the subsidiary guarantor shall be released and
discharged from all obligations. Please tell us what consideration you gave to disclosing, in plain
English, such release provisions to the full and unconditional guarantee in order to more accurately
describe the qualifications to the subsidiary guarantors.
1
Form and content of guarantor financial information
The SEC staff
may insist that a
registrant amend
its filing when
large errors are
identified in
condensed
consolidating
information.
The SEC staff continues to focus on the form and content of condensed consolidating financial
information, which should follow the general guidance for interim financial statements in Article 10 of
Regulation S-X. The staff also frequently questions whether the individual columns are prepared in
accordance with GAAP. For example, intercompany receivables or liabilities should be classified as
current or long-term assets or liabilities, not as liabilities with debit balances or assets with credit
balances. Proper classification in the condensed consolidating statements of cash flows is another
common area where the SEC staff has identified errors.
Example SEC staff comment letter: Guarantor financial information
In future filings, please separately present investment in subsidiaries and intercompany receivables.
In this regard, the intercompany receivables are presumably due on demand. Therefore, it does not
appear appropriate to combine a short-term asset with a long-term asset.
We also note that you have included the parent’s intercompany receivable as a liability. Article 3-10(i)(1)
of Regulation S-X notes that the condensed consolidating financial information is to be presented
following the guidance in Article 10-01 of Regulation S-X. As such, it is unclear how you determined that
the presentation of an asset in the liabilities section of the balance sheet is appropriate. Please revise
this presentation in future filings or advise by providing us with the US GAAP and/or Regulation S-X
guidance that allows such a presentation.
When errors are identified in the condensed consolidating financial information disclosed, we have seen
the SEC staff challenge registrants’ conclusions on the materiality of such errors. Given that condensed
consolidating financial information is a form of relief from separate reporting by the subsidiary issuer or
guarantors, we also have seen the SEC staff insist that a registrant amend its filing to revise the condensed
consolidating financial information even when the error was deemed not material to the consolidated
financial statements taken as a whole.
EY resources
•
Compendium of significant accounting and reporting issues — 2012 AICPA National Conference on Current
SEC and PCAOB Developments (SCORE No. CC0364), 10 December 2012
2
Management’s discussion and analysis (MD&A)
The SEC staff continues to question the sufficiency and completeness of registrants’ MD&A disclosures of
results of operations, critical accounting estimates and liquidity and capital resources, among other topics.
At the 2012 AICPA National Conference on Current SEC and PCAOB Developments, the SEC staff
highlighted disclosures of results of operations as its most frequent area of comment on MD&A. We
continue to see comments from the SEC staff asking registrants to disclose not only what but why
significant changes occurred in their results of operations. Registrants should quantify and discuss the
underlying factors that led to significant changes in financial statement line items.
The SEC staff has increased its focus on disclosures about significant components of operating expense
(e.g., costs of sales) at both the consolidated and segment levels. The SEC staff also has recently
questioned registrants’ use of key metrics, including how these metrics explain fluctuations in their
results of operations.
Results of operations — significant components of expense
Item 303 (a)(3) of Regulation S-K requires registrants to describe the significant components of revenue
and expenses that they believe would help readers understand results of operations. Recently, the SEC
staff has asked registrants to include more discussion about significant components of operating
expenses, such as costs of sales, in their results of operations. In the segment discussion, registrants
often describe only changes in revenue and operating income and do not directly explain changes in
significant operating expenses. The SEC staff frequently asks registrants to quantify and discuss
separately the significant components of operating expenses that have affected segment operating
income. The SEC staff believes this information helps investors better understand a registrant’s business.
Example SEC staff comment letter: Results of operations — significant components of expense
Please expand your discussion of cost of sales and operating income to quantify and discuss the
significant cost components within operating income such as product costs, product development
costs, marketing costs, depreciation and amortization, and any other significant components that
would enable readers to understand your business better. For example, you state that operating
income for the XX segment increased $XX million in the current year due to lower sales volumes and
unfavorable product mix, partially offset by favorable currency impacts, but you do not quantify these
changes or provide the actual cost figures necessary to put these changes in proper context.
While these comments are most commonly issued to registrants in manufacturing industries, all registrants
should consider disclosing significant components of costs that affected their results of operations.
3
Results of operations — key financial metrics
Registrants
should explain
how changes in
To allow investors to view registrants from management’s perspective, the SEC staff has historically
focused on whether MD&A incorporates the key performance metrics used to manage the business and
assess performance. While we continue to see comments on such metrics, the SEC staff also frequently
requests that registrants:
key financial
•
Not only describe but quantify key metrics in MD&A for each period presented
metrics link to
•
Discuss how metrics are calculated and whether there are any limitations in their calculation
•
Provide metrics on a disaggregated basis, such as by segment, geography or revenue stream
(e.g., breaking down same-store sales between e-commerce and in-store sales)
•
Ensure that key metrics used to explain fluctuations from period to period are linked to the financial
statements (e.g., using the increase in the number of customers to explain revenue growth)
changes in the
financial
statements.
When a registrant uses key metrics to explain fluctuations in the financial statements, the connection to
the appropriate financial statement line items should be clear. For example, average monthly users may
be used to illustrate revenue per average user and help explain a change in sales.
Example SEC staff comment letter: Results of operations — key financial metrics
You disclose that key drivers of revenue include growth in same-store sales, user conversion and lead
pricing. Please consider quantifying these drivers for each period presented in order to supplement
your results of operations discussion. Additionally, please ensure you disclose any possible limitations
associated with calculating these metrics (e.g., the presence of fictitious or duplicate users), as
applicable. Finally, ensure that material changes and/or trends in these metrics are addressed in your
discussion of results of operations for revenue to the extent that you have not already done so. See
Item 303(a) of Regulation S-K, and for guidance, refer to Section III.B of SEC Release No. 33-8350.
EY resources
•
•
2012 SEC annual reports — Form 10-K (SCORE No. CC0360), November 2012
4
Materiality and internal control over financial reporting
Background and summary of issues noted
The SEC staff frequently requests that registrants supplementally identify and discuss the quantitative and
qualitative factors considered when assessing materiality. The SEC staff often challenges a registrant’s
conclusions that quantitatively large errors are immaterial. The SEC staff also may question registrants
about the implications of such errors to the effectiveness of internal control over financial reporting
(ICFR) and disclosure controls and procedures.
In recent years, the number of financial statement restatements resulting from immaterial error
corrections1 has increased. Such a restatement, commonly called a “Little r restatement,” may occur when
an error is immaterial to the prior-year financial statements, but correcting the error in the current period
would materially misstate the current period financial statements. As a result, the prior-year financial
statements are restated, even though the revision is immaterial to the prior year. In these circumstances,
the SEC staff may question a registrant’s conclusions on materiality and the effectiveness of ICFR.
The SEC staff
challenges
materiality
assessments
for ‘Little r
restatements.’
A “Little r restatement” generally occurs when an immaterial error remains uncorrected for multiple
periods and grows into a material number. If correcting the cumulative error in the current year would
materially misstate the financial statements in the current year, the prior-period financial statements
must be corrected even though the error was not material to the prior-period financial statements. In
these situations, registrants generally are not required to file an Item 4.02 Form 8-K, Non-reliance on
previously issued financial statements, or a related audit report or completed interim review, nor are
they required to amend prior filings. Instead, registrants may correct the prior-period financial
statements, along with appropriate disclosure, in the next periodic report that includes the prior-period
financial statements.
While a registrant may correct and disclose the effect of a “Little r restatement” on previously issued
financial statements, the SEC staff may request the registrant’s materiality assessment to assess
whether the method of correcting the error is appropriate. Furthermore, the SEC staff may also question
whether the restatement affects current and previous conclusions related to the effectiveness of ICFR
and disclosure controls and procedures and whether it necessitates disclosure of a material change in
internal control when the error is corrected.
1
Based on the report titled 2012 Financial Restatements — A Twelve Year Comparison by Audit Analytics, an online public company
intelligence service from the Ives Group Inc., revision restatements, defined as those restatements for which an Item 4.02 8-K
was not filed, have increased each year from 42% of all financial statement restatements disclosed by registrants in 2007 to 65%
in 2012.
5
Non-GAAP financial measures
The SEC staff continues to focus on the presentation of non-GAAP financial measures. Most notably, the
SEC staff requests that registrants modify or remove disclosure when presentations give greater
prominence to non-GAAP financial measures than GAAP measures. For example, the SEC staff objects to
registrants presenting full non-GAAP income statements in either the MD&A or a Form 8-K and may
request amendments because this presentation gives undue prominence to the non-GAAP information.
In addition, the SEC staff frequently comments on disclosures required by Item 10(e) of Regulation S-K,
such as the requirement to reconcile to the most directly comparable GAAP measure and disclose the
usefulness of the measure to investors.
Recently, the SEC staff also has focused on non-GAAP measures described as liquidity measures.
Non-GAAP financial measures may be presented as performance measures, liquidity measures or both.
Item 10(e)(i) of Regulation S-K requires reconciliation to the most directly comparable GAAP measure(s).
When a non-GAAP measure is used as both a performance and liquidity measure, multiple reconciliations
may be necessary. For example, EBITDA generally should be reconciled to net income if it is presented as
a performance measure and to cash flow from operations if it is presented as a liquidity measure. The
SEC staff frequently questions registrants when their disclosure indicates that the non-GAAP measure is
presented as a liquidity measure (e.g., used to assess ability to service debt, generate cash flows or fund
acquisitions and capital expenditures), but the non-GAAP measure is reconciled only to a performance
measure such as net income. The SEC staff requests that registrants either revise their disclosure to
clarify how the non-GAAP measure is used (i.e., as a performance or liquidity measure) and include the
appropriate reconciliation to the most directly comparable GAAP measure. When a non-GAAP liquidity
measure is disclosed, Item 10(e)(ii)(A) precludes registrants from excluding charges or liabilities that
require cash settlement. If a non-GAAP measure is presented as a liquidity measure, the SEC staff may
challenge the appropriateness of certain adjustments (e.g., excluding certain charges or liabilities that
require, or will require, cash settlement) that are acceptable only when calculating non-GAAP
performance measures.
Example SEC staff comment letter: Non-GAAP liquidity measures
We note your presentation of a non-GAAP measure you identify as “Adjusted EBITDA.” We note you
disclose several uses of this measure, including to “assess your ability to service your debt.” It appears
to us you are presenting this measure as both a performance measure and a liquidity measure. If you
present this measure as a liquidity measure, please revise it to not exclude items that will impact cash
and reconcile it to cash flows from operating activities.
6
Pro forma adjustments
Over the past couple of years, the SEC staff has been increasingly commenting on how registrants have
complied with the requirements of Article 11 of Regulation S-X for pro forma financial information
disclosed in Form 8-K filings, registration statements and certain proxy statements. Pro forma financial
information is intended to help investors understand the effects of a significant transaction, such as an
acquisition or disposition, that has either occurred or is probable after the date of the historical financial
statements (or is not fully reflected in the historical financial statements) by presenting financial
information “as if” the transaction had occurred earlier. The SEC staff continues to challenge whether
pro forma adjustments are (1) directly attributable to each specific transaction, (2) factually supportable
and (3) expected to have a continuing impact (income statement only) as discussed in our publication last
year. However, the SEC staff has recently shifted its view on the continuing impact criterion from the
stance we described in last year’s publication.
In addition to meeting the directly attributable and factually supportable criteria, pro forma adjustments
related to the pro forma income statement must have a continuing impact on the registrant. In our prioryear publication, we said the SEC staff had recently modified its view that items should be considered to
have a continuing impact if they occur more than one time rather than over a period greater than 12
months, which historically had been the SEC staff’s view. As a result, the SEC staff requested that some
registrants conform their adjustments to the more-than-one-time view.
However, at the 2012 AICPA National Conference on Current SEC and PCAOB Developments, the SEC
staff clarified that the historical 12-month rule of thumb to evaluate the continuing impact criterion
continues to be appropriate. The staff also said that adjustments for certain items that affect the pro
forma income statement for a period of 12 months or less may be considered to have a continuing
impact and the evaluation will depend on the individual facts and circumstances. For example, an
adjustment for interest expense on a bridge loan that may be incurred for a period of less than 12
months might be considered to have a continuing impact.
Example SEC staff comment letter: Pro forma adjustments
Pro forma adjustments (pursuant to Article 11 of Regulation S-X) shall give effect to events that are
directly attributable to the offering, factually supportable, and expected to have a continuing impact.
If you continue to believe your adjustments (g) and (j) are appropriate, provide a detailed explanation
supporting your conclusion and justify how your accounting treatment is consistent with Article 11 of
Regulation S-X.
7
Rule 4-08(e) disclosures
The SEC staff commonly asks registrants whether third-party restrictions exist that would (1) limit their
ability to pay dividends to shareholders or (2) limit their ability to transfer net assets from subsidiaries to
themselves. If such restrictions exist, the SEC staff asks registrants to provide disclosures required by
Rule 4-08(e) of Regulation S-X. The SEC staff also asks registrants how they considered the requirements
under Rule 5-04 of Regulation S-X to present condensed financial information of the registrant on an
unconsolidated basis (i.e., parent company financial statements).
Debt covenant
disclosures
evidencing net
Rule 4-08(e) of Regulation S-X requires registrants to include disclosures in the notes to the financial
statements about restrictions that limit their ability to pay dividends. This rule requires similar
disclosures for restrictions on transfers of net assets from subsidiaries and investees to the parent.
asset restrictions
Under Rule 4-08(e)(1) of Regulation S-X, a registrant must describe significant restrictions on its ability
to pay dividends, including:
may prompt
•
The nature and significant terms of such restrictions
•
The amount of retained earnings and net income that is restricted or unrestricted
comments about
Rule 4-08(e)
disclosures and
parent-only
condensed
financial
information.
The SEC staff may use a registrant’s debt footnote disclosures or other contractual provisions described
in the filing as the basis for inquiring about compliance with the requirements of this rule. For example,
disclosures may describe certain restrictions imposed by third parties via financial covenants on the
registrant or its subsidiaries (e.g., quantitative working capital requirements, restricted amounts of net
assets).
Example SEC staff comment letter: Rule 4-08(e)(1) disclosures
In light of the financial covenants imposed by your loan agreement, please tell us your consideration of
disclosing the amount of retained earnings or net income restricted from the payment of dividends or
free from restrictions. Refer to Rule 4-08(e)(1) of Regulation S-X.
Rule 4-08(e)(3) of Regulation S-X requires footnote disclosure in the consolidated financial statements
about the nature and amount of significant third-party restrictions on the ability of subsidiaries to
transfer funds to the registrant through intercompany loans, advances or cash dividends if restricted net
assets of consolidated subsidiaries and equity method investees exceed 25% of consolidated net assets.
Rule 4-08(e)(3) disclosures are similar to those required by Rule 4-08(e)(1), but they must be provided
for subsidiaries with significant restricted net assets. The SEC staff has most often commented on
insurance registrants’ compliance with the Rule 4-08(e)(3) disclosure requirements; however, the staff
has begun expanding the scope of these comments to other industries.
The SEC staff also raises questions about a registrant’s compliance with Rule 5-04(c) and Rule 12-04 of
Regulation S-X. Rule 5-04(c) of Regulation S-X requires registrants to include parent-only condensed
financial information on Schedule I, Condensed financial information of registrant, when restricted net
assets of only the registrant’s consolidated subsidiaries exceed 25% of the registrant’s consolidated net
assets. This schedule shows investors the amount of net assets, operations and cash flows at the parent
level on a standalone basis with all subsidiaries reflected on an unconsolidated basis (i.e., under the
equity method).
8
Example SEC staff comment letter: Rule 4-08(e)(3) disclosures and parent-only financial
information
Please tell us and revise your future filings to disclose the amount of liquid assets held by your
subsidiaries that are restricted from transfer to the parent company and other subsidiaries. In
addition, tell us whether the restricted net assets of consolidated subsidiaries exceed 25% of
consolidated net assets as of XX. If so, tell us whether you considered the guidance in Items 5-04 and
9-06 of Regulation S-X regarding parent-only financial statements and Item 4-08(e)(3) of Regulation S-X
for restrictions on dividend payments.
EY resources
•
9
Consolidation
Recently, the SEC staff has been asking registrants to provide more disclosures related to consolidated
variable interest entities (VIEs), particularly when the registrant has operations in foreign jurisdictions
(e.g., the People’s Republic of China or PRC) that limit direct foreign ownership.
When a foreign jurisdiction limits a registrant’s direct ownership in an entity, the registrant may enter
into contractual arrangements with the entity that give it the power to control the entity. Through these
contractual arrangements, a registrant would consolidate the entity under the Variable Interest Model if
the entity is a VIE and the registrant determines it is the VIE’s primary beneficiary.
The SEC staff expects registrants to avoid boilerplate disclosures of the facts and circumstances they
evaluated to determine the primary beneficiary and reach their consolidation conclusions. For example,
the SEC staff has cautioned registrants that merely listing the contractual arrangements between a VIE
and the registrant does not provide sufficient insight into the judgments the registrant made in
evaluating whether to consolidate the VIE.
Registrants
should discuss
specific
contractual terms
Registrants should describe the terms of the contractual arrangements such as duration, renewal rights,
mutual consent provisions and revocability clauses, and how those terms convey power and benefits to
the registrant. Registrants also should consider disclosing contractual provisions or other circumstances
that might limit their ability to exercise power and how such limitations were evaluated in reaching their
conclusion.
and the effect on
Example SEC staff comment letter: Consolidation of VIEs
their ability to
Revise your disclosures to include the terms of each of the VIE agreements along with a discussion of
which party or parties have renewal rights. Also, revise to clarify how you considered each of these
agreements in concluding that you are the primary beneficiary of the VIEs and specifically address the
agreements from which you obtain effective control over the VIEs and those that provide you the
ability to receive substantially all of the economic benefits of the VIEs.
control a VIE.
Furthermore, the SEC staff often inquires about the risks and restrictions related to a registrant’s VIE
operations in foreign jurisdictions and how contractual arrangements comply with the local laws and
regulations in those jurisdictions.
The SEC staff applies these principles broadly in its comments to registrants. Therefore, all registrants
with interests in material VIEs should closely evaluate their disclosures and discuss the significant
contractual terms that affect their consolidation conclusions.
EY resources
•
•
Financial reporting developments — Consolidation and the Variable Interest Model – Determination of a
controlling financial interest (SCORE No. BB1905), June 2013
10
Contingencies
Loss contingencies have been a frequent area of comment over the past several years. At the 2012
AICPA National Conference on Current SEC and PCAOB Developments, however, the SEC staff noted
that it has seen improvement in the accounting and disclosure of loss contingencies. We have also noted
an overall decline in the number of comments related to loss contingencies from the prior year. The staff
nevertheless has continued to focus on registrants’ processes for estimation and disclosure and has been
challenging whether disclosures evolve appropriately as matters progress.
The SEC staff acknowledges that the recognition and disclosure of contingencies require judgment;
therefore, it is important that registrants “tell their whole story” in their disclosures and in any comment
letter responses relating to loss contingencies. Furthermore, the SEC staff expects loss contingency
disclosures to evolve over time as the contingency progresses and new information becomes available.
The “story” should include how each matter has developed over time and how key developments have
affected the disclosures or amounts recognized in the financial statements. When a loss contingency is
settled, the SEC staff will generally revisit prior-period disclosures to see whether those disclosures were
adequate and whether the loss recognized at the time of settlement was recorded in the correct period.
That is, the SEC staff has focused on whether a registrant records a loss in the first period the loss is
estimable and probable, which may be a period prior to the settlement of the loss.
The SEC staff also has focused on a registrant’s process each reporting period for developing an
estimated loss or range of loss, particularly when the registrant has legal cases that remain open for
several years. If a registrant has not disclosed an estimate of the reasonably possible loss or range of
loss and continues to state that such an estimate cannot be made, the SEC staff may ask the registrant
to provide supplemental information so it can better understand the evolution of the litigation matter
and the specific factors resulting in the company’s inability to make an estimate. The SEC staff may
challenge disclosures that imply a need for precision in estimating the loss or range of loss because US
GAAP does not require a level of certainty or confidence when estimating the range of loss. Additionally,
in evaluating a registrant’s process, the SEC staff may ask how the registrant considered past experience
with similar matters specific to the company or more generally to its peers.
Example SEC staff comment letter: Accounting for and disclosure of loss contingencies
We note the open cases disclosed have been outstanding for several years, but you have not disclosed
an estimate of the reasonably possible loss or range of loss for any. If you conclude that you cannot
estimate the reasonably possible additional loss or range of loss for any of these cases, please explain
to us (1) the procedures you undertake on a quarterly basis to attempt to develop a range of
reasonably possible loss for disclosure and (2) what specific factors are causing the inability to
estimate a loss and when you expect those factors to be alleviated. We recognize that there are a
number of uncertainties and potential outcomes associated with loss contingencies. Nonetheless, an
effort should be made to develop estimates for purposes of disclosure, including determining which of
the potential outcomes are reasonably possible and what the reasonably possible range of losses
would be for those reasonably possible outcomes.
11
Fair value measurements
ASU 2011-04 was issued in May 2011 and effective for calendar year-end public entities in the first
quarter of 2012. In addition to certain other amendments to ASC 820, the ASU required a number of
new fair value disclosures, primarily related to Level 3 measurements.
The SEC staff has focused on the adequacy of the new fair value disclosures provided under ASU 2011-04
(primarily in the banking and insurance industries), including the information provided about valuation
processes, the disclosure of significant unobservable inputs and the level of detail presented in the
qualitative sensitivity disclosures.
The SEC staff
may question the
completeness or
transparency of
fair value
disclosures made
to comply with
Under ASU 2011-04, registrants must disclose the valuation processes related to their Level 3
measurements, quantitative information about the significant unobservable inputs they use in
determining these fair value measurements and a description of the sensitivity of the fair value
measurements to changes in these significant unobservable inputs.
The SEC staff has questioned compliance with the ASU when these fair value disclosures are missing,
vague or incomplete. Specifically, the SEC staff has requested that registrants revise future filings to
enhance disclosures as follows:
•
When registrants disclose a wide range of significant unobservable inputs for a given class of assets
or liabilities, disclose weighted average information or additional discussion about the reasons for
the wide range to provide additional context and understanding for investors
•
When certain classes of assets or liabilities are valued using different methods, separately disclose
the population valued under each method
•
Enhance disclosures about the registrant’s valuation processes, including how the registrant determines
its policies and procedures and analyzes changes in fair value measurements from period to period
•
Expand descriptions of the sensitivity of the fair value measurement to changes in unobservable
inputs to address all of the unobservable inputs for which quantitative information is provided and
how the inputs significantly affect the fair value measurement
ASU 2011-04.
Example SEC staff comment letter: Wide range of quantitative information
Given that some ranges of your significant unobservable inputs are wide, please revise your disclosure
in future filings to also provide a weighted average of the significant unobservable inputs reported,
similar to the illustration provided in ASC 820-10-55-103.
For instruments for which you believe a weighted average may not be meaningful, include a qualitative
discussion of those wide unobservable input ranges that is specific to each financial instrument type. Each
qualitative discussion should address the underlying reason that the input range is wide, and any other
information that explains the range to facilitate an understanding of your views about individual inputs. To
the extent available, revise your qualitative disclosure to address both of the following for each product:
•
Drivers of dispersion within the range, such as a particular position or instrument type
•
Data point concentrations within the range
12
Goodwill
Registrants’ disclosures about goodwill impairment, in both the notes to the financial statements and
MD&A, remain an area of focus for the SEC staff. Specifically, the SEC staff routinely challenges the
information disclosed about reporting units that are at risk for impairment and the conclusions reached
about whether such reporting units have been properly evaluated for impairment. The SEC staff also has
continued to request additional information and disclosure about a registrant’s goodwill impairment
testing policies.
Recently, the SEC staff has been requesting supplemental information and more robust disclosures
about the events and circumstances evaluated in a qualitative assessment resulting from the adoption
of ASU 2011-08 and the “full story” behind the timing and results of interim impairment tests and any
impairment charges.
Timing of interim impairment tests and charges
Registrants are
frequently asked
to provide
supplemental
information and
additional
disclosures
about goodwill
impairment
testing.
In addition to frequently requesting that registrants provide more robust disclosures in MD&A about the
critical accounting estimates for assessing goodwill impairment, the SEC staff recently has requested
supplemental information and additional disclosures in MD&A to better understand the timing of any
impairment charges and the performance of any interim impairment tests.
When a registrant has recognized goodwill impairment, the SEC staff often comments that the registrant
needs to provide the “full story” about why an impairment charge was taken in a specific period,
including identifying the particular events and any related changes in assumptions that may have
triggered the charge. This comment is common when a registrant has recognized goodwill impairment
for a reporting unit regardless of whether it was previously disclosed as being at risk for impairment.
Recent SEC staff comments also have focused on disclosures in MD&A about registrants’ interim
impairment tests. Such comments include requesting that registrants disclose the results of any interim
impairment test (e.g., if the unit passed the interim test, disclose that fact), regardless of whether an
impairment charge was taken. The SEC staff also requests disclosure of the facts and circumstances that
drove the need to perform an interim goodwill impairment test.
Example SEC staff comment letter: Timing of goodwill impairment
In significant detail, please explain to us all of the factors that changed between the time you
performed step 1 of the impairment test in the XX fiscal quarter and when you performed the
impairment test in the end of the subsequent fiscal quarter such that you were required to record a
$XX million impairment charge. In your response, please provide us with the following information at
both impairment test dates: (1) the carrying and fair values; (2) the allocation of the fair value to all of
the assets and liabilities (including any unrecognized intangible assets) to arrive at the implied fair
value of goodwill and; (3) a comparison of the different assumptions that you used in the
determination of the fair value of the reporting unit.
13
Goodwill
Supplemental information on qualitative impairment assessments
ASU 2011-08 was effective in 2012 and allowed registrants to perform a qualitative assessment of
goodwill in their annual goodwill impairment tests in certain circumstances. As a result, when a registrant
has performed a qualitative impairment assessment, the SEC staff has requested that the registrant
provide supplemental information and expand disclosures about the positive and negative events and
circumstances it evaluated in concluding that it is not more likely than not that goodwill is impaired.
Example SEC staff comment letter: Supplemental information on qualitative assessment
Please tell us more about the qualitative analysis performed as of [annual assessment date], including
the specific qualitative factors considered. Tell us whether you performed a step one analysis
subsequent to your qualitative assessment and if so, describe the results. Additionally, tell us what
consideration was given to more clearly disclosing the steps and analyses actually performed as of the
most recent assessment.
EY resources
•
•
Financial reporting developments — Intangibles — Goodwill and other (SCORE No. BB1499), December 2012
14
Income taxes
Realizability of deferred tax assets
The assessment of the realizability of deferred tax assets and the corresponding need for a valuation
allowance is often one of the more challenging aspects of accounting for income taxes. Part of this
challenge is that the evaluation of the realizability of deferred tax assets requires judgment in applying
the more-likely-than-not framework in ASC 740. As market conditions have improved, judgments to
maintain or reverse a historical valuation allowance for some or all of the deferred tax assets can be
challenging. The model for evaluating whether a valuation allowance is required is the same, whether or
not a valuation allowance exists. At the 2012 AICPA National Conference on Current SEC and PCAOB
Developments, the SEC staff reminded registrants of the need to continually assess negative and positive
evidence to determine whether to record, maintain or reverse a valuation allowance.
Foreign earnings
In addition, the SEC staff has focused on income tax disclosures of registrants with substantial foreign
earnings from low-tax jurisdictions that assert that such earnings will be indefinitely reinvested. In prior
publications, we have highlighted observations from the SEC staff related to whether registrants have
appropriately labeled a reconciling item as the difference between the foreign tax rate and the domestic
tax rate and requesting disclosure for countries with low tax rates that have a disproportionate impact on
the effective tax rate.
While the SEC staff continues to issue comments about income tax disclosures, the SEC staff is more
frequently challenging registrants’ assertions that foreign earnings will be indefinitely reinvested and
requests evidence supporting the registrants’ assertions. This line of inquiry is often accompanied by a
request to reconcile a registrant’s assertion with the discussion of liquidity in MD&A.
Realizability of deferred tax assets
In its comments, the SEC staff frequently asks registrants to explain how they have considered both
positive and negative evidence when reversing a valuation allowance, including the following:
•
What were the magnitude and duration of past losses, and what are the expected magnitude and
duration of current profitability?
•
What factors caused losses in prior periods, and what is causing current profitability?
•
How accurate were forecasts of income (loss) in prior periods relative to actual income (losses)?
•
Has the registrant had significant changes in its business that would affect the accuracy of its
projections?
When determining the weight to place on each piece of evidence, registrants should consider how
objectively verifiable the evidence is. By its very nature, future taxable income (exclusive of the reversal of
existing temporary differences and carryforwards) requires estimates and judgments about future events.
15
Income taxes
The SEC staff expects disclosures explaining what occurred in the current reporting period that made the
reversal appropriate at that point in time as well as the positive and negative evidence and the weighting
given in reaching their conclusions.
Example SEC staff comment letter: Realizability of deferred tax assets
We note your discussion regarding the positive and negative evidence that you considered.
•
Please disclose in more detail how this positive and negative evidence was weighted and how that
evidence led you to determine it was appropriate to reverse the valuation allowance during the
quarter ended June 30, 2012.
•
Please discuss the significant estimates and assumptions used in your analysis, including the
specific factors that changed during fiscal 2012 and led you to determine the reversal was
appropriate at this time.
•
Please discuss how you determined the amount of valuation allowance to reverse.
•
Please disclose the amount of pre-tax income you need to generate to realize these deferred tax
assets. Include an explanation of the anticipated future trends included in your projections of
future taxable income. Confirm to us that the anticipated future trends included in your
assessment of the realizability of your deferred tax assets are the same anticipated future trends
used in estimating the fair value of your reporting units for purposes of testing goodwill for
impairment and any other assessment of your tangible and intangible assets for impairment.
•
If you are also relying on tax-planning strategies, please disclose the nature of your tax planning
strategies, how each strategy supports the realization of deferred tax assets, the amount of the
shortfall that each strategy covers, and any uncertainties, risks, or assumptions related to these
tax-planning strategies.
Please show us in your supplemental response what your revisions to future filings will look like.
Foreign earnings
The SEC staff
requests details
of specific plans
when a registrant
asserts indefinite
reinvestment of
foreign earnings.
The SEC staff also may request details of specific plans when a registrant asserts that it is indefinitely
reinvesting earnings of foreign subsidiaries. ASC 740-30-25-3 includes a presumption that all
undistributed earnings of a subsidiary will be remitted to the parent entity. As a result, the default is to
assume repatriation of all earnings and a related provision for income taxes attributable to those
earnings. For undistributed earnings of foreign subsidiaries, registrants may overcome this presumption
if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings
indefinitely or that the earnings will be remitted in a tax-free liquidation.
The SEC staff has asked registrants to explain how they have overcome the presumption and provide
evidence of specific plans for reinvestment of foreign earnings (e.g., past experience, working capital
forecasts, long-term liquidity plans, capital improvement programs, merger and acquisition plans,
investment plans).
The SEC staff also requests similar evidence when registrants assert that they intend to indefinitely
reinvest only a portion of undistributed foreign earnings or when undistributed foreign earnings are
considered to be indefinitely reinvested but there is a recent history of repatriation. In addition, when
there is a change in assertion, registrants should disclose the facts and circumstances that led to the
change in the assertion during the reporting period.
16
Income taxes
Example SEC staff comment letter: Foreign earnings
We note your disclosure that you “have not provided U.S. income taxes and foreign withholding taxes
on the undistributed earnings of foreign subsidiaries as of December 31, 2012 because we intend to
permanently reinvest such earnings outside the U.S.” Please explain to us how you evaluated the
criteria for the exception to recognition of a deferred tax liability in accordance with ASC 740-30-25-17
and 18 for undistributed earnings that are intended to be indefinitely reinvested. Describe the type of
evidence and your specific plans for reinvestment for these undistributed earnings that sufficiently
demonstrates that remittance of earnings will be postponed indefinitely.
EY resources
•
•
Financial reporting developments — Income taxes (SCORE No. BB1150), September 2013
17
Other comprehensive income
ASU 2011-05, as amended by 2011-12, was issued in June 2011 and was effective for calendar year-end
registrants in the quarter ended 31 March 2012. This ASU amended ASC 220 to make the presentation of
other comprehensive income (OCI) more comparable among companies and to increase the prominence
of items reported within OCI in the financial statements.
The change has driven increased SEC staff focus and comments on registrants’ compliance with the
disclosure requirements in ASC 220 overall. Recent comments relate to, among other things:
•
The absence of a single line item for total other comprehensive income for each period presented in
the statement of stockholders’ equity
•
Disclosure of the amount of income tax expense or benefit allocated to each component of OCI
The changes to annual period comprehensive income disclosures in ASU 2011-05, as amended by 2011-12,
included, among other things:
•
Registrants must present components of net income and OCI and a total for comprehensive income
in either a single continuous statement or two consecutive statements. Companies are no longer
allowed to present components of OCI solely in the statement of stockholders’ equity.
•
Registrants must present changes in AOCI by component in the statement of stockholders’ equity or
in the notes to the financial statements. Registrants were previously required to separately present
the accumulated balances for each component of AOCI in the statement of financial position, the
statement of stockholders’ equity or a note to the financial statements.
ASU 2011-05 allows a registrant to present separate components of AOCI in its statement of
stockholders’ equity. Consistent with the guidance in ASC 220-10-45-14, the SEC staff expects the
presentation of one line item showing the total change attributable to OCI for each period presented in
the statement of stockholders’ equity. The SEC staff requests that registrants revise future filings to
include this single line presentation for each period presented, even if changes in the individual
components of AOCI due to OCI are separately presented.
Example SEC staff comment letter: Presentation of other comprehesive income
It appears that you adopted the guidance in ASU 2011-05 (as amended by ASU 2011-12) for
Presentation of Comprehensive Income during fiscal 2012. However, we note that you are still
presenting the components of other comprehensive income in the statement of stockholders’ equity.
Please confirm for us that in future filings you will present one line item representing the total other
comprehensive income for each period in your statement of stockholders’ equity consistent with the
guidance in ASC 220-10-45-14.
18
Other comprehensive income
ASU 2011-05 did not change the income tax requirements of ASC 220. However, the SEC staff’s
comments about the income tax disclosures related to ASC 220 have become more frequent. The SEC staff
asks registrants to disclose either in the notes or on the face of the financial statements the amount of
income tax expense or benefit allocated to each component of OCI, including reclassification adjustments.
Additionally, the SEC staff may request a summary presentation of income tax expense or benefit
attributable to each component of OCI if a registrant’s disclosure is not transparent (e.g., if OCI components
and their tax effects are included in various locations throughout a registrant’s financial statements).
Example SEC staff comment letter: Presentation of other comprehesive income — tax allocations
Please tell us your consideration of disclosing in the notes to the financial statements the amount of
income tax expense or benefit allocated to each component of other comprehensive income, including
reclassification adjustments. Refer to ASC 220-10-45-12 and 220-10-45-17.
ASU 2013-02 was issued in 2013 to further increase the prominence of items reported in OCI and
improve the reporting of reclassifications out of AOCI. This ASU requires companies to present currentperiod reclassifications out of AOCI and other amounts of current-period OCI separately for each
component of AOCI on the face of the financial statements or in the notes.
ASU 2013-02 is effective for public companies for fiscal years and interim periods within those years
beginning after 15 December 2012, so calendar-year registrants were required to make these
disclosures for the first quarter of 2013. We expect the SEC staff to continue to focus on registrants’
compliance with the new disclosure requirements of ASU 2013-02.
EY resources
•
•
•
Technical Line — How to report AOCI in interim periods (SCORE No. BB2523), 16 April 2013
Technical Line — What the new AOCI disclosures will look like (SCORE No. BB2503), 27 February 2013
Technical Line — Changes in reporting comprehensive income (SCORE No. BB2310), 8 March 2012
19
Revenue recognition
Given the significance of revenue and the complexity of certain revenue recognition guidance, the SEC staff
continues to focus on several revenue recognition topics and expects robust disclosure of a registrant’s
accounting policies and discussion of the key terms of significant revenue arrangements. The SEC staff
continues to question registrants on complex revenue arrangements. Although the number of comments
related to gross versus net revenue presentation and long-term revenue contract disclosures declined
slightly compared with the prior year, these topics are challenging areas on which registrants should
continue to focus.
This past year, we have seen the SEC staff increase its focus on the following:
•
Enhanced description of judgments and policies related to multiple-element arrangements
•
Whether collectibility is reasonably assured, particularly when the registrant operates in markets and
countries where economic conditions continue to be weak
•
Magnitude of and accounting for sales incentive programs, including their effect on a registrant’s
results of operations
Multiple-element arrangements
expects further
Over the last several years, the SEC staff has frequently asked registrants about disclosures of their
multiple-element arrangements or the applicability of the multiple-element revenue guidance. Specifically,
the SEC staff comments on the following areas:
improvement in
•
Overall disclosure — Provide a complete description of rights and obligations, separate from the
discussion of the accounting for those rights and obligations
•
Disclosure of significant deliverables — Disclose the judgments made in concluding whether a
deliverable is or is not a separate unit of accounting, and, if a deliverable is deemed to be
perfunctory, disclose the reasons supporting this conclusion
•
Disclosure of relative selling price — Provide an analysis of how total arrangement consideration was
allocated to each unit of accounting, explaining how the estimated selling price for each unit of
accounting was determined and any significant assumptions used in this determination
•
Disclosure of recognition — Provide a discussion of the timing and pattern of recognition for each unit
of accounting
The SEC staff
disclosures of
accounting
policies and
judgments for
multiple-element
arrangements.
Registrants should carefully review their disclosures, conform them to the multiple-element disclosure
requirements in ASC 605-25 and provide a comprehensive discussion of judgments involving the
identification, separation and recognition of multiple-element arrangements.
20
Revenue recognition
Collectibility
In light of the current economic environment, the SEC staff has been focused on the collectibility
criterion for revenue recognition. In general, the SEC staff focuses on registrants that operate in markets
or countries where economic conditions continue to be weak, when the accounts receivable aging or
days sales outstanding ratio deteriorates, or the registrant has recently revised its payment or credit
policy terms. In these cases, the SEC staff asks about the reasons for unfavorable trends and
implications to revenue recognition.
Example SEC staff comment letter: Collectibility
You state that sales revenue is recognized when “collectibility is reasonably assured." It appears that
your new policies could potentially result in an increase in uncollectible accounts and a related
increase in the unearned revenue balance. Tell us if you are experiencing collectibility problems and
how much of the December 31, 2012 accounts receivable balance has been collected to date.
In determining whether collectibility is reasonably assured as required by SAB Topic 13, registrants must
closely evaluate all relevant facts and circumstances and consider historical collection trends and practices.
Sales incentives
Many registrants offer sales incentives, including discounts, rebates, price protection and promotional
products to customers. Under ASC 605-50, consideration given to a customer is presumed to be a
reduction to revenue unless the vendor receives an identifiable benefit and can reasonably estimate
the fair value of that benefit. The SEC staff questions registrants about the accounting for incentive
programs, especially when the registrant records a portion of the incentives within expense. In addition,
the SEC staff often requests that registrants disclose the amount of discounts or allowances and the
corresponding effect these incentives have on the results of operations regardless of their classification
as an expense or reduction of revenue.
Example SEC staff comment letter: Sales incentives
Please provide us with the activity in your price protection, promotions and other activities account
for each year presented and tell us what consideration was given to providing a discussion of this
information in MD&A considering your discussion of the results of operations does not provide
investors much insight into the trends and uncertainties related to these adjustments which may have
a material effect on revenue.
Registrants should clearly disclose their accounting policies related to sale incentives provided to
customers. When there are new incentive programs or changes in their structure or participation rates,
MD&A should include a discussion of the terms of the programs and their effect on operations if material.
EY resources
•
21
Segment reporting
At the 2012 AICPA National Conference on Current SEC and PCAOB Developments, the SEC staff
highlighted segment reporting as one of the most frequent comment areas. The following are recurring
themes the SEC staff focuses on:
•
Identifying operating segments
•
Aggregating operating segments
•
Providing appropriate entity-wide disclosures with respect to products and services, revenues
attributable to individual foreign countries and revenues from major customers
Consistent with the prior year, the SEC staff often requests that registrants supplementally provide a
discussion of their internal structure or an organization chart and examples of resource allocation
decisions to support the identification of operating segments. Under ASC 280, segment disclosures are
based on a “management approach” and should be consistent with a registrant’s internal management
reporting structure. The SEC staff requests information that is provided to a registrant’s chief operating
decision maker (CODM), board of directors and audit committee. When the CODM regularly receives reports
that present discrete operating results for business units of the registrant below the operating segment level
identified by the registrant, the SEC staff presumes that the CODM uses these reports to manage and assess
performance and allocate resources.
The SEC staff also continues to request that registrants supplementally provide a detailed analysis of how
all factors were considered in reaching the conclusion that aggregation of operating segments was
appropriate. ASC 280 requires that aggregated operating segments have “similar economic
characteristics,” such that they would be expected to have similar long-term financial performance. The
SEC staff challenges registrants’ conclusions to aggregate operating segments when historical or projected
financial information suggests that the operating segments do not have similar economic characteristics.
In addition, the SEC staff often requests that registrants disclose disaggregated revenue by product and
service, individual foreign country or significant customers when the registrant’s other disclosures
indicate that this information is required by ASC 280.
The SEC staff continues to comment on themes similar to those it has in the past, but it is increasing its
scrutiny of segment reporting disclosures and expects registrants to continually monitor business
developments that may affect the identification or aggregation of operating segments.
Identification of operating segments
The SEC staff expects registrants to tell their “complete story” in responding to segment reporting
comments. In explaining the identification of operating segments, registrants should analyze how the
CODM makes resource allocation decisions and assesses performance. Furthermore, the SEC staff
frequently comments when a registrant identifies only one operating segment. The SEC staff may
challenge how decisions can be made about performance and resources for the company as a whole
without evaluating discrete financial information at lower levels.
22
Segment reporting
Given that the SEC staff presumes that reports received by the CODM are used to allocate resources and
assess performance, management is more frequently participating in discussions with the SEC staff to
explain how discrete financial information is used and how management assesses performance and
allocates resources.
Registrants
should continually
monitor changes
in facts and
circumstances
that could cause a
change in segment
reporting.
Aggregation of operating segments
Increasingly, the SEC staff reviews the registrant’s website, analyst presentations and information
throughout its public filings and questions inconsistencies with a registrant’s conclusion that operating
segments can be aggregated based on similar economic characteristics. For example, a discussion of
diverging trends or differing results among business lines could indicate that operating segments may
not be economically similar.
Example SEC staff comment letter: Aggregation of operating segments
We note the separate discussions of your three operating segments in your Q1 20XX Earnings
Presentation available on your website. It appears that the economic characteristics of these three
operating segments may not be similar. Since you aggregate these segments, please provide us with
your analysis under FASB ASC 280-10-50-11 on which you based your conclusion.
Continuous monitoring of segment reporting
We have seen an increase in the frequency of repeat segment comments in a subsequent year’s review. We
believe this is linked to the SEC staff’s emphasis on registrants having processes in place to continuously
reassess their conclusions as circumstances may change over time. For example, the SEC staff may want
to understand how a change in a registrant’s internal reporting due to a significant acquisition or changes
in performance among operating segments affected segment reporting conclusions.
Example SEC staff comment letter: Consideration of recent acquisition
We note that the company continues to operate in a single operating segment. Given the significance
of the recent acquisitions and the fact that operating income and net income declined, please tell us
what consideration, if any, was given to whether the recent acquisitions might have different
economic characteristics from the business prior to the acquisition.
EY resources
•
Financial reporting developments — Segment reporting — Accounting Standards Codification 280
(SCORE No. BB0698), December 2012
23
Statement of cash flows classification
and presentation
For many companies in recent years, classification among operating, investing and financing activities in the
statement of cash flows has been a frequent source of SEC staff comments, as well as some restatements.
ASC 230 may be unclear or silent about how companies should classify cash flows from certain
transactions, and certain cash flows may have aspects of more than one classification. This requires
registrants to apply judgment in determining the proper classification and, in some cases, has resulted
in diversity among registrants in how they classify cash flows from similar transactions. In these
circumstances, the SEC staff continues to comment on the appropriateness of cash flow classification.
The SEC staff also asks registrants to justify net presentation within the statement of cash flows in
accordance with the criteria in ASC 230.
To determine appropriate classification (i.e., operating, investing or financing) for cash flows when
guidance in ASC 230 is not explicit, a registrant must analyze the nature of the activity and the
predominant source of the related cash flows. Just because ASC 230 isn’t explicit, it does not mean that
any classification is appropriate. When the most appropriate classification is not clear in the guidance, a
registrant should:
•
Retain documentation of its rationale for classification
•
Provide transparent disclosure of classification either on the face of the statement of cash flows or
the notes to the financial statements
When the SEC staff asks registrants to explain the classification basis for items in the statement of cash
flows, the registrant should explain the judgment it applied in determining the classification. However,
even registrants that make transparent disclosure may receive comments from the SEC staff about the
basis for cash flow conclusions. Retaining sufficient documentation about such conclusions will help
registrants respond to SEC staff questions. The SEC staff also requests that registrants expand their
significant accounting policy footnote disclosures to address how certain items are classified in the
statement of cash flows and the basis for the registrant’s accounting policy.
The SEC staff also asks registrants to explain why net presentation for certain cash flows is appropriate.
ASC 230-10-45-7 notes that generally the gross amounts of cash receipts and payments during a period
are more relevant than information presented on a net basis. However, ASC 230-10-45-8 and 9 allow
cash flows for certain assets or liabilities (e.g., investments, debt, loans receivable) with original
maturities of three months or less to be presented net if the gross cash flows are not necessary to
understand the registrant’s various cash flow activities.
The SEC staff asks registrants to explain how the net presentation criteria included in ASC 230 were met,
especially if the related asset or liability is classified as non-current in the registrant’s balance sheet.
24
Statement of cash flows classification and presentation
Example SEC staff comment letter: Statement of cash flows presentation
We note the presentation of borrowings under your revolving unsecured credit facility within your
consolidated balance sheet as non-current, and the presentation of these borrowings as net within the
financing activities section of your consolidated statements of cash flows. Please explain in detail how
these borrowings meet the criteria for net presentation within the consolidated statements of cash
flows. See FASB ASC 230-10-45-7 through ASC 230-10-45-9. Please specifically address the original
maturities of these borrowings in your response.
EY resources
•
Financial reporting developments — Statement of cash flows — Accounting Standards Codification 230
(SCORE No. 42856), May 2012
25
Appendix A: Industry sections
This appendix is intended to update you on the SEC staff’s concerns and areas of focus over the past
year. We did not identify new trends in all industries, but we highlighted areas in certain industries when
we have seen the SEC staff increase its focus or when there have been significant developments from the
prior year.
As we said in the introduction to this publication, this update to our October 2012 SEC Comments and
Trends focuses on changes in SEC staff emphasis over the past year. The topics discussed in last year’s
publication are still relevant today, and we encourage you to continue to refer to our 2012 publication.
We encourage you to read this appendix in conjunction with last year’s publication and the main section
of this supplement for a complete analysis of SEC staff comments that may be relevant to registrants in
these industries.
Banking industry
In April 2012, the SEC staff issued disclosure guidance specific to banks, CF Disclosure Guidance: Topic
No. 5 — Staff Observations Regarding Disclosures of Smaller Financial Institutions2 (CF Topic No. 5).
While the guidance addresses smaller financial institutions, the SEC staff has said that it should be
considered by financial institutions of all sizes. In the current environment, the staff continues to focus
on disclosures regarding the credit quality of registrants’ loan portfolios, as previously discussed in this
publication last year.
In recent periods, the SEC staff has focused on the thoroughness and clarity of registrants’ risk
disclosures. We understand from discussions with the staff that its focus on risk disclosures is influenced,
at least in part, by recommendations made in the fourth quarter of 2012 by the Enhanced Disclosure
Task Force (EDTF).3 The EDTF was established by the Financial Stability Board to develop fundamental
principles, recommend improvements and identify examples of best or leading practices to enhance risk
disclosures presented by global financial institutions.
Risk governance and market risks
The SEC staff has requested additional detail about banks’ market risk disclosures as well as their
associated risk management frameworks. These comments have been particularly directed to foreign
private issuers and large US banks with operations in other countries.
2
3
CF Topic No. 5 is available at http://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic5.htm.
The EDTF report summarizing the recommendations is available at https://www.financialstabilityboard.org/publications/r_121029.pdf.
26
Risk governance
The SEC staff has requested that registrants provide thorough descriptions of their risk management
processes. In particular, the SEC staff asks about the structure of various business-unit risk committees and
board-level risk committees and how they communicate with one another and with senior management.
Market risks
Registrants
should consider
the thoroughness
The SEC staff has asked registrants to provide robust discussions of market risk, including how various
types of risk are related (e.g., interest rate risk, credit risk, equity risk, inflation risk, foreign exchange
risk). When a registrant uses a value-at-risk (VaR) model to quantify market risk, the SEC staff may ask
the registrant to provide:
of their risk
•
The number of VaR models used and the rationale behind the use of multiple models
disclosures,
•
Whether the VaR models used are the same as those used for regulatory purposes
•
How the output of multiple VaR models is aggregated for analysis and whether adjustments are
made to facilitate such an analysis
•
A discussion of any changes made to key model characteristics, assumptions and parameters, as well
as an overview of the model validation change processes and procedures
•
A quantitative rollforward of VaR model results and a qualitative discussion of changes reflected in
the rollforward
•
A description of any risks excluded from the VaR analysis and, if so, a discussion of why they are excluded
•
Quantitative metrics or qualitative considerations used in assessing VaR model changes and whether
those factors vary depending on the type of model change made
•
Disclosure of VaR by type of asset and by type of risk
•
Disclosure of the assets and subsidiaries included in each VaR analysis
particularly when
changes are made
to a value-at-risk
(VaR) model.
Liquidity and interest rate risk
The SEC staff has requested further detail regarding banks’ liquidity and interest rate risk disclosures.
Liquidity
The SEC staff continues to focus on a registrant’s liquidity position and its associated risk management.
In particular, the SEC staff has asked:
•
How large multinational institutions manage liquidity risk at the group level, including instances
where excess liquidity in one jurisdiction or entity cannot be used to meet the liquidity requirements
at the group level
•
Whether minimum liquidity requirements have been met across jurisdictions during the periods presented
•
Further detail regarding liquidity management programs in place, including the associated
counterparties as well as pricing sensitivity and availability due to fluctuations in market conditions
•
How registrants calculate key liquidity metrics
•
How registrants manage maturity gaps
27
Example SEC staff comment letter: Liquidity management
Discuss whether you maintain a liquidity pool at either the parent company level or a lower level
such as the individual subsidiary, business unit or country level. Briefly discuss how you manage the
reserve levels between these levels as well as any regulatory requirements for minimum amounts at
various levels.
Interest rate risk
Registrants
should consider
providing more
detail on interest
The potential for rising interest rates could adversely affect the cost of funds and, ultimately, banks’ net
interest margins. The SEC staff has focused more specifically on how banks plan to manage interest rate
risk in the current environment, asking registrants to discuss in further detail the sensitivity of earnings
to interest rates and how repricing risk is managed. Further, the SEC staff focuses on how capital levels
might be affected by interest rate changes.
rate risk exposure
Capital adequacy
in the current
The SEC staff has requested more detail regarding banks’ capital position, including the potential impact
of changes in regulatory capital requirements. The SEC staff has requested that registrants identify
Basel III 4 regulatory metrics as “non-GAAP measures” and describe how such metrics are calculated.
The SEC staff has required registrants to comply with Item 10(e) of Regulation S-K, including disclosure
about how the Basel III regulatory metric is useful to investors and reconciliation to the most directly
comparable GAAP measure. In some cases, the SEC staff also has requested further detail regarding the
anticipated impact of Basel III standards on the registrant’s business.
rate environment.
Example SEC staff comment letter: Regulatory capital disclosures
We note that you have disclosed certain regulatory capital metrics on a Basel III basis. Given that these
metrics are not currently required to be disclosed by GAAP, Commission rules or banking regulatory
requirements, they would appear to be non-GAAP measures under Item 10 of Regulation S-K. As such,
please clearly label these measures as non-GAAP in your future filings and show how such measures
have been calculated.
4
Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen
the regulation, supervision and risk management of banks. More information is available at www.bis.org.
28
Health care industry
Registrants in the health care industry were required to expand disclosures about the allowance for
doubtful accounts for patient accounts receivable and net patient service revenue to comply with the
requirements of ASU 2011-07, which was effective for fiscal years that began after 15 December 2011
and interim periods within those years. Over the last year, the SEC staff has frequently raised questions
about whether health care entities have complied with the requirements of the new standard.
ASU 2011-07 provides greater transparency regarding patient service revenue and related bad debts by
requiring additional financial statement disclosures. The amendments require:
•
Disclosures about management’s policy for assessing the timing and amount of uncollectible patient
service revenue recognized as bad debts by major payor source of revenue
•
Qualitative and quantitative disclosures about significant changes in the allowance for doubtful
accounts related to patient accounts receivable, including information such as significant changes in
estimates and underlying assumptions, the amount of self-pay write-offs, the amount of third-party
payor write-offs and other unusual transactions
•
Disclosures about management’s policy for assessing collectibility in determining the timing and
amount of patient service revenue to be recognized
•
Disclosure of patient service revenue net of contractual allowances and discounts before the
provision for bad debts by major payor source
The SEC staff questions registrants about the adequacy and completeness of the required disclosures.
Most frequently, the SEC staff focuses on whether the required qualitative and quantitative disclosures
about significant changes in the allowance for doubtful accounts are provided. The SEC staff generally asks
registrants to provide proposed disclosures to be included in future filings that satisfy the requirements
of the standard.
Example SEC staff comment letter: ASU 2011-07 disclosures
Please provide us proposed disclosure to be included in future periodic filings that discusses the
qualitative information about significant changes in the allowance for doubtful accounts as required
by ASC 954-310-50-3b.
29
Insurance industry
Background and summary of issued noted
The SEC staff continues to comment on property and casualty loss reserves and loss adjustment expense
reserves, as well as the accounting and disclosure related to reinsurance agreements, as we discussed in
last year’s publication. More recently, the SEC staff has been requesting:
•
Expanded disclosures under Rule 4-08(e) of Regulation S-X when there are restrictions on the
payments of dividends
•
Disclosures regarding the amount of statutory capital and surplus necessary to satisfy regulatory
requirements
•
Disclosure in MD&A of the effects on the registrant’s business of the prevailing low-interest-rate
environment
Statutory disclosures and dividend restrictions
The SEC staff frequently comments on financial statement disclosures of statutory and regulatory
requirements under ASC 944 and Rule 4-08(e) of Regulation S-X. The SEC staff requests that insurance
registrants disclose the nature of dividend restrictions at the parent and subsidiary levels and the
amount of retained earnings or net income restricted or unrestricted for payment of dividends. In
addition, when restricted net assets exceed 25% of consolidated net assets, Rule 4-08(e) requires
additional disclosure to describe the nature of such restrictions and the amount of restricted net assets
for subsidiaries as of the end of the most recently completed fiscal year. For further discussion on
Rule 4-08(e) disclosure requirements, please refer to the Rule 4-08(e) disclosures section under SEC
reporting issues in this publication.
The SEC staff also has challenged registrants’ compliance with disclosure requirements about statutory
capital and surplus under ASC 944-505-50, including the following:
•
Disclose the difference between US GAAP and statutory capital and surplus amounts for each
balance sheet date presented
•
Disclose the amount of statutory capital and surplus necessary to satisfy regulatory requirements or
that the amount required is not significant in relation to actual statutory capital and surplus
•
Disclose the statutory income or loss for each period for which a balance sheet is presented
•
Provide the annual disclosures on an audited basis
The SEC staff’s comments emphasize the importance of disclosing all minimum capital requirements,
including those required for non-regulated, non-US-domiciled subsidiaries or foreign insurance
operations. However, because many insurance entities operate in numerous jurisdictions, the SEC staff
has accepted capital requirement disclosures for only those jurisdictions with significant operations
rather than all jurisdictions.
30
Example SEC staff comment letter: Statutory disclosures and dividend restrictions
Provide us proposed disclosure, to be included in your notes to consolidated financial statements in
future periodic reports that address the following:
•
If “policyholder surplus” is the same as capital and surplus as required by ASC 944-505-50-1a,
please revise to clarify. Otherwise revise to disclose the amount of statutory capital and surplus as
of the date of each balance sheet presented.
•
Disclose the amount of statutory capital and surplus necessary to satisfy regulatory requirements
or disclose that the amount required is not significant in relation to actual statutory capital and
surplus. Refer to ASC 944-505-50-1b.
•
Disclose the amount of retained earnings or net income restricted or free of restrictions for the
payment of dividends by the Corporation to its stockholders. Refer to Rule 4-08(e) (1) of
Regulation S-X.
•
Disclose the amounts of restricted net assets for your subsidiaries as of the end of the most
recently completed fiscal year. Refer to Rule 4-08(e) (3) (ii) of Regulation S-X.
The SEC staff has continued to comment that merely stating that total adjusted capital is in excess of the
risk-based capital for all insurance entities is not sufficient under ASC 944-505-50-1b. The registrant
must disclose the amount of statutory capital and surplus necessary to satisfy regulatory requirements if
it is significant in relation to actual statutory capital and surplus. If it’s not significant, the registrant must
explain why it isn’t in the notes to the financial statements.
Example SEC staff comment letter: Statutory capital and surplus
Although you disclose on page XX that all of the company’s insurance subsidiaries had total adjusted
capital in excess of the RBC requirement, disclose the amount of statutory capital and surplus
necessary to satisfy regulatory requirements if significant in relation to actual statutory capital and
surplus, as required under ASC 944-505-50-1b. If not significant, please clarify in the disclosure.
When registrants have labeled their statutory capital and surplus disclosures as “unaudited,” “approximate”
or “preliminary,” the SEC staff has reminded them that these disclosures are required to be audited.
EY resources
•
Prevailing low interest rates
The SEC staff has asked insurance registrants to provide expanded disclosures about how low interest
rates are expected to affect future financial position, cash flow and profitability of certain products.
Specifically, the SEC staff requests information on how cash flows will be reinvested as investments
mature or are called, and the cash flows that are committed to pay guaranteed features that are due.
The SEC staff also asks registrants to disclose information such as the amount of maturing or callable
investments, their weighted average yields and insurance liabilities with minimum interest rate
guarantees by product type.
31
Example SEC staff comment letter: Prevailing low interest rates
Please provide us proposed disclosure to be included, in MD&A, in future periodic reports that
discloses the expected effects of this known trend or uncertainty on your future financial position,
results of operations and cash flows.
To the extent that information about (1) the amount you expect to invest from new cash flows, (2) the
amount you expect to reinvest at lower rates or (3) the amount of products with guaranteed rates, is
necessary to understand these effects, please include these amounts and their effects in your
proposed disclosure to the extent known.
32
Oil and gas industry
Background and summary of issued noted
The SEC staff continues to comment on the reserve disclosures by registrants in the oil and gas industry.
Among the issues being raised are the technical support for and consistency of significant reserve
estimates and compliance with the SEC rule, Modernization of Oil and Gas Reporting Requirements.
In addition, the SEC staff also frequently comments on the disclosures involving registrants’ use of
hydraulic fracturing as a production technique. These topics were discussed in last year’s publication.
Over the past year, the SEC staff has increasingly commented on the following:
•
Assumptions used in registrants’ impairment analyses of oil and gas properties
•
Disclosures by master limited partnerships or their controlling parent related to governance and
conflicts, related-party transactions and contingencies
•
Adjustments to non-GAAP financial measures for mark-to-market gains and losses on commodity
derivative transactions
Impairment assumptions
The SEC staff often comments on the assumptions used in registrants’ impairment analyses for oil and
gas properties under ASC 932-360-35 and whether these assumptions are consistent with other
information presented in the same or other filings.
The questions address matters ranging from pricing to the types of items included in cash flow analyses.
They often focus on the assumptions applied, the consistency of those assumptions with other analyses,
the calculations themselves and related disclosures. Occasionally, the SEC staff will request that
information in one section of the filing be reconciled to another, or that entities provide more detailed
information about how assumptions were developed to explain discrepancies. These requests seek
information about the consistency of assumptions used in operating and capital budgeting, recent
business combinations and reserve determination information.
Example SEC staff comment letter: Impairment assumption consistency
Explain to us, in reasonable detail, how the price assumptions used in your impairment testing
compare to those used to value the acquired properties. Additionally, explain to us how the pricing
assumptions used for your impairment testing compare to those used for purposes of preparing any
operating or capital budgets. To the extent that the assumptions used for purposes of valuing the
acquired properties or preparing budgets differ from those used for purposes of impairment testing,
explain to us how you considered the guidance in FASB ASC paragraph 360-10-35-30.
Additionally, the SEC staff sometimes asks whether reserves information suggesting properties are not
profitable at current pricing levels (e.g., proved property balances exceed discounted cash flow amounts
disclosed in accordance with ASC 932-235-50) led to impairment analyses of the properties.
33
Master limited partnerships
In recent years, oil and gas entities have expanded the use of master limited partnerships (MLPs) to raise
capital and as a risk-sharing strategy. Particularly in initial public offerings, the SEC staff asks MLP
registrants or their controlling parent to provide information or enhance disclosures related to
governance and conflicts, related party transactions, and controlling entity reporting of contingencies
related to MLPs. The SEC staff requests expanded disclosures primarily in the MLP’s initial public
offering, but also in the controlling entity’s recurring annual and interim reports.
Governance and conflicts
MLP entities often are controlled by other public entities and share upper-level executives. The SEC staff
questions how MLP executives’ time will be divided between the MLP and their other responsibilities and
the effect of these separate responsibilities on their compensation arrangements.
Example SEC staff comment letter: MLP executive roles and compensation
We note that you are in the process of finalizing the philosophy and design of your compensation plans
and programs. Please ensure that any forthcoming disclosure describes whether your executive officers
and directors will be paid by both [Entity A — MLP] and by [Entity B — controlling entity] and how such
compensation amounts will be determined in light of their respective positions at both companies.
The SEC staff
asks MLP
registrants to
disclose potential
conflicts, how
they are managed
or how they may
affect the MLP.
The SEC staff requests that MLP registrants disclose information regarding potential conflicts, how they
are managed or how they may affect the MLP.
Example SEC staff comment letter: MLP conflicts
We note the statement that your general partner may, but is not required to, seek approval from the
conflicts committee to resolve conflicts. Please disclose how your general partner’s board of directors
will decide whether to seek approval from the conflicts committee …
Please disclose the categories of persons that you anticipate will be included in the term “related
persons.” Please also disclose, or cross-reference to disclosure of, the anticipated role of the conflict
committee for the review, approval and ratification of transactions with related persons. See Item 404(b)
of Regulation S-K.
Related party transactions
The SEC staff inquires about related-party transactions between the MLP and the controlling interest
holder or its affiliates. The SEC staff requests information about operating arrangements and contractual
commitments with related parties, as well as their effect on the MLP’s ability to obtain third-party
contracts, make distributions and enter into other arrangements. The SEC staff also questions how
related-party transactions affect the liquidity and capital resources of the MLP.
Example SEC staff comment letter: MLP related-party transactions
We read that you provide firm storage services utilizing 100% of the storage capacity at your storage
facility to an affiliate under a contact entered into in March 20XX. Please ensure that your related
party footnote provides all disclosures required by ASC 850-10-50-1 and tell us how you considered
the guidance in Rule 4-08(k) of Regulation S-X.
EY resources
•
Master limited partnership accounting and reporting guide (SCORE No. BB1889), October 2011
34
Controlling entity reporting of contingencies related to MLPs
The SEC staff has
asked registrants
that control
master limited
partnerships
The SEC staff requests information about any inconsistencies between the information presented by the
MLP in its filings and the disclosures made by the holder of its general partner interest in its own filings.
These requests focus particularly on contingencies. The SEC staff inquires about whether guarantees
and indemnifications made by investor entities are appropriately recorded and disclosed. The SEC staff
also requests that MLP controlling interest holders disclose any significant changes in the underlying
contingencies reported by the MLP if they also are material to the controlling interest holder.
about
Example SEC staff comment letter: MLP controlling entity reporting
inconsistencies
We note that in connection with the contribution of certain of your operations to your MLP, you
entered into a support agreement pursuant to which you are obligated to provide contingent, residual
support of approximately $XXX million of aggregate principal amount of your MLP’s 7.5% senior
unsecured notes due 2018. Please tell us how you considered the guidance in ASC 460, Guarantees,
and whether you recorded a liability for this agreement. If you do not believe that the substance of this
debt support is a guarantee, please provide us with your analysis of the applicable accounting
guidance. Additionally, please tell us why you have not discussed this debt support within the Liquidity
section of your MD&A.
in reporting,
particularly about
contingencies.
Non-GAAP measures
Oil and gas enterprises frequently use non-GAAP measures such as adjusted EBITDA, distributable cash
flow and other metrics to explain performance. Because many of these entities use commodity derivatives
as economic hedges for commodity price exposure, but do not elect to use hedge accounting, unrealized
gains and losses on derivatives (sometimes referred to by registrants as “noncash” or “mark-to-market”
gains and losses) are recorded through profit and loss.
In some cases, registrants have presented an adjusted EBITDA or distributable cash flow measure that
includes adjustments intended to reflect cash flows associated with commodity derivatives settled during
the period and therefore excludes the effects of unrealized gains and losses. The SEC staff frequently
requests that registrants disclose why such measures are useful to investors and how adjustments
related to commodity derivatives are presented in the reconciliation to the most directly comparable
GAAP measure.
For example, the staff may request that the registrant include a separate line item in its reconciliation
for (1) the total gain or loss recognized during the period under GAAP and (2) the amount of net cash
received or paid for commodity derivatives settled during the period, with disclosure of how the recovery
of any costs previously incurred to acquire or modify the derivative (i.e., premium paid) is reflected in
the adjustment.
35
Real estate industry
The SEC staff continues to request additional disclosures about registrants’ cost capitalization policies
and the nature of their capital expenditures. The SEC staff also frequently asks registrants to provide
additional or modified disclosures when presenting funds from operations (FFO) and other non-GAAP
financial measures. These topics were discussed in our publication last year.
Recently, the SEC staff has also questioned registrants in the real estate industry about the following:
•
Consideration of whether acquired properties meet the definition of a “business” as defined by
ASC 805
•
Presentation of same-property net operating income (NOI) and the registrant’s policies for
determining when properties are included and excluded from the same-property portfolio
•
Relationship of rental rates for expiring leases to the current market
Asset acquisition versus business combination
When properties are acquired, the SEC staff may request that registrants provide additional information
about their consideration of whether the acquired property does or does not meet the definition of a
“business” in ASC 805.
The definition of a “business” in ASC 805 is broad and requires the exercise of professional judgment.
Consequently, careful evaluation by management is required in determining whether the acquired set of
assets and activities constitutes a business. This determination is critical because the accounting for a
business combination differs significantly from that of an asset acquisition. For example, in an asset
acquisition, qualifying transaction costs would be capitalized, while in a business combination those same
costs would be expensed when incurred.
Under ASC 805, a business generally will consist of the following three elements: (1) inputs, (2) processes
applied to those inputs and (3) outputs that are used to generate revenues. However, ASC 805 emphasizes
that to be considered a business, a set of activities and assets is required to have only the first two of
those three elements (i.e., inputs and processes), which together are or will be used to create outputs.
Further, the acquired set of assets and activities must only be capable of being conducted and managed
in order to produce outputs from the viewpoint of a market participant.
The SEC staff comments have focused on obtaining an understanding of registrants’ evaluations of
whether acquired properties have inputs and processes that are capable of producing outputs. For
example, the staff has requested additional information to support conclusions that the buyer assumed
processes at the acquired properties. The SEC staff also requests registrants to provide references to the
accounting literature used when formulating their conclusion.
Example SEC staff comment letter: Evaluation of business combination vs. asset acquisition
Please tell us how you determined that your acquisition of Property A constitutes a business
combination rather than an asset acquisition. Please refer to the applicable accounting literature you
utilized in coming to this determination.
36
EY resources
•
Financial reporting developments — Business combinations (SCORE No. BB1616), December 2012
Same-property portfolio composition
Real estate companies engage in a variety of activities that result in expansion or contraction of their
operating portfolios (e.g., acquisition, disposition, development, redevelopment). The absence of specific
guidance on determining what to include in a same-property portfolio, including the appropriate timing of
a transfer of a property into or out of the portfolio, results in diversity of practice among registrants.
Therefore, the SEC staff is focused on transparent disclosure in this area.
Registrants may present same-property portfolio NOI in order to facilitate a comparison of results of
properties that they have consistently owned and operated throughout the periods presented. The SEC
staff frequently requests enhanced MD&A discussion about registrants’ policies to determine sameproperty portfolio NOI. The SEC staff also asks registrants to provide additional quantitative and
qualitative disclosures about properties that are added to or removed from the measure.
In particular, the SEC staff requests that registrants disclose:
•
Whether management considers same-property NOI to be a key performance indicator and why the
measure is useful to investors
•
Policies for determining which properties are included in the same-property portfolio
•
Policies for determining the timing of transfers into and out of the same-property portfolio, by
category, and a quantification of such activity during the period
•
A definition of same-property NOI and reconciliation to the most directly comparable GAAP measure
Example SEC staff comment letter: Same-property portfolio
Please advise us whether you consider same-property NOI a key performance indicator. If so, please
revise your disclosure in future Exchange Act periodic reports to discuss how you define this measure
and, to the extent material, explain management’s determinations to exclude certain properties from
the same-property portfolio. In your response, please also describe your policies related to including
developed and acquired properties in the same-property pool and the various reasons and policies for
removing a property from the pool.
Relationship of market to expiring rents
To help users understand current and future performance, the SEC staff is requesting enhanced
disclosure in the MD&A from registrants about how rental rates for expiring leases compare with the
current market.
The difference between contractual rental and market rates is known as “rental spread.” The disclosure
of registrants’ expected rental spreads allows a user to more accurately project changes to future
revenues resulting from renewal or replacement of expiring leases. This insight is particularly useful if a
registrant has significant leases expiring in the next 12 months.
The SEC staff also may request additional information that summarizes the volume of leasing activity
(e.g., number of executed leases, square footage leased, rental rate per square foot) during the periods
presented, the rental spread between expired and recently executed leasing rates, and costs incurred to
secure new or renewed leases (e.g., leasing commissions, tenant allowances).
37
Example SEC staff comment letter: Relationship of market to expiring rents
In future periodic filings, to the extent you have material lease expirations in the next year; please
include discussion of the relationship of rents on expiring leases to market rents. In addition, please
expand your disclosure of your leasing activities for the most recent period, including a discussion of
the volume of new or renewed leases, average rents or yields on new and renewed leases, the
relationship between new rents and old rents on re-leased space and, where applicable, average
tenant improvement costs, leasing commissions and tenant concessions.
38
Retail and consumer products industry
The SEC staff often requests that registrants in the retail and consumer products industry quantify the
effects of e-commerce sales on key performance metrics such as comparable-store sales. When
e-commerce sales are material or result in a material change to the comparable-store sales metrics, the
SEC staff frequently asks retailers to provide more information about the e-commerce component of
comparable-store sales.
Comparable-store sales is a key performance metric to retailers. Because the definition of this metric
varies, the SEC staff asks retailers to disclose how they define this metric, and more specifically, whether
their comparable-store sales metric includes sales from e-commerce.
Many retailers continue to invest in e-commerce platforms as a sales channel. As these sales channels
continue to grow, the SEC staff requests that the registrant disclose information about the effect of
e-commerce on the registrant’s business. When e-commerce sales are material, the SEC staff expects a
robust discussion of e-commerce sales in MD&A and the related effects on key performance metrics. If
e-commerce sales are included in the registrant’s comparable-store sales metric, the SEC staff believes
that disaggregating sales from e-commerce provides more transparent disclosure about changes in
comparable-store sales.
Example SEC staff comment letter: Comparable-store sales
Throughout MD&A, you refer to comparable-store sales. Please tell us and disclose how you define this
metric, including whether or not this metric includes the effects of e-commerce sales. To the extent
e-commerce sales are included in this metric and have had a material effect on your comparable-store
sales or on any change in trends of this metric, please confirm that you will present this key
performance indicator in a manner that either separately quantifies the e-commerce activity or
provides transparent disclosure regarding the impact of e-commerce sales on this metric.
EY resources
•
39
Appendix B: Foreign private issuers
The SEC staff’s comments to foreign private issuers (FPIs) often are similar to its comments to domestic
registrants. These comments involve financial reporting matters, whether the FPI prepares its financial
statements in accordance with US GAAP, International Financial Reporting Standards (IFRS) or homecountry GAAP.5 Many of the topics in the main and industry sections of this publication and last year’s
publication are equally relevant for FPIs.
This section focuses on topics that the SEC staff has recently raised in comments to FPIs. As we
highlighted in last year’s publication, the SEC staff continues to focus on FPI disclosures about sovereign
debt exposures, US GAAP expertise and reconciliations of home-country GAAP to US GAAP.
Over the past year, the SEC staff has expanded its inquiries related to the disclosures of first-time
adopters of IFRS as issued by the International Accounting Standards Board (IASB). The staff also has
continued to focus on the inclusion of risk factors to highlight to investors the lack of Public Company
Accounting Oversight Board (PCAOB) inspection in certain foreign jurisdictions.
First-time adopters of IFRS as issued by the IASB
Paragraphs 7 and 8 of IFRS 1, First-time Adoption of International Financial Reporting Standards, require
companies to use the same accounting policies in their opening IFRS statement of financial position and
throughout all periods presented in their first IFRS financial statements. Those accounting policies are
required to comply with the standards effective at the end of the company’s first IFRS reporting period,
unless retrospective application is prohibited under IFRS 1. During the past year, the SEC staff has
focused on the effective date that FPIs have used to determine which accounting policies to apply.
The SEC staff frequently comments on incomplete disclosure in the financial statements regarding
compliance with IFRS as issued by the IASB. FPIs are required to explicitly state that their financial
statements comply with IFRS “as issued by the IASB” if they don’t want to provide a reconciliation to
US GAAP. Over the past year, the SEC staff has continued to ask FPIs whether they prepared their
financial statements in accordance with IFRS “as issued by the IASB” and, if not, to provide a
reconciliation to US GAAP.
5
We do not cover IFRS-specific accounting topics in this publication. However, at the 2012 AICPA National Conference on Current
SEC and PCAOB Developments, the SEC staff identified several common themes in its comment letters issued on IFRS financial
statements. These themes are consistent with the themes in its comment letters issued to US GAAP filers, including financial
instruments, especially the impairment of loan portfolios, financial statement presentation, provisions and contingencies, asset
impairments, consolidation and joint ventures, revenue recognition, income taxes, the factors used to identify operating segments
and business combinations.
40
Appendix B: Foreign private issuers
Auditor not subject to PCAOB inspection
In our prior publication, we highlighted certain countries that have legal or regulatory frameworks that
currently prohibit the PCAOB from inspecting the audit work performed by registered firms in those
jurisdictions. The SEC staff frequently asks registrants in foreign jurisdictions that have not permitted the
PCAOB to conduct principal auditor inspections to disclose that fact as a risk factor.
Due to agreements reached over the past year, the PCAOB can now conduct inspections in France and
certain other countries. Other countries such as China, Greece and Italy still don’t permit the PCAOB to
conduct inspections.6
6
A list of issuers that are audit clients of PCAOB-registered firms from non-US jurisdictions that don’t allow the PCAOB to conduct
inspections is available at http://pcaobus.org/International/Inspections/Pages/IssuerClientsWithoutAccess.aspx.
41
Appendix C: Abbreviations
Abbreviation
FASB Accounting Standards Codification
ASC 220
FASB ASC Topic 220, Comprehensive Income
ASC 230
FASB ASC Topic 230, Statement of Cash Flows
ASC 280
FASB ASC Topic 280, Segment Reporting
ASC 360
FASB ASC Topic 360, Property, Plant, and Equipment
ASC 460
FASB ASC Topic 460, Guarantees
ASC 605-25
FASB ASC Topic 605-25, Revenue recognition — Multiple-Element Arrangements
ASC 605-50
FASB ASC Topic 605-50, Revenue Recognition — Customer Payments and Incentives
ASC 740
FASB ASC Topic 740, Income Taxes
ASC 805
FASB ASC Topic 805, Business Combinations
ASC 820
ASC 850
FASB ASC Topic 820, Fair Value Measurement
FASB ASC Topic 850, Related Party Disclosures
ASC 932
ASC 944
FASB ASC Topic 932, Extractive Activities — Oil and Gas
FASB ASC Topic 944, Financial Services — Insurance
ASC 954
FASB ASC Topic 954, Health Care Entities
Abbreviation
Other Authoritative Standards
ASU 2011-04
Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820):
Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in US GAAP and IFRSs
ASU 2011-05
Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220):
Presentation of Comprehensive Income
ASU 2011-07
Accounting Standards Update No. 2011-07, Health Care Entities (Topic 954):
Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and
the Allowance for Doubtful Accounts for Certain Health Care Entities — a consensus of
the FASB Emerging Issues Task Force
ASU 2011-08
Accounting Standards Update No. 2011-08, Intangibles — Goodwill and Other (Topic
350): Testing Goodwill for Impairment
ASU 2011-12
Deferral of the Effective Date for Amendments to the Presentation of Reclassifications
of Items Out of Accumulated Other Comprehensive Income in Accounting Standards
Update No. 2011-05
ASU 2013-02
Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
SAB Topic 11-M
SEC Staff Accounting Bulletin Topic 11-M, Disclosure Of The Impact That Recently
Issued Accounting Standards Will Have On The Financial Statements Of The Registrant
When Adopted In A Future Period
SAB Topic 13
SEC Staff Accounting Bulletin Topic 13, Revenue Recognition
42
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specific advice.

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