Quarterly Update: Accounting and the SEC

Weaver’s December 15, 2022 Accounting and SEC Update highlighted four areas: recent accounting pronouncements and upcoming effective dates, credit impairment under ASC 326 (CECL), pay versus performance disclosures as well as comment letter trends and other year-end reminders. Across these areas, the SEC is increasingly emphasizing disclosures. Regulators want more context behind financial results, which will take more time for audit and reporting teams to prepare.

Recent Accounting Pronouncements

Six accounting standards updates (ASUs) with effective dates in 2023 for calendar year-end public entities:

• ASU 2017-04 will now be required for smaller reporting companies (SRC). It simplifies impairment testing for goodwill for intangible assets by reducing the impairment quantification to a one-step analysis, and requires certain disclosure items.
• ASU 2018-12 is narrowly focused on long-duration contracts. It requires enhanced information about disclosures and the assumptions and inputs used to measure liabilities. It’s effective for most calendar year-end filers for 2023, excluding SRCs.
• ASU 2021-08 simplifies business combination reporting by exempting certain contract assets and liabilities accounted for under ASC 606 from the fair value concepts in ASC 805. Instead, filers should account for contract assets and liabilities using their value at the time of acquisition.
• ASU 2022-01 attempts to simplify derivatives and hedge accounting. It amends ASU 2017-12 to change certain nomenclature and expands the application of the portfolio layer method to portfolios of all assets, rather than just prepayable financial assets per previous guidance.
• ASU 2022-03 looks at how companies measure equity securities that are subject to sale restrictions. Essentially, there’s no difference between how a company measures the fair value of equity securities with or without sales restrictions. 
• ASU 2022-04 requires additional disclosures for companies with supplier finance programs, but does not change how filers interact with suppliers, account for, or measure supplier financing. Regulators want to see the key terms and components of arrangements, as well as their impact on cash flow. The ASU is effective at the beginning of Q1 2023 for entities that operate on calendar year-end. Filers will also need to roll forward obligations from the beginning of each period, although the ASU provides for an additional year before this rollforward requirement is effective. Give yourself plenty of time to collect, aggregate, and disclose this data, and ensure adequate controls are in place.

Credit Impairment Under ASC 326 (CECL)

While previously effective for larger filers, seven current expected credit loss (CECL)-related ASUs go into effect in 2023. While CECL is generally viewed as most significantly impacting large financial institutions, it also applies to trade receivables and potential challenges should not be overlooked. Unless your entity operates solely on a cash basis, there is most likely an impact.    

Keep in mind the spirit of the guidance, which is to give investors more useful and timely information, and generally results in earlier recognition of expected or potential credit losses.

Under ASC 326:

• There’s a no probability threshold. Day 1 recognition is required for allowances, even if the chances are remote.
• Pooling of assets was previously permitted, but is now required. CECL offers some flexibility on how assets are pooled so you can create buckets that make sense for your company and situation (e.g., credit scores, risk rating, type of financial assets, terms).
• Reporting becomes more forward-looking. Filers should be able to provide reasonable and supportable forecasts, along with an estimation of risk. Longer forecast duration equates to increased risk. Within your organization, different levels of risk may require different levels of review, documentation, or approval. 
• Loss recoveries are clarified. Entities should consider recoveries and can adjust the allowance. An allowance can have a negative balance, if recovered. A $0 allowance is also possible, although unusual and rare.   

Many filers already have processes, systems, and controls in place to pull historic data and create up-to-90-day analyses. Now, filers need to layer on future economic considerations. Take time to understand the guidance and elections, and to document your calculation methods, processes, and procedures.  

Pay versus Performance: Item 402(v) of Regulation S-K

Companies with fiscal years that ended on or after December 16, 2022, are required to disclose additional information about executive compensation in an entities proxy disclosures. The disclosures help investors understand the relationship between executive compensation for named executive officers (NEOs) and the principal executive officer (PEO) and a registrant’s financial performance. The disclosure requirements also apply to SRCs, but with certain scaled requirements.  

Executive compensation is a tabular disclosure and includes the following key information for a period of five years (three years for SRCs):

• Summary compensation for PEO and NEOs: Calculate the salaries, bonuses, stock awards, incentive plans, nonqualified deferred compensation, and changes in pension value, among other items, for the covered fiscal year.
• Compensation actually paid to the PEO and NEOs
• Shareholder Return and Peer Group Shareholder Return: Using like-for-like measurement periods, calculate the cumulative shareholder returns (TSR) based on a fixed investment of $100. (Peer group information not required for SRCs.)  
• Net income
• Company-selected measure: Registrations can choose their own, most-important financial performance measure that links company performance to compensation. (SRCs are not required to complete this field.)

Other disclosures:

• Use footnotes to explain amounts that are deducted from or added to your compensation calculations and include the names of PEOs and NEOs.
• Describe the relationship between the registrant and its TSR peer group. Peer groups can come from the same index or issuers that you use for Item 201 purposes. With appropriate disclosure, peer groups may change.
• Create an unranked tabular list of the top three to seven performance measures that influence executive compensation; these can be financial or non-financial.​​​​
• Transitional relief is provided for three years (or two years for SRCs).
• Use XBRL to separately tag each value in the pay versus performance table, as well as block-text tag footnotes, relationship disclosures, and tabular lists.

Comment Letter Trends

Heading into 10K season, the “usual suspects” are still front-and-center in SEC comment letters: revenue recognition, business combinations, and non-GAAP measures.

• Revenue recognition comments stem from aggregation of revenue streams. Revenue streams can be grouped if they have similar risk levels, characteristics, or patterns. Give readers enough information to understand the characteristics of aggregate groups, including how and when revenue is generated, measured, and recognized. Through disclosures, investors should also understand forward-looking impacts.
• Business combinations need strong definitions. Explain how and why you distinguished a business combination from an asset allocation. Likewise, you may be asked to defend decisions around acquisitions. Even if you fall below the threshold of a “significant” acquisition, prepare proforma information around revenue, net income, and net loss.
• Non-GAAP measures are still relevant to readers. Report clearly and consistently period-over-period, so it doesn’t look like you’re only sharing the best results. Give readers enough information to understand and analyze non-GAAP measures of performance, and explain why they are relevant (e.g., what comprises goodwill?). Don’t make non-GAAP results more prominent than the corresponding GAAP disclosures.

Consistency, clarity, specificity … We expect these to continue to be key themes in the coming year and to have bearing on rising issues, such as:

• Climate change. Regulators are reviewing corporate social responsibility (CSR) reports, annual reports and other presentations in addition to your financial statements. Consistency is key. If the figures or information contained are different, be able to explain why. If new regulations or proposed legislation introduce risk, disclose how they would affect financial results. Help readers understand the material and expected costs related to climate change and climate-related compliance.
• Management Discussion and Analysis (MDA). In 2021, a major overhaul of MDA went into effect. The focus was on providing clarity management’s viewpoint about the Company’s results and potential challenges or changes ahead, rather than just repeating the changes reported in the financial statements and notes. Help readers understand the “why” behind the results and where the company is going.  
• The SEC is also looking for more specificity. For example, when making fair value measurements, disclose the critical accounting assumptions that fed the assessment. The SEC also wants to see specifics around internal controls, which aren’t always considered during external disclosures. If the business has undergone change – from an acquisition to an IT upgrade – include details in 10K and 10Q statements about the impact on internal controls.

For additional information, visit Weaver’s Executive Resource Center and sign up for our quarterly series to stay informed.

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Weaver’s Accounting and SEC Update

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