Accounting Standards

Representatives from the Office of Chief Accountant discussed new accounting standards.  The Staff commented on the implementation of the new revenue recognition standard, which requires companies to provide a comprehensive view of revenue arrangements in their financial statements, including their disclosures.  The Staff intends to continue to monitor, and comment on, the implementation of the revenue standard.  The Staff noted that nearly all companies will be affected by the adoption of the new lease accounting standard, which will soon be effective.  To that end, representatives of the Staff have provided guidance on implementation of the standard, which, representatives of the Staff caution require significant time and effort.  Various representatives noted that steps for lease accounting implementation include:  understanding the accounting and disclosure requirements of the new standard; identifying relevant arrangements and leases within those arrangements; determining appropriate accounting policies, including applicable transition elections; applying the guidance to arrangements within the standard’s scope; preparing transition and ongoing disclosures; and establishing adequate and appropriate processes and controls to support implementing and applying the new standard, including preparing required disclosures.  Representatives noted that “it is crucial for each registrant to ensure its implementation plans include sufficient time to identify arrangements that are leases in their entirety or that include embedded leases….[i]t is also critical for companies to identify and resolve transition, application, and other implementation issues arising from the new leases standard.  A lesson learned from the implementation of the new revenue standard is that entities benefit from an early and thorough discussion of implementation issues with their auditors and audit committees.”

Audit Committee Oversight

Various Staff members noted the important role of the audit committee in connection with the implementation of new accounting standards.  To that end, the Staff noted that the audit committee should exercise oversight over management’s approach to implementation of new accounting standards, should establish appropriate controls and procedures over the transition; maintain appropriate controls and procedures over ongoing application of the new accounting standard; and should understand how the effects of the new standard are communicated to investors at transition and on an ongoing basis.

Internal Control over Financial Reporting

Various speakers addressed internal control over financial reporting.  In this regard, the speakers again emphasized the important role of audit committees.  Audit committees should have discussions of ICFR in all areas—from risk assessment to design and testing of controls, as well as the appropriate level of documentation.  The Staff noted the importance of identifying and communicating material weaknesses before these manifest in the form of a financial statement restatement.  The Staff noted there has been progress in the evaluation of the severity of internal control deficiencies.  The Staff encouraged audit committee training regarding “the adequacy of and basis for a company’s effectiveness assessment, particularly where there are close calls in the assessment of whether a deficiency is a significant deficiency (and reported to the audit committee) or a material weakness (and reported also to investors).”  Speakers also emphasized that the assessment of ICFR is especially important this year-end as a result of the implementation of new accounting standards, which also affects a company’s internal controls.

Material Weakness Disclosures

Representatives of the Staff noted improvement in the disclosures of a material weakness; however, suggestions were offered that are intended to make the disclosures more useful to investors.  One of the speakers suggested considering the following questions in evaluating the proposed disclosure:

  • Does the disclosure allow an investor to understand what went wrong in the control that resulted in a material weakness?
  • Is it sufficiently clear from the disclosure what the impact of each material weakness is on the company’s financial statements?  For example, is the material weakness pervasive or isolated to specific accounts or disclosures?
  • Are management’s plans to remediate the material weakness sufficiently clear?  For example, does disclosure of the remediation plans provide sufficient detail that an investor would understand what management’s plans are and how the remediation plans would address the identified material weakness?

Implementation Activities for Communicating Critical Audit Matters

The Staff also addressed implementation activities related to the CAM standard.  In order to prepare for the CAM standard implementation, the Staff encourages auditors and registrants to conduct a dry run this year with the auditors and audit committees, share implementation questions and issues with the Staff, and begin to focus on the differing disclosure requirements for MD&A critical accounting estimates and CAMs.

In a recent speech, Commissioner Kara Stein addressed a number of disclosure related concerns, including cyber disclosures and ESG disclosures.  Just as many of us had been reading about a decline in the number of SEC Staff comments regarding the use of non-GAAP measures in SEC filings, Commissioner Stein’s remarks seemed to focus renewed attention on this issue.  Commissioner Stein cited studies that show that approximately 97% of S&P 500 companies cite at least one non-GAAP metric in their reports.  In addition to echoing prior Staff concerns regarding the possibility that the use of non-GAAP measures may be misleading or may “disguise financial performance,” Commissioner Stein raised a new issue—the lack of uniform standards for non-GAAP measures.  Hopefully, such concerns can be allayed with more detailed disclosures, rather than prescriptive standards regarding frequently used non-GAAP measures.  Commissioner Stein also focused on “key performance indicators” (KPIs).  While remarks from Commission Staff representatives in recent months have indicated that attention is being paid during disclosure reviews on the use of “tailored” performance measures reported by registrants, Commissioner Steins’ comments appear to reflect some intensified focus.  Commissioner Stein noted that more and more companies are provided tailored measures of financial performance, which may include same store sales, sales per square foot, customer churn rates, sales conversion rates, customer retention, etc.  Stein also noted that non-GAAP measures and KPIs appear to be used in the private markets, with forward-looking adjustments, such as cost savings.  While noting that many of these measures may be used by the key decision makers within companies to track the companies’ performance and, therefore, may provide useful insights for investors, the lack of transparency regarding the calculation of many such measures, the lack of comparability as to such measures, and the possible selective use of such measures may raise investor protection concerns.  See the full text of the Commissioner’s remarks here.

Wednesday, August 1, 2018
1:30 p.m. – 2:00 p.m. EDT

During this session, the speakers will address some of the topics that should be among the principal areas of focus for disclosure committees, audit committees and others with responsibility for, or oversight of, reporting company disclosures.  We will focus on:

  • Reviewing risk factor disclosures in light of current areas of staff focus;
  • Policies and procedures related to the use of non-GAAP financial measures;
  • Cyber related disclosures;
  • Perk disclosures; and
  • Implementing recently adopted or new accounting standards.


  • Michael L. Hermsen
    Partner, Mayer Brown LLP
  • Anna T. Pinedo
    Partner, Mayer Brown LLP

For more information, or to register for this session, please visit the event website.

The Securities and Exchange Commission has proposed to amend its auditor independence rules in order to determine whether an auditor is independent if it has a lending relationship with certain shareholders of an audit client during its professional engagement period.  The auditor independence standard set forth in Rule 2-01 of Regulation S-X requires auditors to be independent of audit clients both “in fact and in appearance.”  Rule 2-01(c)(1)(ii)(A) addresses debtor-creditor relationships and requires that one consider whether an audit firm has a lending relationship with an entity having record or beneficial ownership of more than 10% of the equity securities of either the firm’s audit client or any entity that is a controlling parent company of the audit client, a controlled subsidiary of the audit client, or an entity under common control with the audit client.  Several aspects of the current rule have resulted in challenges, especially for funds and fund families.  The proposed amendments would focus solely on beneficial (not record) ownership, would replace the bright-line 10% ownership test with a “significant influence” test, would add a “known through reasonable inquiry” standard in relation to identifying beneficial owners of the audit client’s equity securities, and would amend the definition of “audit client” for a fund under audit to exclude from the provision funds that otherwise would be considered “affiliates of the audit client.”  In assessing whether a lender has the ability to exert a significant influence over the audit client’s operating and financial policies reference is made to the principles articulated in the Financial Accounting Standard Board’s ASC Topic 323, Investments–Equity Method and Joint Ventures.  The ability to exert a significant influence would require a facts-and-circumstances assessment of, among other things, board representation, participation in policy-making, material intra-entity transactions, interchange of management personnel, or technological dependency.  The proposing release notes that a benefit of the proposed amendments would be that compliance monitoring would be less burdensome.  This seems unlikely in light of the analysis required to be undertaken to assess any “significant influence,” which is fact-based and seemingly more subjective than the current standards.

In a wide-ranging speech today, SEC Chief Accountant Wesley Bricker addressed recent changes and forthcoming changes to accounting standards, including the new revenue recognition standard.  He noted the need to continue to focus on the implementation of the lease accounting standard next year and the credit losses standard.  Bricker also commented on accounting for equity investments in other companies.  Bricker touched briefly on non-GAAP financial measures, reminding the audience that reporting companies must have disclosure controls and procedures that address the use of non-GAAP measures.  In this regard, he noted that audit committees have an important role to play in reviewing the presentation of non-GAAP measures, understanding the purpose and integrity of the non-GAAP measures, evaluating whether the measures are consistently prepared and presented period to period, and understanding how corrections of errors in such measures will be presented.  Bricker also noted the importance of the audit committee’s role with respect to the disclosure of market risks.  Bricker mentioned the Commission’s recently proposed rulemaking addressing the auditor independence rules.  He concluded his remarks with observations regarding the importance of independent minded audit committees as one element of a strong corporate governance structure.  The full text of his remarks may be found here.