SEC Comments
and Trends
An analysis of current reporting issues
October 2009
Contents
Management’s discussion and analysis........................................ 2
Appendix A: Industry Supplements........................................... 41
Reporting issues......................................................................... 4
Oil and gas ............................................................................... 42
Reserves .............................................................................. 42
Improved recovery costs........................................................ 44
Proportionate consolidation................................................... 44
Regulatory assets.................................................................. 45
Statement of cash flows.............................................................. 5
Earnings per share...................................................................... 7
Segment reporting ..................................................................... 8
Financial instruments................................................................. 9
Equity method investments....................................................... 11
Inventory.................................................................................. 12
Goodwill.................................................................................... 13
Intangible assets....................................................................... 15
Impairment of long-lived assets................................................ 17
Disposal of long-lived assets..................................................... 18
Contingencies........................................................................... 19
Debt......................................................................................... 20
Financial instruments............................................................... 22
Share-based payments............................................................. 26
Revenue recognition................................................................. 29
Pension and other post-retirement employee benefit plans............ 32
Income taxes............................................................................ 33
Consolidation............................................................................ 36
Fair value measurements ......................................................... 37
Real estate ............................................................................... 46
Redeemable financial instruments.......................................... 46
Life sciences ............................................................................. 47
Revenue recognition.............................................................. 47
Collaborations....................................................................... 49
Research and development assets acquired in business
combinations.................................................................... 50
Other reporting issues........................................................... 51
Retail ....................................................................................... 52
Management’s discussion and analysis ................................... 52
Consideration given by (or received from) a vendor................. 53
Gift cards.............................................................................. 54
Customer loyalty programs.................................................... 55
Deferred rent........................................................................ 56
Telecommunications ................................................................. 57
Segment reporting................................................................ 57
Impairments.......................................................................... 57
Media and entertainment .......................................................... 58
Goodwill and intangible assets................................................ 58
Revenue recognition.............................................................. 58
Technology................................................................................ 59
Revenue recognition.............................................................. 59
Banking and capital markets ...................................................... 60
Management’s discussion and analysis.................................... 60
Federal Home Loan Bank stock............................................... 62
Non-GAAP measures ............................................................ 62
Insurance ................................................................................. 63
Fair value ............................................................................. 63
Other-than-temporary impairments........................................ 63
Investments guaranteed by third parties................................. 64
Property and casualty loss and loss adjustment
expense reserves .............................................................. 64
Appendix B: SEC Review Process.............................................. 65
Appendix C: Abbreviations used in this publication.................... 67
To our clients and other friends
The SEC staff’s review process provides registrants with comments
on filings where the staff believes the filing could be improved or
enhanced. The reviews may result in a variety of outcomes, including
requests for future disclosure to restatement of previously issued
financial statements. An awareness of the SEC staff’s underlying
concerns and topical areas of focus is generally helpful in the
preparation of SEC filings. Although each registrant’s facts and
circumstances are different, there is often commonality both in the
overall concepts that drive financial reporting and the economic
conditions in which registrants are operating. SEC Comments and
Trends summarizes selected issues raised during the course of SEC
staff reviews, accompanied by a contextual discussion of these
matters, in a manner designed to provide registrants and audit
engagement teams with insight into the types of transactions and
disclosures that appear to be areas of keen interest to the SEC staff.
In addition, this publication provides an industry supplement that
highlights the focus of the SEC staff in certain industries.
In addition, this fourth edition includes excerpts from and references
to the FASB Accounting Standards Codification (“the Codification”
or “ASC”). The Codification is the single source of authoritative
nongovernmental U.S. generally accepted accounting principles (US
GAAP), with the exception of guidance issued by the SEC and the
SEC staff, and is effective for interim and annual periods ending after
15 September 2009. The Codification comprises all US GAAP issued
by a standard setter, excluding those standards for state and local
governments, and supersedes previously issued accounting standards.
We hope that you continue to find this publication’s insights helpful.
In addition to focusing on the traditional issues such as revenue
recognition, segments, financial instruments and earnings per share,
many new comments issued in the past year related to financial
reporting issues that may be driven in part by the overall economic
conditions. In the past year, the global economic conditions affected
entities in almost every industry sector. Registrants’ financial
reporting reflected these circumstances as more companies
recognized impairments, restructured their operations and challenged
the value of their assets. The comments from the SEC staff were
indicative of the current trends in the global markets. For example, the
SEC staff has frequently commented on fair value related disclosures,
particularly when the staff has perceived such disclosures were overly
aggregated or lacked a sufficiently clear discussion of significant
assumptions and inputs used to measure individual or groups of
assets and liabilities. Another common example involves registrant’s
critical accounting policy disclosures. The staff continued to challenge
these disclosures when they perceived the disclosures lacked a
sufficiently robust discussion of critical accounting judgments used in
formulating a registrant’s accounting policies.
SEC Comments and Trends October 2009
Management’s discussion
and analysis (MD&A)
Liquidity and capital resources
Critical accounting policies and estimates
Discussion of issues noted
Discussion of issues noted
The recent turmoil in the mortgage and credit markets has led the
SEC staff to issue comment letters asking for detailed disclosures
regarding liquidity and capital resources.
The SEC staff continues to comment on critical accounting policy
disclosures for key financial statement items. In particular, the SEC
believes that MD&A should make investors aware of the sensitivity
of financial statements to the methods, assumptions and estimates
underlying their presentation.
Analysis of current issue
Items 303(a)(1) and (2) of Regulation S-K requires a registrant
to discuss known trends, demands, commitments, events or
uncertainties that are reasonably likely to materially affect liquidity or
capital resources in any way. Specifically, the SEC staff has requested
that registrants provide the following:
• An overview of how the registrant’s business has been affected
by economic developments and how the registrant intends to
maintain sufficient liquidity. The SEC staff has indicated that the
discussion should provide detailed information on the global
economic downturn and its effect on the registrant’s customers,
recent order activity, expected trends and management’s
responses to these events
• An analysis of all internal and external sources of liquidity, beyond
cash on hand, as of the balance sheet date. The registrant should
consider disclosing the amounts outstanding and available at the
balance sheet date under each source of liquidity
• A discussion regarding the sufficiency of the unused availability
under any existing short-term credit arrangement, the anticipated
circumstances requiring its use, any uncertainty surrounding the
ability to access funds when needed and any implications of not
being able to access the funds
• A discussion regarding any uncertainty or trends surrounding
future compliance with financial covenants and the material
implications of a breach. When the filing specifies minimum
financial ratios under the agreement, the SEC staff has requested
that the registrant also disclose its calculated ratio for the latest
compliance dates or periods
• Plans to remedy any identified material deficiency in short or
long-term liquidity
Analysis of current issues
FR-601 alerts registrants to the need for improved disclosures about
“critical accounting policies”. Critical accounting policies are defined
as those most important to the financial statement presentation and
that require the most difficult, subjective and complex judgments.
Specifically, FR-60 states, “We encourage public companies to include
in their MD&A full explanations, in plain English, of their ‘critical
accounting policies,’ the judgments and uncertainties affecting
the application of those policies and the likelihood that materially
different amounts would be reported under different conditions
or using different assumptions.” FR-60 also suggests that MD&A
would be enhanced by an explanation of the interplay of identified
uncertainties with accounting measurements in the financial
statements. In making disclosures under FR-60, registrants need
not repeat information that is included in the financial statements or
elsewhere in the registrant’s MD&A.
FR-722 emphasizes that registrants should consider providing
enhanced disclosure and analysis of critical accounting estimates
and assumptions in MD&A. FR-72 notes that “such disclosure
should supplement, not duplicate, the description of accounting
policies that are already disclosed in the notes to the financial
statements. The disclosure should provide greater insight into the
quality and variability of information regarding financial condition
and operating performance. While accounting policy notes in the
financial statements generally describe the method used to apply
an accounting principle, the discussion in MD&A should present
a registrant’s analysis of the uncertainties involved in applying a
principle at a given time or that variability is reasonably likely to result
from its application over time.”
Resources
EY Publication, SEC annual reports — Reports to shareholders
Form 10-K (SCORE No. CC0267)
2
SEC Financial Release No. 60, Cautionary Advice Regarding Disclosure About Critical
Accounting Policies
2
SEC Financial Release No. 72, Commission Regarding Management’s Discussion and
Analysis of Financial Condition and Results of Operations
1
SEC Comments and Trends October 2009
FR-72 reminds registrants that current MD&A rules would require
disclosure of critical accounting estimates or assumptions when:
• The nature of the estimates or assumptions is material due to the
levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change
• The effect of the estimates and assumptions on financial condition
or operating performance is material
In these cases, the SEC expects registrants to provide analysis of the
uncertainties involved in applying a principle at a given time and the
variability that is reasonably likely to result from its application over
time. Specifically, the SEC indicates that the MD&A disclosure should
(1) address why the accounting estimate or assumption bears the
risk of change and (2) include an analysis to the extent material of
the following:
• How the registrant arrived at the estimate
Because critical accounting estimates and assumptions are based on
matters that are highly uncertain, the SEC believes that registrants
should analyze their specific sensitivity to change based on other
outcomes that are reasonably likely to occur and would have a material
effect. The SEC believes that registrants should provide a quantitative,
as well as qualitative disclosure, when quantitative information is
reasonably available and would provide material information.
In particular, the SEC staff has noted that registrants’ disclosures
about critical accounting policies often are too general and should
be expanded to include a description of the significant estimates and
assumptions made by management. Some of the areas that the SEC
staff has commented on include, but are not limited to, allowance
for loan losses, contingencies, derivatives, goodwill and other asset
impairments, inventory, pensions and other postretirement benefit
costs and obligations, recognition of intangible assets as part of a
business combination, revenue recognition and share-based payments.
• How accurate the estimate/assumption has been in the past
Resources
• How much the estimate/assumption has changed in the past
EY Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
• Whether the estimate/assumption is reasonably likely to change in
the future
In particular, the SEC staff has noted that
registrants’ disclosures about critical accounting
policies often are too general and should
be expanded to include a description of the
significant estimates and assumptions made
by management.
SEC Comments and Trends October 2009
3
Reporting issues
Non-GAAP financial measures
Executive compensation disclosures
Discussion of issues noted
Discussion of issues noted
The SEC staff frequently issues comment letters requesting that
registrants provide additional disclosures when presenting non-GAAP
financial measures. A non-GAAP financial measure is a numerical
measure of a registrant’s historical or future financial performance,
financial position or cash flow that:
The SEC staff has continued to focus reviews on registrants
Compensation, Discussion & Analysis in an effort to provide more
direct, specific and clear disclosures.
• excludes amounts, or is subject to adjustments that have the
effect of excluding amounts, that are included in the most directly
comparable measure calculated and presented in accordance with
GAAP in the statement of income, balance sheet or statement of
cash flows of the issuer; or
Item 402 of Regulation S-K specifies the required disclosure related
to the compensation of directors and executive officers. Item 402
disclosures are required in most proxy or information sheets, as well
as in Form 10-K filings and various registration statements. The SEC
staff has frequently requested registrants to specifically identify
peer companies that were used for the purpose of benchmarking
executive compensation. To the extent that a benchmarking exercise
is material to a registrant’s compensation program, registrants have
been asked to consider confirming that all identified peers were used
in the benchmarking analyses. Additionally, registrants have been
asked to consider providing sufficient detail about how the competitor
information was used in making compensation decisions with respect
to executive officers.
• includes amounts, or is subject to adjustment that have the effect
of including amounts, that are excluded from the most directly
comparable GAAP measure calculated and presented.
Analysis of current issue
Item 10(e)(1)(i) of Regulation S-K requires a registrant to provide
certain disclosures whenever a non-GAAP measure is presented. The
SEC staff frequently issues comment letters addressing compliance
with Item 10(e)(1)(i). For each non-GAAP measure presented, the
letters have requested registrants to provide the following:
• A presentation, with equal or greater prominence, of the most
directly comparable financial measure or measures calculated and
presented in accordance with GAAP
• A quantitative reconciliation of the differences between the
non-GAAP financial measure disclosed with the most directly
comparable financial measure presented in accordance with GAAP
• A statement disclosing the reasons why the registrant’s
management believes that presentation of the non-GAAP financial
measure provides useful information to investors regarding the
registrant’s financial condition and results of operations
• To the extent material, a statement disclosing the additional
purposes, if any, for which the registrant’s management uses the
non-GAAP financial measure
The SEC staff has indicated in its comment letters that the reconciliation,
noted above, should both identify and quantify each reconciling
adjustment included in the non-GAAP measure. The SEC staff also has
indicated that the statement explaining why the non-GAAP measure is
useful should address each of the adjusting items included in the nonGAAP measure and should be specific and not broad or overly vague.
Resources
Analysis of current issue
It was also noted that the SEC staff routinely requested registrants
to provide the detail of individual and corporate performance criteria
and targets, both quantitative and qualitative, for each executive.
If a non-GAAP measure is used as a performance target, then the
registrant is required to define the components of the target. In cases
where the disclosure of these targets would result in competitive
harm, a registrant is able to omit the information; however, if the
registrant has sufficient basis to keep goals and targets confidential,
then they must address the likelihood or the difficulty of achieving
these undisclosed goals. Registrants should be mindful that the SEC
staff has indicated that general statements do not satisfactorily meet
their disclosure expectations.
Finally, the SEC staff has requested that registrants explain the
reasons for material differences in compensation amounts or types
among named executive officers.
Resources
• EY Publication, 2009 Proxy Statements, An Overview of the
Requirements (SCORE No. CC0268)
• EY Publication, Summary of SEC Final Rule— Executive
Compensation and Related Person Disclosure (SCORE No. CC0218)
EY Publication, SEC annual reports — Reports to shareholders
Form 10-K (SCORE No. CC0267)
4
SEC Comments and Trends October 2009
Statement of cash flows
Materiality
Classification of activities
Discussion of issues noted
Discussion of issues noted
The SEC staff continues to issue comment letters that challenge
registrants’ conclusions regarding materiality.
The SEC staff continues to ask registrants to explain the classification
basis for items within the statement of cash flows. When the
classification of certain items is not clearly addressed in the relevant
accounting guidance, the SEC staff expects registrants to explain the
judgment applied in determining the classification. However, the SEC
staff has demonstrated through its comments that this judgment
requires registrants to analyze the nature of the activity and the
predominant source of the related cash flows. The SEC staff may also
request that additional disclosures be provided to inform investors of
the classification chosen and the alternative classification considered
and rejected.
Analysis of current issue
SAB Topic 1-M3 (codified primarily in ASC 250-10-S99-1), includes
a list of possible qualitative and quantitative factors that registrants
might consider when assessing how a reasonable investor might
consider the materiality of a financial statement item, including a
financial statement error. The factors listed in SAB Topic 1-M are
not intended to be exhaustive and therefore each registrant should
consider all qualitative and quantitative factors that may be relevant in
their situations, regardless of whether such factor is included in SAB
Topic 1-M examples. The SEC staff frequently issues comment letters
requesting that registrants supplementally identify what company
specific factors were considered when assessing materiality. However,
many registrants have responded to SEC staff materiality inquiries
by concentrating solely on the examples listed in SAB Topic 1-M. The
SEC staff has indicated that these responses often are boilerplate
and insufficient in the particular facts and circumstances and often
lead to additional SEC staff inquiries. Consequently, the SEC staff has
encouraged registrants to be as company-specific as possible in their
responses, including consideration of the effects of errors on key
performance indicators disclosed by the registrant in its SEC filings
(including earnings releases).
Resources
EY Publication, SAB 99 — Summary (SCORE No. CC0105)
Analysis of current issue
The statement of cash flows is one of the primary financial
statements and, as such, is relied on by users of financial statements
including capital providers, analysts and others. Appropriate
classification and presentation of items in the statement of cash flows
is important in allowing these users to determine the registrant’s
ability to generate positive future cash flows, meet its obligations, pay
dividends and to assess needs for external financing. Guidance on
appropriate classification of cash flows provided by in ASC 230-104
is explicit with respect to the proper classification of certain items;
however, other items require a registrant to apply judgment. At the
2006 AICPA Conference5, the SEC staff cautioned that if the most
appropriate classification is not clear, it does not mean that any
classification is appropriate. Rather, registrants must analyze the
nature of the activity and the predominant source of the related cash
flows. The SEC staff also noted at the 2006 AICPA Conference, that
registrants should provide disclosure sufficient to inform investors
of the classification selected and the alternative classifications
considered and rejected.
Comment letters issued by the SEC staff address the classification
of items such as changes in restricted cash, trading securities
and receivables held for investment, as well as distributions from
unconsolidated joint ventures, and other activities. Following is a brief
discussion of some of these items.
FASB ASC Topic 230, Statement of Cash Flows
Speech by SEC Staff: Remarks Before the 2006 AICPA National Conference on Current SEC and PCAOB Developments.
4
SEC Staff Accounting Bulletin (SAB) Topic 1-M, Materiality
3
5
SEC Comments and Trends October 2009
5
Restricted cash
Distributions from unconsolidated entities
The SEC staff has asked registrants why the classification of
restricted cash activity is not presented as cash flows from financing
activities. Classification as a financing activity may be appropriate,
for instance, when the primary purpose of the restricted cash is to
serve as collateral for borrowings. In other instances, the SEC staff
commented that classification, as an operating activity may be more
appropriate, for example, if the restricted cash is related to workers’
compensation obligations.
Distributions received from unconsolidated entities that represent
returns on the investment (i.e., dividends) should be reported as cash
flows from operating activities in the statement of cash flows, while
cash distributions from unconsolidated entities that represent returns
of the investment should be reported as cash flows from investing
activities (ASC 230-10-45-16(b) and 45-12(b)). Accordingly, for
those entities that have equity method investments, it is important
to evaluate the nature of cash distributions from the investee for
purposes of appropriately reporting the distribution in the statement
of cash flows.
Cash that is restricted by agreements with third parties for a particular
purpose generally is not a cash equivalent (ASC 230-10-20).
Moreover, Rule 5-02 of Regulation S-X requires separate disclosure
of cash that is restricted as to withdrawal or usage, including a
description of the provisions of any restrictions. At the 2006 AICPA
Conference, the SEC staff discussed changes in restricted cash
as an area where more than one cash flow classification might be
appropriate, while noting that, generally, restricted cash would appear
to be an investment, and the related cash flows classified in investing
activities. However, the SEC staff indicated that classification as
an operating activity could be supported when the purpose of
the restriction on cash is directly related to the operations of the
registrant’s business. In considering the appropriate classification
of changes in restricted cash, the SEC staff reminded registrants to
consider “the activity that is likely to be the predominant source of
cash flows for the item” (ASC 230-10-45-22 and 45-23). In addition,
the SEC staff commonly requested that registrants expand their
disclosures, by including a separate accounting policy discussion in
the footnotes regarding statement of cash flows classification.
Trading securities
SEC staff comments have asked registrants to provide, in the
statement of cash flows, separate disclosure for purchases and sales of
trading and available-for-sale securities. Cash flows must be reported
separately for each security classification (ASC 320-10-45-11).6 In
addition, trading securities are no longer required to be classified as
operating cash flow activities, but instead, should be classified based
on the nature and purpose for which the securities were acquired (ASC
230-10-45-19). As a result, the SEC staff has asked registrants to
explain the basis for continued classification of cash flows related to
trading securities as operating activities when another classification
may be more appropriate.
There are two acceptable methods to determine whether distributions
received from an unconsolidated investee are returns on or returns
of the investment: the cumulative earnings approach and the “lookthrough” approach. Under the cumulative earnings approach, all
distributions received are deemed to be returns on the investment
unless the cumulative distributions exceed the cumulative equity
in earnings recognized, in which case the excess distributions are
deemed to be returns of the investment. SEC staff comments have
reminded registrants following this approach to apply this concept
based on life-to-date earnings and life-to-date distributions. The SEC
staff has also requested expanded disclosures to describe the use of
this approach. Under the “look-through” approach, a presumption
exists that the distributions are reported under the cumulative
earnings approach unless the facts and circumstances of a specific
distribution clearly indicate that the presumption has been overcome
(e.g., a liquidating dividend or distribution of the proceeds from the
investee’s sale of assets), in which case the specific distribution is
deemed to be a return of the investment (i.e., an investing cash flow).
Registrants should consider disclosing their accounting policy for
classifying distributions from unconsolidated investees, if material.
Resources
EY Publication, Financial Reporting Developments, Statement of Cash
Flows – Understanding and Implementing FASB Statement No. 95
(SCORE No. 42856)
FASB ASC Topic 320, Debt and Equity Securities
6
6
SEC Comments and Trends October 2009
Earnings per share
Two-class method of calculating earnings per share
Discussion of issues noted
The SEC staff continues to raise questions regarding registrants’
application of the two-class method of calculating earnings per share
(EPS). The SEC staff has requested additional information from
registrants that have multiple classes of equity and other securities
outstanding when it is unclear to the staff what the relative rights
of each class of shareholder are. For example, when it is unclear
whether all classes participate in dividends (i.e., are participating
securities). In particular, the SEC staff has focused on registrants with
more than one class of common stock that have different dividend
rates and registrants with other securities that may have a right to
participate in dividends with common stock. Additionally, the SEC
staff has questioned how the two-class method was applied when a
registrant incurs losses.
Analysis of current issue
An enterprise with multiple classes of common stock or with securities
other than common stock that participate in dividends is required to
use the two-class method of computing EPS (ASC 260-10-45-59A
through 45-70 and ASC 260-10-55-23A through 55-31).7 The
two-class method is an earnings allocation method used to determine
EPS for each class of common stock and participating securities
considering both dividends declared (or accumulated) and
participation rights in undistributed earnings as if all such earnings
had been distributed during the period (ASC 260-10-45-59A through
45-70 and ASC 260-10-55-23A through 55-31).
The presentation of basic and diluted EPS for a participating security
other than common stock is not required, but is also not precluded
(ASC 260-10-45-60). However, the SEC staff has expressed a view8
that an enterprise with two classes of common stock must present
both a basic and diluted EPS number for each class of common stock.
As a reminder, an entity should allocate undistributed losses to
a participating security only if the participating security has a
contractual obligation to share in, or fund, the losses of the enterprise
(ASC 260-10-45-67 through 45-68). The determination of whether a
participating security holder has this obligation should be made on a
period-by-period basis.
Also as a reminder, for interim periods beginning after 15 December
2008, both vested and unvested share-based payment awards
may be participating securities if they have the right to receive
nonforfeitable dividends (ASC 260-10-45-61 and 45-61A). Generally,
entities should not allocate undistributed losses to participating
share-based awards for the reasons discussed above.
Resources
EY Publication, Technical Line, Two-class method of computing EPS:
Applying FSP EITF 03-6-1 and EITF 07-4 (SCORE No. BB1628)
The SEC staff has emphasized that when applying the two-class
method, consideration must be given to all of the rights and privileges
of each class when evaluating whether a security participates in
earnings and when determining the allocation of undistributed
earnings to the security. For example, if an enterprise has preferred
shares that are entitled only to cumulative dividends of a fixed
amount, the preferred shares are not considered participating
securities. However, if the preferred shares participate in distributions
after the cumulative dividend has been paid, then the preferred
shares would be considered participating securities and, as a result,
undistributed earnings would be allocated to the common and
preferred shares pursuant to the two-class method.
FASB ASC Topic 260, Earnings Per Share
7
Speech by SEC Staff: Remarks Before the 2006 AICPA National Conference on Current SEC and PCAOB Developments.
8
SEC Comments and Trends October 2009
7
Segment reporting
Identification and aggregation of operating segments
Discussion of issues noted
The SEC staff regularly questions registrants regarding the
determination and aggregation of operating segments. In doing so,
the SEC staff routinely reviews public information available about a
registrant including information included in public filings, registrant
websites and industry or analyst presentations and asks the registrant
to explain any perceived inconsistencies.
Analysis of current issues
The accounting guidance for segment reporting is conceptually
based on a “management approach” (ASC 280-10-5).9 That is,
a registrant’s segment disclosures should be consistent with its
management reporting structure. This approach enables investors to
view the entity similar to the manner in which management views the
entity. Registrants should challenge any conclusions they reach as
to operating segment determinations that are inconsistent with the
basic organizational structure of their operations.
The first step in preparing segment disclosures is the identification
of an entity’s operating segments (ASC 280-10-50-1 through 50-9).
In this analysis, it is critically important to identify (1) at which levels
within an entity revenues are earned and expenses are incurred, (2) the
entity’s chief operating decision maker (CODM) and (3) what operating
performance information is available for review by the CODM.
If the CODM regularly receives reports that present discrete operating
results for components of the entity, the SEC staff presumes that
the CODM uses these reports to assess performance and allocate
resources, and as such, the SEC staff challenges registrant assertions
that conclude otherwise.
It is important to note that the correct identification of operating
segments is also important for goodwill impairment testing (refer to
the “Goodwill” section for further discussion).
After identifying its operating segments, an entity must determine
if those operating segments meet the aggregation criteria and,
if so, whether the entity elects to aggregate those operating
segments (ASC 280-10-50-11). There are three key elements to the
aggregation criteria, all of which must be met and require the use of
judgment. These elements are:
ASC 280 requires that aggregated operating segments have “similar
economic characteristics,” such that they would be expected to
have similar long-term financial performance (e.g., similar long-term
average gross margins). The similarity of the economic characteristics
should be evaluated based on future prospects and not solely on
the current indicators (ASC 280-10-55-7A). That is, if currently the
segments do not have similar gross margins and sales trends, but
the economic characteristics and the other five criteria in ASC 280
are met and the segments are expected to have similar long-term
average gross margins and sales trends, the two segments may be
aggregated.
In the comment letter process, the SEC staff looks closely at
gross margins, operating margins or other measures of operating
performance provided to the CODM when challenging the
determination and the aggregation of operating segments.
Where economic characteristics are dissimilar, the SEC staff presumes
that an investor would be interested in separate information about
the operating segments. Further, when operating segments are based
on geography and when the relevant macroeconomic indicators have
varied or are expected to vary between the respective geographic
regions, it might be difficult for a registrant to sustain an assertion
that its geographic operating segments exhibit similar long-term
financial performance and qualify for aggregation.
In addition to having similar economic characteristics, operating
segments must be similar in all of the following five qualitative areas:
(1) nature of the products and services; (2) nature of the production
processes; (3) type or class of customer for their products and
services; (4) methods used to distribute their products or provide
their services and (5) the nature of the regulatory environment, if
applicable (ASC 280-10-50-11).
Resources
EY Publication, Financial Reporting Developments, Disclosure about
Segments of an Enterprise and Related Information - FASB Statement
No. 131 (Revised June 2008) (SCORE No. BB0698)
• The aggregation must be consistent with the objective and basic
principles of ASC 280
• The operating segments must be economically similar
• The operating segments must have similar characteristics
FASB ASC Topic 280, Segment Reporting
9
8
SEC Comments and Trends October 2009
Financial instruments
Other-than-temporary impairments
Discussion of issues noted
The SEC staff continues to inquire how registrants determined that
declines in the fair value of debt and equity securities (classified
as either available-for-sale or held-to-maturity in accordance with
ASC 320) below their cost basis (i.e., impairments) are not otherthan-temporary. Given the decline in fair value of many debt and
equity securities over the past year, the SEC staff has requested
additional discussion in both the financial statements and MD&A
of the methodology and analysis used in the reviews to support a
conclusion that impairments were not other-than-temporary. In
numerous instances, the SEC staff requested registrants to improve
their disclosures and provide greater qualitative information sufficient
to allow financial statement users to understand the quantitative
disclosures provided as well as the information that the registrant
considered (both positive and negative) in reaching the conclusion
that unrealized losses are not other-than-temporary impairments.
When registrants have recognized other-than-temporary
impairments, the SEC staff has occasionally requested additional
discussion about the facts and circumstances that resulted in the
recognition of the impairment, particularly clarifying why the current
period was the appropriate period to recognize the impairment as
opposed to an earlier (or later) period.
Additionally, in connection with registrants’ early adoptions of precodification standard FSP FAS 115-2 (codified primarily in ASC 320-10),
the SEC staff has issued a number of comments about:
• the presentation in the statement of earnings of total other-thantemporary impairments with an offset in a separate line item for
any amount of the total other-than-temporary impairment that is
recognized in other comprehensive income; and
• the measurement of the portion of other-than-temporary
impairments related to credit losses, with particularly emphasis on
asking for more robust disclosure of the inputs and assumptions by
major security type.
Analysis of current issue
The SEC staff continues to challenge whether a registrant’s analysis
and methodology is sufficiently robust for purposes of evaluating
whether an impairment is other-than-temporary. For a marketable
equity security, the evaluation of whether an impairment is, or is not,
other-than-temporary is based on two key assessments. The first is
an assessment of whether and when an equity security will recover in
value. Factors that should be considered in this assessment include,
but are not limited to, the duration and severity of the impairment
and the financial condition and near-term prospects of the issuer.
The SEC staff often requests additional disclosure of the information
considered by management in evaluating these factors (e.g., actual
number of days the security’s fair value has been below cost, actual
percentage decline, specific events that may influence the operations
of the investee, etc.). The second assessment is whether the investor
has the positive intent and ability to hold that equity security until the
anticipated recovery in value occurs. To support that an impairment
is temporary, the investor would need to support, with observable
market information, that a recovery in the fair value to at least the cost
basis of the equity security is expected to occur within a reasonably
forecasted period. As such, the registrant’s ability to hold the equity
security until a more favorable market develops and until the issuer
specific uncertainties are resolved is only relevant if persuasive
evidence exists that those changes will occur in the near term. With
respect to intent and ability to hold to recovery, the SEC staff has
challenged registrants’ previous assertions in light of subsequent sales
of equity securities at a loss and has requested disclosures that discuss
the effect on management’s assessment of their intent and ability to
hold securities in light of certain disclosed facts and circumstances
specific to a registrant (i.e., future liquidity needs, etc.).
In addition, in cases where registrants had not explicitly asserted
their intent and ability to hold equity securities for a period of time
sufficient for a recovery in value, the SEC staff asked the registrants
to provide such an explicit assertion in its disclosures. Finally, the SEC
staff has requested registrants disclose information about the specific
nature of marketable equity securities, the factors that affect the
value of those securities, the sensitivity of the value of the securities
on those factors and to disclose any material risks.
For debt securities, the SEC staff requested similar information as
for equity securities. However, with the required adoption of precodification standard FSP FAS 115-2 in interim and annual periods
ending after 15 June 2009, the impairment models for debt and equity
securities are no longer similar. Pursuant to pre-codification standard
FSP FAS 115-2, an impairment is considered other–than-temporary if
(a) the company has the intent to sell the impaired debt security (that
is, the company has decided to sell the impaired security), (b) it is more
likely than not that the company will be required to sell the impaired
security before recovery in value is anticipated or (c) the company does
not expect recovery of its entire amortized cost of the security. When
an entity intends to sell an impaired debt security or it is more likely
than not it will be required to sell prior to recovery of its amortized
cost basis, an other-than-temporary impairment is deemed to have
SEC Comments and Trends October 2009
9
occurred. In these instances, the other-than-temporary impairment
loss is recognized in earnings equal to the entire difference between
the debt security’s amortized cost basis and its fair value at the
balance sheet date.
When an entity does not intend to sell an impaired debt security and
it is not more likely than not it will be required to sell prior to recovery
of its amortized cost basis, the entity must determine whether it will
recover its amortized cost basis. If it concludes it will not, a credit
loss exists and the resulting other-than-temporary impairment is
separated into:
• The amount representing the credit loss, which is recognized in
earnings, and
• The amount related to all other factors, which is recognized in
other comprehensive income
The total other-than-temporary (difference between the fair value
and the amortized cost of the debt security) should be presented in
the statement of earnings with an offset in a separate line item for
any amount of the total other-than-temporary impairment that is
recognized in other comprehensive income.
The SEC staff has noted that some registrants have disclosed the
gross other-than-temporary impairment and the other comprehensive
income portion parenthetically within the other-than-temporary
impairment caption on the statement of earnings. Others have
provided these amounts separately at the bottom of the statement
of earnings. The SEC staff has indicated that it will not object to such
presentation. However, disclosure of these amounts in the notes to
the financial statements (as opposed to on the face of the statement
of earnings) would be acceptable only if the other-than-temporary
impairment amounts are not material.
Required disclosures include a discussion of how the amount of
an other-than-temporary impairment loss that was recognized in
earnings (when an other-than-temporary impairment resulting from
other factors is recognized in other comprehensive income) was
10
determined. Additionally, registrants are required to disclose by
major security type, the methodology and significant inputs used to
measure the amount related to credit losses. Examples of significant
inputs include, but are not limited to, performance indicators of the
underlying assets in the security (including default rates, delinquency
rates, and percentage of nonperforming assets), loan to collateral
value ratios, third party guarantees, current levels of subordination,
vintage, geographic concentration and credit ratings. When providing
these disclosures, many registrants provided ranges of the significant
inputs within the major security types. In some of these cases, the
SEC staff challenged the usefulness of overly broad disclosed ranges
as well as the registrants’ determinations of its major security types.
In these instances, the SEC has suggested that further disaggregation
may be necessary to provide the reader of the financial statements
with more adequate or meaningful information about the nature and
risks of certain securities in the investment portfolio.
The SEC staff has also issued comments related to changes to
significant inputs used in the determination and measurement of
an other-than-temporary impairment loss, particularly when such
changes reduced the amount of such a loss. If a change in the
methodology or in the significant inputs used in the determination
and measurement of an other-than-temporary impairment loss is
appropriate, the SEC staff has indicated that the specific nature of
such a change and its effect on the measurement of other-thantemporary impairment losses should be disclosed.
Resources
EY Publication, Technical Line, Other-than-temporary impairment:
Questions and interpretive responses about FSP FAS 115-2
(20 May 2009) (SCORE No. BB1760)
EY Publication, Technical Line, Other-than-temporary impairment:
Accounting considerations for available-for-sale equity securities
(17 June 2009) (SCORE No. BB1788)
SEC Comments and Trends October 2009
Equity method investments
Other-than-temporary impairments
Discussion of issues noted
Analysis of current issue
The SEC staff continues to question registrants about the carrying
amount of equity method investments with readily determinable
fair values when the investments are carried above fair value for
prolonged periods. Accordingly, the SEC staff has required registrants
to demonstrate that an other-than-temporary impairment of the
investment has not occurred. The SEC staff also has requested
registrants to provide their documentation that supports the carrying
value of their equity method investments.
Registrants are required to evaluate whether a loss in the value of an
equity method investment is other-than-temporary. A loss in value
of an investment that is other than a temporary decline shall be
recognized. Evidence of a loss in value might include, but would not
necessarily be limited to, absence of an ability to recover the carrying
amount of the investment or inability of the investee to sustain an
earnings capacity that would justify the carrying amount of the
investment. A current fair value of an investment that is less than
its carrying amount may indicate a loss in value of the investment.
However, a decline in the quoted market price below the carrying
amount or the existence of operating losses is not necessarily
determinative that a loss in value is other-than-temporary. All are
factors that shall be evaluated (ASC 323-10-35-32).11
The SEC staff’s questions are based on its belief that an equity
method investment with readily determined fair value is substantially
equivalent to an investment in a marketable equity security accounted
for under ASC 320. Therefore, the staff believes the impairment
recognition guidance provided in ASC 320 and SAB Topic 5-M10
(codified primarily in ASC 320-10-S99-1), should be applied by
analogy to an equity method investment with a readily determinable
fair value. The SEC staff has seldom waivered in its view that readily
determinable fair values should be used in an other-than-temporary
analysis and lengthy periods in which the market value is less than
the carrying amount is a strong indicator that recognition of an
impairment of the investment is required.
SEC Staff Accounting Bulletin (SAB) Topic 5-M, Other Than Temporary Impairment of
Certain Investments in Equity Securities
10
Resources
EY Publication, Financial Reporting Developments, Accounting for
Certain Investments in Debt and Equity Securities – FASB Statement 115,
as amended (Revised January 2005) (SCORE No. BB0961)
EY Publication, Technical Line, Other-than-temporary impairment:
Accounting considerations for available-for-sale equity securities
(17 June 2009) (SCORE No. BB1786)
FASB ASC Topic 323, Investments – Equity Method and Joint Ventures
11
SEC Comments and Trends October 2009
11
Inventory
Lower of cost or market
Discussion of issues noted
The SEC staff has continued to issue comments asking registrants to
provide more information regarding how they have determined that
inventories are stated at the lower of cost or market. The SEC staff
has questioned the registrants’ determinations of market values, net
realizable values and replacement costs. The SEC staff has also issued
comments regarding the sufficiency of a registrant’s disclosures
surrounding inventory impairment, including the consideration given
to disclosure of a critical accounting policy in this area.
Analysis of current issue
ASC 330-1012 provides the basic accounting framework for
inventories. Pursuant to ASC 330-10, inventories are to be valued
at cost to reflect the amount paid for or consideration given to bring
the inventory to its current condition and location. The term “cost”
refers to the price paid at acquisition, or production costs recognized
in inventory, using any of the acceptable cost-flow methods (e.g.,
FIFO or LIFO). However, a departure from carrying inventories at cost
is required when there is evidence that the utility of inventory, when
disposed of in the ordinary course of business, will be less than cost
(whether due to physical deterioration, obsolescence, changes in price
levels or other causes). When such situations exist, the difference
between an entity’s inventory carrying value and replacement cost
(subject to a floor and ceiling) should be recognized as a loss of the
current period. This is accomplished by stating inventories at the
lower of cost or market. The term market is defined as the “current
replacement cost (by purchase or by reproduction, as the case may
be) except that: (1) market should not exceed the net realizable
value (i.e., estimated selling price in the ordinary course of business
less reasonably predictable costs of completion and disposal); and
(2) market should not be less than net realizable value reduced by an
allowance for an approximately normal profit margin.”
by the current replacement cost; however, judgment is required to
determine whether evidence exists to support that a loss in value
in fact has been sustained. Replacement cost is not an appropriate
measure of utility to the extent that the selling price less reasonable
selling costs is lower. In this case, the net realizable value reflects
utility more appropriately. It also is inappropriate to recognize a loss
on the value of inventory to the extent a normal profit margin is
expected on sale of the inventory in the normal course of business.
Given recent market trends, there has been an increase in the
frequency and size of inventory impairments. A registrant should
consider disclosing the manner in which lower of cost or market
is determined, including the level at which lower of cost or market
analyses are prepared and how market prices are determined. If writedowns of inventory are significant, the registrant should consider
disclosing the loss amounts and consider separately displaying the
amount of loss in the statement of income as a separate component
of cost of goods sold. Additionally, based on comments issued by
the SEC staff, they believe that registrants should give consideration
to providing disclosures around inventory impairment, including
disclosures relating to critical estimates and assumptions used in
evaluation inventory for impairment, within both critical accounting
policies of MD&A (see “MD&A” section for further discussion) and
within the significant accounting policies disclosures.
Resources
EY Publication, Hot Topic, Considerations for inventory LOCOM
analyses (SCORE No. BB1670)
The general principle of lower of cost or market is intended to
establish a value for inventories that reflects the equivalent cost of
the expenditure should the same goods be procured as of the date of
the financial statements. The utility of goods is generally determined
FASB ASC Topic 330, Inventory
12
12
SEC Comments and Trends October 2009
Goodwill
Impairment analysis and disclosures
Discussion of issues noted
Supplemental information on impairment analysis
The SEC staff continues to issue a number of comments in the area
of goodwill impairment. Though many registrants have provided
disclosures in this area, the SEC staff has sometimes commented that
the information provided has not necessarily been meaningful. SEC
staff comment letters have requested disclosures in Management’s
Discussion and Analysis that discuss the present and future
implications of a goodwill impairment on the registrant’s business.
Impairment analysis
The SEC staff frequently asks for supplemental information about:
• D
 etails of the goodwill impairment analysis for each reporting
unit, including how reporting units are identified and how assets,
liabilities and goodwill are assigned to reporting units
• Details on sensitivity analysis of material assumptions used in
assessing recoverability of goodwill, including qualitative and
quantitative factors and how changes in those assumptions might
affect the outcome of the goodwill impairment test
• D
 etails of the registrant’s analysis of events that occurred since
the latest annual goodwill impairment assessment and whether
those events are indicators of impairment necessitating an interim
goodwill impairment assessment
• The reconciliation of the aggregate fair values of the reporting
units to the registrant’s market capitalization
• The type of events that could result in a goodwill impairment,
specifically, a reduction in market capitalization
The SEC staff often asks registrants to provide more robust
disclosures of accounting policies for assessing goodwill for
impairment and the details of any recognized goodwill impairments.
These comments have asked for more discussion of the following:
• T
 he accounting policies relating to the goodwill impairment
tests, including when the two-step impairment test is performed,
identification of reporting units and how goodwill is assigned to
reporting units
• T
 he facts and circumstances leading to an impairment
• H
 ow the fair value of each reporting was estimated and the
significant assumptions and estimates used in its determination of
the fair value of reporting units
Analysis of current issues
SEC staff comments on goodwill and goodwill impairments are
frequent and in light of the current economic conditions, goodwill
impairments have been more common. We expect the staff will
continue to focus on this area.
A common SEC staff comment focuses on identification of a
registrant’s reporting units. The staff often requests clarification as
to how registrants determined their reporting units for purposes of
testing goodwill for impairment. In addition, the SEC staff frequently
asks for supplemental information supporting how assets and liabilities
are assigned to such reporting units. The identification and assignment
methodology is important because to test goodwill for impairment
at the reporting unit level requires assets acquired and liabilities
assumed to be assigned to a reporting unit as of the date of acquisition
(ASC 350-20-35-39).13 The purpose of this assignment process is to
establish the “carrying value” of the reporting units so that Step 1 of
the goodwill impairment test (i.e., the comparison of the carrying value
of a reporting unit to its fair value) can be completed each year or
more frequently if goodwill impairment indicators arise.
Recovery analysis and sensitivity
The SEC staff also has aggressively probed the method of estimating
the fair value of reporting units, including asking about the significant
assumptions used in the valuation. The SEC staff also frequently asks
registrants to provide a sensitivity analysis of material assumptions
used in assessing recoverability of goodwill, including qualitative
and quantitative factors and how hypothetical changes in those
assumptions might affect the outcome of the goodwill impairment test.
In addition to the above, the SEC staff is increasingly requesting
registrants to disclose the carrying value, fair value and goodwill for
each reporting unit.
Consideration of subsequent events
In addition, the SEC staff frequently request that registrants provide
details of the registrant’s analysis of events that occurred since
the latest annual goodwill impairment assessment and whether
those events suggest that the fair value of goodwill is less than its
carrying amount. This request often includes information on how
the significant assumptions used to determine the fair value of a
reporting unit has changed since the last goodwill impairment test.
Reconciliation of fair value of reporting units to market capitalization
The SEC staff has frequently asked registrants to provide a
reconciliation of their market capitalization to the aggregate fair
value of their reporting units. When those reconciliations include
a control premium, the SEC staff frequently asked registrants to
13
FASB ASC Topic 350, Intangibles – Goodwill and Other
SEC Comments and Trends October 2009
13
provide documentation supporting the reasonableness of the control
premium. The SEC staff has noted that they do not apply a bright-line
test and instead understand that the application of judgment can
result in a range of reasonably possible control premiums. Whether
the analysis is quantitative, qualitative, or some combination thereof,
the SEC staff expects object evidence to support the judgments that
the implied control premium is reasonable.
Triggering events
In circumstances in which the registrant’s market capitalization or
operating results have declined significantly, the SEC staff asks
registrants whether those factors represent indicators that the fair
value of a reporting unit is less than its carrying value, requiring an
interim goodwill impairment test.
Accounting policies
The SEC staff frequently asks registrants to provide additional
information in MD&A that allows users of the financial statement
statements to assess the likelihood of a future goodwill impairment.
The staff expects registrants to provide comprehensive disclosures
in the critical accounting policies section of MD&A regarding the
process for assessing goodwill impairment. As a reminder, registrants
are required to disclose in MD&A, the risks and uncertainties
associated with the recoverability of goodwill in the periods prior
to an asset impairment. The SEC staff frequently issues comments
when these disclosure requirements are not met or when they
believe the disclosures are not clear or meaningful. At a minimum,
the disclosures should include the annual assessment date and a
description of when an interim test is required, as well as a description
of how the estimated fair value of a reporting unit is determined and
the significant assumptions used in that analysis and how they have
changed since the last impairment test. When registrants disclose
that multiple approaches (e.g., income and market approaches) were
used to determine the fair value of a reporting a unit, the SEC staff
frequently asks for additional disclosures on how each method was
weighted and the basis for that weighting.
Facts and circumstances leading to an impairment
When the SEC staff believes that the factors resulting in a goodwill
impairment have not been satisfactorily disclosed, the SEC staff
frequently requests additional information as to the business and/or
operational factors and circumstances leading to the impairment and the
method used to determine the fair value of the associated reporting unit.
Even if no impairment is identified in a particular reporting period,
registrants should disclose their accounting policy related to
goodwill impairment testing as discussed above in the “Accounting
policies” section.
Resources
EY Publication, Financial Reporting Developments, Intangibles —
Goodwill and Other (SCORE No. BB1499)
A common SEC staff comment focuses on
identification of a registrant’s reporting units.
The staff often requests clarification as to how
registrants determined their reporting units for
purposes of testing goodwill for impairment.
14
SEC Comments and Trends October 2009
Intangible assets
Recognition, measurement, amortization
and impairment
Discussion of issues noted
The SEC staff frequently asks registrants to enhance their existing
intangible asset disclosure to include:
• Information on intangible assets recognized as part of a business
combination. The SEC staff’s comments have recently focused on
the values assigned to specific identifiable intangible assets and
goodwill, as well as the significant estimates and assumptions
used in calculating fair value measurement and the subsequent
accounting for such recognized intangibles
• Explanation on how the useful lives were determined, and the
factors leading to the amortization method selected. The SEC staff
has been particularly focused on the method selected to amortize
acquired customer relationship intangible assets
• Details on how indefinite-lived intangible assets were assessed
for impairment
Analysis of current issue
ASC 80514 requires an entity to determine the fair value of
identifiable assets acquired and liabilities assumed (with certain
limited exceptions), including intangible assets that (a) arise from
contractual or other legal rights or (b) that are separable. The excess
of the consideration transferred (including the fair value of any
noncontrolling interest and the fair value of any previously held equity
interest) over the value assigned to the identifiable assets, net of
assumed liabilities, is recognized as goodwill.
When the SEC staff believes that the factors resulting in the
recognition of significant goodwill have not been satisfactorily
disclosed, they frequently challenge whether or not additional assets
should have been recognized. The SEC staff’s focus is primarily on
intangible assets that meet the criteria for recognition apart from
goodwill and thus should be recognized pursuant to ASC 805.
The SEC staff also frequently requests that registrants explain how the
fair value of certain recognized intangible assets was measured. ASC
805 requires the recognition of identifiable intangible assets at fair value
in accordance with ASC 820.15 The fair value of an identifiable intangible
asset embodies the future cash flows that are expected to result from
ownership of the asset. Quoted market prices in an active market are
the best evidence of fair value and, if available, should be used as the
basis for the fair value measurement. If quoted market prices are not
FASB ASC Topic 805, Business Combinations
FASB ASC Topic 820, Fair Value Measurement and Disclosures
14
available, fair value should be estimated based on the best information
available, including prices for similar assets and the use of other
valuation techniques, such as a discounted cash flow model.
When determining the useful life of the identifiable intangible assets,
registrants should consider the period over which the asset is
expected to contribute directly or indirectly to the future cash flows
of the entity. This analysis should encompass all pertinent factors in
determining the useful lives of intangible assets. The factors listed in
ASC 350, are not all-inclusive and, thus, other relevant information
should be considered (ASC 350-30-35-1 through 35-5). In addition,
when determining the useful life of an intangible asset, registrants
should consider their own historical experience in renewing or
extending similar arrangements (consistent with the intended use of
the asset by the entity), regardless of whether those arrangements
have explicit renewal or extension provisions.
Only when a registrant performs an analysis that considers all
relevant factors and finds that there is no limit on the useful life
should the intangible asset be considered indefinite lived. That is, if no
legal, regulatory, contractual, competitive, economic or other factors
limit the useful life of an intangible asset to the reporting company,
the useful life of that intangible asset should be considered indefinite.
The SEC staff routinely challenges assertions that intangible assets
have an indefinite life and, when not otherwise provided, frequently
asks registrants to disclose what factors were considered in reaching
a determination that an intangibles asset has an indefinite life. If an
intangible asset is determined to have a finite life, an appropriate
amortization method should be applied. The method of amortization
should reflect the pattern in which the economic benefits of the
intangible asset are consumed or otherwise used up. If that pattern
cannot be reliably determined, a straight-line amortization method
shall be used (ASC 350-30-35-6 and 35-7). While a straight-line
amortization method should not necessarily be assumed to be
appropriate in all cases, other methods may be used only if the
pattern of economic benefits is reliably determinable.
The SEC staff has focused in particular on customer-related intangible
assets (e.g., customer lists, customer contracts and customer
relationship intangibles). These types of intangible assets are often
valued using the income approach, with an attrition rate resulting in
a dissipation of the cash flows over time. If the pattern of declining
cash flows is reliably determinable, an accelerated amortization
method that reflects the economic benefit to the entity should
be used. However, if it has been determined that the pattern of
economic benefit to the entity cannot be reliably determined, but the
15
SEC Comments and Trends October 2009
15
underlying cash flows supporting the measurement of the customerrelated intangible asset shows a decay, the straight-line method of
amortization using a shortened estimated useful life is appropriate.
The SEC staff also frequently requests that registrants explain how
indefinite-lived intangible assets were tested for impairment. Unlike
the impairment test for amortizing intangible assets, the impairment
test for indefinite-lived intangible assets does not include a
recoverability test. As a result, registrants should consider disclosing
the significant estimates and assumptions used to determine the
estimated fair value of indefinite-live intangible assets.
As a reminder, registrants should consider the effects that the current
economic conditions might have on the assessment of intangible
assets for impairment. An indefinite-lived intangible asset should be
tested for impairment annually or more frequently (in accordance
with ASC 350) if events or changes in circumstances indicate that
the asset might be impaired. Similar to the discussion of goodwill
impairment, the SEC staff frequently challenges whether impairments
of indefinite-lived intangibles should be recognized when the market
capitalization of the registrant or its operating results (or that of
the relevant segment) have declined significantly. Intangible assets
that are being amortized under ASC 350 should be reviewed for
impairment in accordance with ASC 360.16
See “Impairment of long-lived assets” section for a further discussion
of SEC staff comments related to impairment assessments of longlived assets.
Resources
EY Publication, Financial Reporting Developments, Accounting for
Business Combinations — FASB Statement 141(R)
(SCORE No. BB1616)
EY Publication, Financial Reporting Developments, Intangibles –
Goodwill and Other (SCORE No. BB1499)
When the SEC staff believes that the factors
resulting in the recognition of significant
goodwill have not been satisfactorily disclosed,
they frequently challenge whether or not
additional assets should have been recognized.
FASB ASC Subtopic 360-10, Property, plant, and equipment – Impairment or Disposal
of Long-Lived Assets
16
16
SEC Comments and Trends October 2009
Impairment of long-lived assets
Assets held and used
Discussion of issues noted
The SEC staff has recently issued comments asking registrants how
they have considered the effects of the global credit crisis in their
impairment assessments of long-lived assets. Specifically, the SEC
staff has asked how the global credit crisis has affected a registrant’s
process for identifying impairment indicators, and whether the credit
crisis caused the registrant to evaluate long-lived assets for impairment.
Additionally, the SEC staff frequently asked registrants to provide
more comprehensive disclosures about evaluating the impairment
of long-lived assets in their critical accounting policies. The SEC staff
has specifically requested improved disclosure regarding the facts
and circumstances leading to the impairment, the assumptions and
valuation methods used in the impairment analysis and a discussion of
the sensitivity of the assumptions.
In addition, the SEC staff has questioned registrants about the use
of similar assumptions and projections of future income to assess
the impairment of long-lived assets as those used to assess the
realizability of deferred tax assets (see “Income tax” section for
further discussion).
factors triggered a goodwill impairment assessment , and particularly
when a goodwill impairment charge was recognized, the SEC staff
asked registrants to discuss if and how they considered the effect
of these factors on their long-lived assets prior to the goodwill
impairment assessment.
The SEC staff have often commented that the critical accounting
policies for the impairment of long-lived assets are too general and
should be expanded to include:
• Description of the indicators evaluated by management that led to
the need to evaluate the assets for impairment
• Assumptions with regard to how the amount of the impairment
was determined
• Discussion of the recoverability of any remaining assets that were
not impaired
• Description of the steps performed in assessing the impairment,
including a description of the main assumptions used in the
analysis
• Discussion of the sensitivity of each of the key assumptions
Analysis of current issues
Long-lived assets that are held and used are to be reviewed for
impairment when events or changes in circumstances indicate that
the carrying amount of the long-lived assets might not be recoverable
(ASC 360-10-35-15 through 35-36). Accordingly, entities do
not need to routinely perform tests of recoverability but should
routinely assess whether impairment indicators are present. A list
of impairment indicators, which is not meant to be exhaustive, is
provided in ASC 360-10-35-21.
The SEC staff’s comments about the effects of the global credit crisis
on impairment testing generally have been directed to registrants
whose key performance indicators have trended downward, including
decreases in stock price (particularly when market capitalization falls
below the carrying amount of the entity), revenue declines, the loss
of major customers or contracts, operating losses or idle facilities
or equipment. When any of these factors appear to be present, and
the registrant did not record an impairment charge, the SEC staff
has often asked if the economic factors were considered indicators
of impairment that required the registrant to evaluate the carrying
amount of the long-lived assets for recoverability. If the registrant
did not review its long-lived assets for impairment, the SEC staff
requested detailed information supporting why such economic factors
were not indicators of impairment. Additionally, when economic
The SEC staff also has asked whether any undiscounted cash
flow analyses resulted in amounts that were close to the carrying
amount of the asset and, if so, to provide an explanation of the
consideration given to providing investors with an understanding
of the risk associated with a potential impairment. At times, the
SEC staff also has requested a copy or summary of a registrant’s
impairment analysis. Furthermore, if an entity’s critical accounting
policies exclude a discussion regarding the impairment or disposal
of long-lived assets, when material, the SEC staff has required such
disclosure to be provided, even in circumstances when an impairment
charge has not been recognized.
Resources
EY Publication, Financial Reporting Developments, Accounting for the
Impairment or Disposal of Long-Lived Assets — FASB Statement 144
(SCORE No. BB0997)
EY Publication, Highlights, 2008 AICPA Conference on Current SEC
and PCAOB Developments (SCORE No. CC0271)
EY Publication, Current economic conditions: Accounting and reporting
considerations (SCORE No. BB1785)
SEC Comments and Trends October 2009
17
Disposal of long-lived assets
Discontinued operations
Discussion of issues noted
In light of the current economic conditions, many registrants have
curtailed, ceased, sold or abandoned portions of their operations.
Although a portion of the operations may not continue, the
presentation of such operations as discontinued operations may
or may not be appropriate under U.S. GAAP. The SEC staff has
questioned registrants about whether operations related to assets
held for sale or disposed of are or are not appropriately presented as
discontinued operations.
Analysis of current issues
In a period in which a component of an entity either has been
disposed of or is classified as held for sale, the registrant’s income
statement for current and prior periods shall report the results
of operations of the component in discontinued operations if the
requirements of ASC 205 17 are met. A component of an entity
is classified as a discontinued operation when (a) the operations
and cash flows of the component have been (or will be) eliminated
from the registrant’s ongoing operations as a result of the disposal
transaction and (b) the registrant will not have any significant
continuing involvement in the operations of the component after the
disposal transaction (ASC 205-20-45-1).
For example, a registrant may have disclosed information in a SEC
filing or press release about a planned sale, disposal or abandonment
of certain assets or operations, but may not have presented them as
discontinued operations. In those cases, the SEC staff has questioned
why the registrant did not present discontinued operations related
to those assets held for sale. In other situations, a registrant may
have presented assets held for sale as discontinued operations while
disclosing some form of ongoing involvement with the buyer. In these
situations, the SEC staff has asked whether discontinued operations
presentation is appropriate.
Resources
EY Publication, Financial Reporting Developments, Accounting for the
Impairment or Disposal of Long-Lived Assets — FASB Statement 144
(SCORE No. BB0997)
A component of an entity comprises operations and cash flows that
can be clearly distinguished, operationally and for financial reporting
purposes, from the rest of the entity. A component of an entity
may be a reportable or an operating segment, a reporting unit, a
subsidiary or an asset group. If an entity disposes of assets that do
not qualify as a component, then the related operations should not be
presented as discontinued operations in the income statement.
When a registrant presents discontinued operations or discloses
that it has disposed of an asset group, the SEC staff has questioned
registrants about the appropriate presentation of the disposal (i.e.,
discontinued or continuing operations).
FASB ASC Topic 205, Presentation of Financial Statements
17
18
SEC Comments and Trends October 2009
Contingencies
The accounting for and disclosure of contingencies
Discussion of issues noted
The SEC staff continues to ask registrants to provide additional
information and/or enhance disclosures related to loss contingencies.
Analysis of current issues
A loss contingency should be recognized if its occurrence is
probable and can be reasonably estimated. A registrant is also
required to disclose:
• The nature of the loss accrual
• An estimate of the possible loss, or range of estimated loss. If such
estimate is not determinable, the registrant is required to disclose
that fact (ASC 450-20-25-1 through 25-5)18
These same disclosures are required in circumstances when it is
reasonably possible that an exposure to a loss in excess of the amount
recognized also exists.
The SEC staff has asked registrants to provide appropriate
disclosures, such as the nature of the contingency, management’s
assessment of the likelihood of a material loss being incurred
relative to a contingency, the amount of exposure above the accrued
amount that is reasonably possible of occurring, and, if applicable,
a statement that the amount of a loss cannot be estimated. In
addition, when a registrant discloses a loss that is reasonably possible
of occurring, the SEC staff has requested detailed disclosures
concerning the specific contingencies, rather than generalized
risk disclosures. The SEC staff also has questioned the registrants’
accounting treatment for gain contingencies.
Resources
EY Publication, Hot Topic, FASB hosts loss contingency disclosure
roundtables (SCORE No. BB1714)
Gain contingencies are not recognized in the financial statements
until the gain is realized (ASC 450-30-25-1). Prior to realization, the
existence of gain contingencies may require disclosure, but an entity
should exercise care in making any such disclosure in order to avoid
misleading implications as to the likelihood of realization.
FASB ASC Topic 450, Contingencies
18
SEC Comments and Trends October 2009
19
Debt
Compliance with covenants
Discussion of issues noted
In light of the current economic environment and the increased
operating and financing challenges that go with it, many registrants
are facing debt covenant compliance challenges. Likewise, the SEC
staff has recently issued comments asking registrants to provide
more comprehensive disclosure of their material debt covenants as
well as situations where indicators of increased risk of default are
present or management has concluded it is reasonably likely that
covenants will not be met in the future.
Analysis of current issue
Failing to comply with material debt covenants can have significant
implications on a registrant’s liquidity. Accordingly, the SEC staff has
requested that a number of registrants, whose risk of non-compliance
with debt covenants is more than remote, improve their related
disclosures. The SEC staff has focused on providing users of financial
statement information with greater transparency into the nature of, and
measurement against, such covenants as well as the potential risks and
actual or reasonable effects of non-compliance with such covenants on
the registrant’s financial condition and liquidity. Specifically, the SEC
staff has requested the following types of disclosures:
• Actual quantitative ratios or amounts compared to required
minimum/maximum values contained in debt covenants along with
explanations of how such ratios or amounts are determined and
their relationship to amounts reported under US GAAP
• The impact existing covenants may have on a registrants
borrowing capacity, cash flows and/or financial position
• The nature of waivers and/or modifications of existing debt
covenants to cure or prevent any potential violation(s), including
how long such waivers apply and a description of the related
covenant
• The impact of credit downgrades and late payments on covenants
and the classification of outstanding debt
Less frequently, although equally as important, the SEC staff has
asked questions regarding debt balance sheet classification as
either current or noncurrent. The classification conclusion requires
consideration of the maturity date of the debt and rights of the
lender to accelerate repayment, the consideration of debt covenants
and any waivers for failed covenants and related topics. The
accounting literature addressing the classification of debt is found in
ASC 470-10-4519, with some examples and interpretative guidance in
ASC 470-10-55.
Resources
EY Publication, 2008 SEC annual reports- Reports to shareholders
Form 10-K (Score No. CC0267)
• Potential risks and consequences of non-compliance with debt
covenants and any potential trends in such compliance or that may
lead to non-compliance
• Default provisions in debt agreements which could cause an event
of default on one debt instrument to trigger default under another
debt agreement (cross-default provisions)
FASB ASC Topic 470, Debt
19
20
SEC Comments and Trends October 2009
Modifications, exchanges or extinguishments
Discussion of issues noted
Recent market conditions have led to many corporate debt
modifications, exchanges and extinguishment transactions. The
SEC staff has recognized these market events and have focused
their comments on a registrant’s accounting, including whether
transactions are considered a troubled debt restructuring under
ASC 470-60, or whether such events should be treated as
modifications or extinguishments under ASC 470-50 or induced
conversions under ASC 470-20-40-13 through 40-17.
Analysis of current issue
Modifications or exchanges of existing debt can fall into one of several
complex accounting models. The determination of the appropriate
model is critical due to the significant differences in the accounting
treatment afforded these transactions. Careful evaluation of the
terms of the modification or restructuring and consideration of
whether or not the transaction is a troubled debt restructuring is
required. Registrants should be prepared to provide a thorough
accounting analysis for the transaction, as the SEC staff questions
often probe this challenging area of accounting.
If economic or legal considerations related to the registrant’s financial
difficulties lead the creditor to grant the issuer a concession it would
not otherwise have granted, the transaction is considered a troubled
debt restructuring and should be accounted for under ASC 470-60.
A troubled debt restructuring, which can take several forms, is
excluded from the scope of ASC 470-50, which addresses nontroubled modifications or exchanges. The accounting for a troubled
debt restructuring by a debtor depends on the type of restructuring:
transfer of assets in full settlement, grant of equity interest in full
settlement, modification of terms, or some combination therein.
instruments are “substantially different” if the present value of the
cash flows under the terms of the new debt instrument is at least 10
percent different from the present value of the remaining cash flows
under terms of the original instrument (ASC 470-50-40-10). If the
original and new debt instruments are substantially different, the new
debt should be initially recorded at fair value and the original debt is
derecognized, with the difference recognized as an extinguishment
gain or loss. Other modifications or exchanges not considered to
be substantially different are accounted for prospectively as yield
adjustments. The analysis of whether the original and new debt
instruments are substantially different is quickly complicated if
there are variable terms to the instruments, if there are embedded
conversion options, or if intermediaries are involved in the transaction
between the debtor and creditor. There is additional guidance in
ASC 470-50-40 and 470-50-55 for those situations.
The accounting for modifications to or exchanges of line-of-credit or
revolving-debt agreements generally depends on whether the borrowing
capacity (the product of the remaining term and the maximum available
credit) has increased or decreased (ASC470-50-40-21 through 40-23).
In other circumstances involving the conversion of convertible debt
instruments, registrants may offer additional securities or other
consideration (often referred to as a “sweetener”) not required
under the original terms to encourage the counterparty to agree
to retire or exchange the outstanding instrument - resulting in an
induced conversion. When an induced conversion occurs, expense
recognition equal to the fair value of the additional securities or
other consideration issued to induce conversion is required
(ASC 470-20-40-13 through 40-17 and 40-26).
If the transaction is not considered a troubled debt restructuring,
then the modification or extinguishment of debt is evaluated under
ASC 470-50. Regardless of the form of the transaction (that is,
regardless of whether it is nominally a “modification,” an “exchange”
or an “extinguishment”), these transactions are considered to be
extinguishments of the original debt if the terms of the new debt and
original debt are substantially different. The original and new debt
SEC Comments and Trends October 2009
21
Financial instruments
Warrants and embedded conversion features
Discussion of issues noted
Given the importance that financial statement users assign
to classification and measurement of registrant’s financing
arrangements, the SEC staff has continued to focus on registrants’
classification and measurement of convertible instruments and/
or other equity derivatives that may be settled in a company’s own
stock. In applying the guidance contained in ASC 815-40-1520 and
ASC 815-40-25 to the accounting for freestanding and embedded
equity derivatives, the SEC staffs inquiries emphasize the need for
a thorough analysis of the complex provisions contained in many of
these arrangement. For convertible instruments that do not require
bifurcation of the conversion feature, the SEC staff continues to focus
on the correct assessment of any beneficial conversion features as
required throughout the guidance in ASC 470-20. Because of the
general complexity involved in this area, it is not unusual for the SEC
staff to request a copy of the company’s full accounting analysis of
the related instrument.
Analysis of current issues
Registrants could use the following hierarchy of accounting literature
(which reflects guidance that became effective for fiscal years
beginning after 15 December 2009 related to whether an instrument
is indexed to the issuer’s stock) as a guide to assist their evaluation of
freestanding derivative instruments:
• Analyze the instrument under ASC 48021 to determine whether
liability classification is required
Registrants could also use the following hierarchy of accounting
literature (which reflects guidance that became effective for fiscal
years beginning after 15 December 2009 related to (a) whether an
instrument is indexed to the issuer’s stock and (b) the accounting for
conversion options that may be settled in cash (including partially
settled in cash) upon conversion) to assist in their evaluation of
convertible debt or convertible preferred stock instruments:
• Analyze the instrument under ASC 480 to determine whether
liability classification is required. If so, continue to evaluate any
potential embedded derivatives as discussed below
• If the instrument is not within the scope of ASC 480, consider
whether the instrument is a “debt-like” or “equity-like” host in
accordance with ASC 815-15-25-17 and ASC 815-10-S99-3 as
that conclusion affects the evaluation of any embedded conversion
options and other potential embedded derivatives
• Next, consider ASC 815-40-25-39 through 25-42 and whether
the instrument qualifies as a “conventional convertible”
instrument, as that conclusion affects the evaluation of the
embedded conversion option
• Next, analyze the embedded conversion option for potential
bifurcation under ASC 815-15-25, including whether it would
qualify for an exception from derivative accounting under
ASC 815-10-15-74 if freestanding
• If the instrument is not required to be classified as a liability under
ASC 480, evaluate the instrument under ASC 815-10-15 to
determine if it is a derivative
• If the conversion option is not bifurcated and potentially settled in
cash (or other assets), it must be evaluated under the guidance in
ASC 470-20 under the headings “Cash Conversion” to determine
what portion of the instrument should be allocated between a
liability and equity component
• If the instrument meets the definition of a derivative, determine
if it falls under the exception from derivative accounting under
ASC 815-10-15-74 which requires further analyses under
ASC 815-40-15 and 40-25
• If the conversion option is not bifurcated and the instrument is not
required to be allocated between a liability and equity component,
consider whether the instrument has a beneficial conversion
feature under the relevant guidance in ASC 470-20
• When evaluating the instrument under ASC 815-40-25, consider
all its criteria, including ASC 815-40-25-7 through 25-38 (i.e.,
employ the “long test”)
• Finally, consider if there are any other embedded derivative
features in the instrument under ASC 815-15
• If the exception from ASC 480-10-15-74 applies, and the
instrument is freestanding, it should be classified as an equity
instrument under ASC 480-40-25
FASB ASC Topic 815, Derivatives and Hedging
FASB ASC Topic 480, Distinguishing Liabilities from Equity
20
21
22
SEC Comments and Trends October 2009
Registrants face various “pitfalls” in accounting for freestanding
instruments and embedded conversion features commonly found in
convertible debt and convertible preferred stock, often resulting from
an inaccurate or incomplete application of the relevant accounting
guidance. These include, but are not limited to, challenges in:
• Calculating “sufficient authorized and unissued shares” under
ASC 815-40-25-19 through 25-24 when analyzing a warrant
or conversion option for possible equity classification (and the
exception to derivative accounting under ASC 815-10-15-74)
• Determining how a contract settles(for example, “net-share
settlement” vs. “net-cash settlement”) and who controls the choice
of settlement form under ISDA Agreements for equity derivative
contracts when applying ASC 815-40-25-1 through 25-4
• Determining “conventional convertible” status under ASC 815-4025-39 through 25-42
• Considering beneficial conversion features under the relevant
guidance in ASC 470-20
• Considering puttable warrants under ASC 480-10-25-8 through
25-13 and ASC 480-10-55-33
The SEC Staff has issued comments and requested additional
information focusing on how registrants have applied all of the pieces
of accounting guidance above and have also occasionally raised
questions with respect to the accounting for associated registration
rights arrangements under ASC 825-20.22
Resources
EY Publication, Financial Reporting Developments, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity Under FASB Statement No. 150 (SCORE No. BB1110)
EY Publication, Financial Reporting Developments, Accounting for
Derivative Instruments and Hedging Activities — A Comprehensive
Analysis of FASB Statement 133, as Amended and Interpreted
(Revised December 2006) (SCORE No. BB0977)
EY Publication, Accounting Release, Accounting For Derivative
Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock — A Summary of EITF Issue 00-19
(SCORE No. BB4162)
EY Publication, Hot Topic, 2007 AICPA National Conference on
Current SEC and PCAOB Developments Compendium of Significant
Accounting and Reporting Issues (SCORE No. CC0243)
EY Publication, Hot Topic, Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion
(SCORE No. BB1522)
EY Publication, Technical Line - Implementation Issues Related to
FASB Staff Position APB 14-1 (SCORE No. BB1623)
EY Publication, Technical Line - EITF Issue No. 07-5, “Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock” (SCORE No. BB1662)
FASB ASC Topic 825, Financial Instruments
22
SEC Comments and Trends October 2009
23
Recent literature updates related to debt and
equity instruments
Redeemable minority interests and redeemable
equity instruments
Discussion of issues noted
Discussion of issues noted
In advance of registrants adopting the accounting guidance related
to (a) the evaluation of whether an instrument or embedded feature
was indexed to the issuer’s own stock in ASC 815-40-15 and (b) the
accounting for convertible instruments that may be settled in cash
upon conversion (including partial cash settlement) in ASC 470-20
under the headings “Cash Conversion”, the SEC staff asked question
about registrants’ initial assessment of the application of that
guidance even in advance of the effective date. The SEC staff has also
focused on the adequacy of any disclosures under SAB Topic 11-M23
(codified primarily in ASC 250-10-S99-5). See further discussion in
the “SAB Topic 11-M, Disclosures on the Impact of Recently Issued
Accounting Pronouncements” section.
The SEC staff’s balance sheet and measurement concerns also
extend to the accounting for “redeemable minority interests” and
“redeemable equity instruments.” In 2008, the SEC staff updated the
guidance in EITF Topic D-98 to respond to changes in the underlying
accounting for noncontrolling interests issued by consolidated
subsidiaries under ASC 810.25 This has brought renewed attention
to these arrangements. Redeemable equity instruments of a parent
or noncontrolling interests of a subsidiary that are subject to put
rights (or perhaps a combination of put and call rights) or a forward
purchase agreement are relatively common.
Analysis of current issues
For issuers of equity derivatives and convertible instruments, the
adoption of these two standards was potentially very significant. Under
ASC 815-40-15, certain freestanding equity derivatives, and certain
embedded conversion options in convertible instruments, may have
no longer qualified for equity classification, or non-bifurcation under
ASC 815. Under the “Cash Conversion” guidance in ASC 470-20,
some of the most popular forms of convertible debt issues in the last
several years required separate reporting of a liability component
and an equity component. That guidance also required retrospective
application to all periods presented. In addition, EITF Topic D-9824,
“Classification and Measurement of Redeemable Securities,” provided
additional guidance on the classification of amounts within temporary
equity related to convertible debt instruments that may require
settlement in cash or partial cash.
What is particularly notable over the last twelve months, however, is
that the SEC staff has occasionally asked specific questions related to
how a registrant expected to apply the detailed requirements of those
future standards.
Resources
EY Publication, Hot Topic, Accounting for Convertible Debt Instruments
That May Be Settled in Cash upon Conversion (SCORE No. BB1522)
Redeemable equity instruments are most commonly found in
the form of preferred securities, but there are situations in which
common shares may include redemption rights.
A redeemable noncontrolling interest arrangement is often present
when investors desire a contractual means to extricate themselves
from an arrangement at a specified future date in situations where
(a) a registrant initially acquires a controlling interest in an entity and
the sellers retain a noncontrolling interest (perhaps for tax purposes),
(b) a larger, well-established parent enters into a venture with
individual shareholders/entrepreneurs, or (c) two large investors start
a venture. Economically these arrangements are used because the
common shares of the subsidiary normally will not be registered and
traded. Therefore, the noncontrolling interest holder often seeks a
mechanism to obtain liquidity for its shares, which might be provided
by the controlling interest holder agreeing to a derivative contract or
feature. These generic derivatives can be freestanding instruments
or embedded features and can take the form of options (written or
purchased, puts or calls), forwards (date-certain or contingent) or
even swap-like contracts.
The SEC staff has asked questions about the underlying accounting
for these instruments and given the complexity, often requests a full
accounting analysis.
EY Publication, Technical Line - Implementation Issues Related to
FASB Staff Position APB 14-1 (SCORE No. BB1623)
EY Publication, Technical Line - EITF Issue No. 07-5, Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock (SCORE No. BB1662)
SEC Staff Accounting Bulletin (SAB) Topic 11-M, Disclosures of the impact that
recently issued accounting standards will have on the financial statements of the
registrants when adopted in a future period
24
EITF Topic D-98, Classification and Measurement of Redeemable Securities
23
24
FASB ASC Topic 810, Consolidations
25
SEC Comments and Trends October 2009
Analysis of current issues
Resources
The accounting in this area can be complex because of the different
sources of GAAP that must be considered. This complexity is
compounded because of the interaction of the form of the redemption
feature (that is, whether it is embedded or freestanding), the nature
of the redemption feature (option-like or forward-like) and the pricing
of the redemption feature (fixed or variable price or at fair value).
EY Publication, Financial Reporting Developments, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity Under FASB Statement No. 150 (SCORE No. BB1110)
The primary literature to be considered includes ASC 480 and ASC
815, and the SEC’s guidance in both ASR 26826 (incorporated into
Rule 5-02.28 of Regulation S-X) and EITF Topic D-98.
In updating EITF Topic D-98 in March 2008 for its interaction with
equity-classified noncontrolling interests arising from ASC 810, the
SEC staff noted that the application of ASR 268 and the related
guidance in the D-topic to a redeemable noncontrolling interest is
consistent with the SEC staff’s longstanding position. Thus, while EITF
Topic D-98 previously did not explicitly address redeemable minority
interests, the SEC staff nonetheless believes its guidance is, and has
been historically, relevant in classifying and measuring redeemable
minority interests in the form of both common stock and preferred
stock. The update, in part, was to clarify this issue.
EY Publication, Financial Reporting Developments, Accounting for
Derivative Instruments and Hedging Activities — A Comprehensive
Analysis of FASB Statement 133, as Amended and Interpreted
(Revised December 2006) (SCORE No. BB0977)
EY Publication, E&Y on the EITF — Summary of the March 12, 2008
Emerging Issues Task Force Meeting (SCORE No. BB1496)
EY Publication, Financial Reporting Developments, FASB Statement
No. 160, Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51 (SCORE No. BB1577)
SEC Accounting Series Release No. 268, Presentation in Financial Statements of Redeemable Preferred Stocks
26
SEC Comments and Trends October 2009
25
Share-based payments
Valuation assumptions and disclosures
Discussion of issues noted
Expected term
The SEC staff continues to issue comment letters requesting
registrants to provide further disclosure related to the assumptions
utilized to determine the grant-date fair value of share-based
payments. In particular, the SEC staff appears to be focusing on
the risk-free interest rate, expected term and expected volatility
assumptions applied in a Black-Scholes-Merton option pricing
model. The SEC staff has also requested registrants to provide the
calculations and methodology that support subjective assumptions
(e.g., expected term and volatility).
The expected term of a share option has a significant effect on the
option’s fair value. The longer the term, the more time the option
holder has to allow the share price to increase without a cash
investment and, thus, the more valuable the option.
The SEC staff continues to encourage the use of current marketbased information where appropriate, expects registrants to
incorporate all substantive characteristics of the share-based
payment into the valuation and expects consistent application of the
method used to develop the fair value estimate from period-to-period.
Analysis of current issue
Valuation techniques or models used to estimate the fair value of an
employee share option or similar instrument must take into account
at least six inputs (ASC 718-10-55-21).27 Several of those inputs are
objectively determinable (e.g., exercise price, grant-date share price),
while others are subjective (e.g., expected term, expected volatility).
Registrants should ensure their disclosure includes a discussion of
each significant assumptions used during the year to estimate the
fair value of share-based payments (ASC 718-10-50-2(f)(2)). These
disclosures would include how the risk-free interest rate, expected
term and expected volatility were determined.
Risk-free interest rate
The risk-free interest rate applied in a closed-form option-pricing
model (i.e., Black-Scholes-Merton formula) is the implied yield
currently available on US Treasury zero-coupon notes issues with
a remaining term equal to the expected term used within the
option-pricing model. A higher risk-free interest rate will result in
a higher estimated fair value. Under a lattice model, a registrant
will utilize a separate risk-free interest rate for each node in the
lattice. Registrants using a valuation technique or model that applies
differing risk-free interest rates are required to disclose the range of
risk-free interest rates used (ASC 718-10-50-2(f)(2)(iv)).
FASB ASC Topic 718, Compensation – Stock Compensation
27
26
Historical empirical data shows that, for a variety of reasons,
employees typically do not wait until the end of the contractual
term of an option to exercise. However, recent economic conditions
and accompanying decreases in share prices have resulted in many
share options becoming “out-of-the-money” (option exercise prices
exceed current share prices). Consequently, employees are typically
not exercising vested options and instead are choosing to hold those
options for longer periods. Changes in employee exercise behavior,
such as holding vested options for a longer period of time, could affect
future estimates of the expected term of employee share options. Due
to the subjectivity of the expected term assumption and the potential
effect on the financial statements to changes in this and other
assumptions, it is likely that the SEC staff may increase their requests
for information regarding the valuation of share-based payments.
There are several factors to consider when estimating the expected
term of an option, including the vesting period of the award, historical
exercise and post-vesting employment termination behavior, expected
volatility, blackout periods and other coexisting arrangements and
employees’ ages, lengths of service and home jurisdictions (ASC 71810-55-29 through 55-34). New registrants that have “plain vanilla”
options, as defined in Question 5 of Section D.2 of SAB Topic 1428
(codified primarily in ASC 718-10-S99-1) may not have sufficient
historical employee exercise data available to estimate the expected
term of employee share options. Other registrants with “plain vanilla”
options may also, in certain circumstances, have insufficient historical
employee exercise data available. In these situations, registrants may
estimate the estimated term assumption using a “simplified” method.
SEC Staff Accounting Bulletin (SAB) Topic 14, Share-Based Payments
28
SEC Comments and Trends October 2009
Under the “simplified” method, the expected term is calculated as
the midpoint between the vesting date and the end of the contractual
term of the option (Question 6 of Section D.2 of SAB Topic 14). The
SEC staff does not expect the “simplified” method to be used when
sufficient information regarding exercise behavior, such as historical
exercise data or exercise information from external sources, becomes
available. The SEC staff has questioned certain registrants’ use of the
“simplified” method when historical data may appear to be available.
Registrants that use the “simplified” method to estimate the expected
term of “plain vanilla” options should disclose in the notes to the
financial statements:
• The use of the method
• The reason why the method was used
• If the method was not used for all share option grants, the types of
share option grants for which the method was used
• If the method was not used in all periods, the periods for which the
method was used
Expected volatility
the method previously used to estimate expected volatility no longer
produces the best estimate of expected volatility consistent with the
requirements of ASC 718. In these situations, registrants should
disclose in their critical accounting policies, as applicable, the basis
for their conclusions regarding the extent to which historical volatility,
implied volatility or a combination of both were used (Question 5
Section D.1 of SAB Topic 14). Registrants should consider explaining
the reasons for any change to the method used to estimate expected
volatility compared with the prior reporting period. While the SEC staff
often comments when a registrant relies exclusively on either implied
volatility or historical realized volatility in estimating expected volatility,
it is likely that the SEC staff will question the usefulness of a registrant’s
disclosure if its disclosure discussion does not adequately convey the
reasons and nature of any change in a material expected volatility
assumption that affects share-based compensation.
Resources
EY Publication, Financial Reporting Developments, ShareBased Payment, FASB Statement No. 123 (revised 2004)
(Revised November 2006) (SCORE No. BB1172)
Much of the value of a share option is derived from its potential for
appreciation. The more volatile the underlying shares, the more
valuable the option due to the greater possibility of significant
changes in share price. There are certain factors to consider in
estimating expected volatility, including historical and implied (derived
from a traded option in the registrant’s shares) volatility measures
(ASC 718-10-55-37).
The weakening economy has affected the operating results and
share prices of many publicly-traded entities. As a result, registrants
currently experiencing higher share price volatility may be considering
this increased volatility when evaluating their methods used to
estimate expected volatility. In particular, registrants may believe that
SEC Comments and Trends October 2009
27
Modifications
Discussion of issues noted
The recent economic conditions have resulted in many employees
earning or holding share-based payments that are believed to carry
little to no value. Registrants have been considering alternatives
to maintain the value in employee share-based payment awards.
Modifications to existing awards are accounted for in accordance with
ASC 718-20-35-3. The SEC staff has been issuing comments asking
registrants to provide additional detail on how they accounted for
modifications, including the specific types of modifications made, the
amount of compensation cost recognized, how each modification was
valued and the accounting literature that supports the conclusions
presented.
Analysis of current issue
Some registrants have modified or removed vesting conditions tied
to their operating results, including share price performance. Other
modifications have included repricing share options to reduce the
exercise price, adding cash settlement alternatives or a combination
of these alternatives.
The modification of a share-based payment award may result in
incremental compensation cost that will need to be recognized together
with any remaining unrecognized compensation cost measured on the
original grant date. Incremental fair value is calculated based on the fair
value of the modified award in excess of the fair value of the original
award measured immediately before its terms are modified based on
current circumstances. The value of the original (pre-modification)
award will be estimated based on current assumptions, without regard
to the assumptions made on the grant date.
Registrants that choose to modify an award to provide a cash
settlement alternative will need to assess whether the change should
be accounted for as a settlement or modification. This assessment
will depend on whether future service is required to earn the cash
payment or whether the cash payment continues to be tied to the
registrant’s share price. In addition, registrants will need to assess
whether all or a portion of the award following the modification
should be classified as a liability.
When a modification occurs, the SEC staff will expect that registrants
disclosure would include a description of each significant modification,
including the modification terms, number of employees affected and
the total incremental compensation cost, if any, that has resulted from
applying modification accounting (ASC 718-10-50-2(h)(2)).
Resources
EY Publication, Financial Reporting Developments, ShareBased Payment, FASB Statement No. 123 (revised 2004)
(Revised November 2006) (SCORE No. BB1172)
Registrants that are modifying the vesting conditions of a sharebased payment award should determine at the modification date
whether the original vesting conditions were expected to be satisfied
(i.e., was the award probable or improbable of vesting) (ASC 71820-55-107 through 55-108). If the award was probable of vesting
at the modification date, then cumulative compensation cost for the
modified award will at least equal the grant-date fair value of the
original award. Examples of changes to vesting conditions would
include, but are not limited to, the acceleration of vesting periods,
adjustments to vesting performance targets and the extension of
vesting periods in exchange for lowering the exercise price of out-ofthe-money options.
28
SEC Comments and Trends October 2009
Revenue recognition
Meeting the ‘fixed or determinable’ criteria of
SAB Topic 13
Discussion of issues noted
Estimating returns
Revenue is often a key financial performance metric used by financial
statement users. Therefore, it is no surprise that the SEC staff
continues to issue comment letters asking registrants to explain
how their revenue recognition policies comply with SAB Topic 1329
(codified primarily in ASC 605-10-S99-1)30. Of the four basic revenue
recognition criteria outlined in SAB Topic 13, the SEC staff most
frequently questions registrants’ policies for recognizing revenue
when it appears that the criteria for a seller’s price to be fixed or
determinable is not met at the time revenue is recognized. Based on
the information included within the registrant’s disclosures of revenue
transactions, the SEC staff often questions how the registrants believe
they have been able to meet the fixed or determinable criterion,
particularly for arrangements that contain general rights of return or
concessions. In other comment letters, the SEC staff has asked for an
explanation or enhanced disclosures in situations where the registrant
has deferred revenue because the fixed or determinable criterion was
not met for certain revenue arrangements.
If an arrangement includes general rights of return, then the registrant
must apply the product returns guidance contained in ASC 605-15.
This guidance requires that the amounts of future returns or refunds be
reasonably estimable before the registrant may recognize any revenue
under the arrangement. If the returns or refunds are not reasonably
estimable, or if the other requirements described in ASC 605-15 are
not met, then the arrangement fee is not considered to be fixed or
determinable which would require a deferral of revenue.
Analysis of current issue
The fixed or determinable criterion refers to whether the total
consideration in an arrangement is either known or estimable with
reasonable certainty. The fixed or determinable analysis does not
consider the ability of the customer to pay the fees contained in the
arrangement, but rather the analysis considers whether the fees will
be reduced by the exercise of rights of return or refund granted, either
explicitly or implicitly, to the buyer or by a future action of the vendor
(e.g., by granting a future concession). If a registrant cannot conclude
at the outset of an arrangement that the fee is fixed or determinable,
then the revenue generally is recognized either as payments from the
customer are received or as rights of return or refund lapse, assuming
all of the other basic criteria outlined in SAB Topic 13 have been met.
When the arrangement fee is stated in a contract, this may help in
reaching a conclusion as to whether a fee is fixed or determinable
but it is only a small part of the assessment. The key is whether the
vendor can reliably estimate the total fee that will be received from
the arrangement. If the fee may vary because of future actions, the
fee may not be determinable. Factors, which should be considered
when making this assessment, include whether a vendor has the
ability to estimate refunds and/or returns, whether a contract
includes customer cancellation or termination provisions and whether
a vendor will grant a concession to a customer. These factors are
discussed in greater detail below.
Of the six conditions discussed in the product returns guidance (see
ASC 605-15) that are required to be met in order for a registrant to
recognize revenue at the time of sale, the ability to make a reasonable
estimate of returns is often the most problematic. The ability to make
reasonable estimates can be affected by matters such as susceptibility
of the product to technological obsolescence or changes in customer
demand, the length of the return period, the presence or absence
of relevant historical return experience and the seller’s marketing
policies and relationships with customers/distributors. In addition to
those factors listed in ASC 605-15, the SEC staff has identified several
other variables for registrants to consider when determining whether
they are able to make reasonable and reliable estimates of returns. As
discussed in SAB Topic 13, some of these additional factors include,
but are not limited to, a registrant’s lack of visibility into the distribution
channel or into the current level of sales to end customers, the newness
of the product and external market factors including a competitor’s
introduction of new products or the significance of a particular
distributor in the market. The process of building support for estimating
a reserve for product returns is based on the registrant’s individual facts
and circumstances. Registrants should have sufficient internal control
processes in place to capture and evaluate relevant sales and returns
data to enable them to adjust their estimates on a timely basis for
changes in facts and circumstances.
Customer cancellation provisions
If the customer retains the unilateral right to cancel the contract (or
other evidence of the arrangement if the contracts are not customarily
used) if certain conditions are not met, the registrant must defer revenue
recognition until the cancellation provisions are no longer effective
because the fee is neither fixed nor determinable. In these situations,
a fee that is variable until the occurrence of future events would not be
considered fixed or determinable until the future event occurs. When the
cancellation provisions expire rateably over the contract period, the fees
become determinable as the cancellation provisions lapse.
SEC Staff Accounting Bulletin (SAB) Topic 13, Revenue Recognition
FASB ASC Topic 605, Revenues
29
30
SEC Comments and Trends October 2009
29
Gross versus net presentation of revenue
History of offering concessions
Discussion of issues noted
In determining if a fee is fixed or determinable, a registrant should
consider whether factors exist, that could cause it to grant the
customer a refund or other concessions. If a registrant has a history of
granting concessions that are not required under the original terms of
the arrangement, the registrant should challenge the appropriateness
of recognizing revenue until the conditions that have historically
caused the registrant to grant the concessions have been resolved.
The SEC staff continues to question how registrants evaluate their
revenue streams in determining whether to present revenues on a gross
basis or on a net basis. Notably, the SEC staff has challenged registrants
on their conclusions that net revenue reporting is appropriate nearly
as often as they have challenged registrants that record revenue on
a gross basis. The SEC staff has asked several registrants to provide
an analysis of all of the indicators discussed in ASC 605-45, to
support whether gross revenue reporting or net revenue reporting
is appropriate. In many cases, the SEC staff has required registrants
to expand financial statement disclosures related to the registrant’s
accounting policies on gross versus net reporting of revenue.
Concessions extend beyond simply refunding a portion of the fee
or crediting the customer’s account. Concessions include, but are
not limited to, the following if made subsequent to the outset of an
arrangement: accepting returns that are not required to be accepted
under the terms of the original arrangement, offering a larger
than normal discount on the next purchase that was not a part of
the original arrangement, extending the time frame or geographic
area for a reseller to sell the product or allowing other products
not specified in the original arrangement to be included under the
arrangement without obtaining additional consideration.
Extended payment terms
When a registrant has not yet developed a sufficient history of
collecting payments in arrangements with extended payment terms
without granting concessions, arrangements with extended payment
terms do not meet the fixed or determinable fee criterion. Any
extended payment terms beyond normal customary payment terms
may indicate that the fee is not fixed or determinable. This requires
registrants to examine and document what represents their “normal”
payment terms. Frequently, normal payment terms may differ
based upon the type of the business, the class of customer or other
factors. The differences should be clearly identifiable, objectively
determinable and consistently applied.
Registrants need to carefully apply the criteria contained in SAB
Topic 13 to all sales transactions prior to recording revenue for
those transactions. Particular consideration should be given to
arrangements that contain provisions that may call into question
the registrant’s ability to determine that the ‘fixed and determinable’
criterion is met at the onset of the arrangement. Those arrangements
that contain concessions, cancelation or termination provisions or
any other return rights are most likely to be subjected to scrutiny
by the SEC staff and thus should be most carefully analyzed with
appropriately robust disclosures included in the financial statements
to enable users to understand the nature of the revenue transactions.
30
Analysis of current issue
In many revenue generating arrangements, a company may assist a
supplier in the fulfillment of goods or services provided to a customer
(e.g., a company may store and ship goods on behalf of a supplier).
In these circumstances, a company should analyze whether it should
report revenue based on (a) the gross amount billed to a customer
because it has earned revenue from the sale of the goods or services
or (b) the net amount retained (that is, the amount billed to a
customer less the amount paid to a supplier) because it has earned
a commission or fee. The objective is to determine whether the
company is in substance acting as the principal in the transaction that
holds substantially of all the risks and benefits related to the sale of a
product or service or whether the company is acting as an agent on
behalf of another party.
The revenue recognition guidance on principal agent considerations
is applicable for revenue transactions in all industries unless specific
guidance is provided in other authoritative literature. The guidance
does not provide any bright-lines or objective factors for registrants to
consider. Rather, it provides indicators that often require registrants
to apply considerable judgment, setting forth criteria that should be
used to evaluate whether gross revenue reporting or net revenue
recognition is most appropriate, given the facts and circumstances of
the arrangement. Individually, none of the indicators is presumptive
or determinative; however, all of the indicators should be analyzed
in totality to determine whether the preponderance of evidence
supports gross or net revenue reporting.
SEC Comments and Trends October 2009
The following two items are strong indicators that gross revenue
reporting is appropriate:
1) The company is the primary obligor in the relationship and
2) The company has general inventory risk (before customer order is
placed or upon customer return)
The principal agent considerations guidance provides the following
additional criteria that are considered weaker indicators that a
reseller may be acting as a principal in a transaction. However, the
presence of any or all of the following factors may not be a sufficient
basis to conclude that gross revenue reporting is appropriate, if
the reseller is not the primary obligor in the arrangement with the
customer or does not assume general inventory risk. The additional
factors include the following:
3) The company has latitude in establishing price
4) The company changes the product or performs part of the service
5) The company has discretion in supplier selection
6) The company is involved in the determination of product or
service specifications
The last two indicators that support reporting revenues on a gross
basis are as follows:
7) The company has physical loss inventory risk (after customer
order or during shipping)
8) The company has credit risk
Conversely, the presence of any of the following indicators may
provide evidence that the registrant is an agent of the supplier and
should record revenue net based on the amount retained (that is, the
amount billed to the customer less the amount paid to a supplier):
1) The supplier (not the company) is the primary obligor in the
arrangement
2) The amount the company earns is fixed
3) The supplier (and not the company) has credit risk
The SEC staff has frequently requested that registrants provide
their analysis for each of the indicators discussed above to support
their conclusions that either gross revenue reporting or net revenue
reporting is appropriate. Many of these analyses will require significant
judgment based on the facts and circumstances of a registrant’s
arrangement with its supplier. It is important for registrants to
maintain thorough, contemporaneous documentation to support the
conclusions made in analyzing these indicators. It is also important
for all registrants to perform the analysis of these indicators for each
type of revenue arrangement. It is not uncommon for a company to
act in the capacity of the principal in one arrangement whereby gross
revenue presentation is appropriate while acting in an agent capacity
in another arrangement, which would require reporting revenue on
a net basis. To the extent the registrant has significant operations
subject to principal agent considerations, disclosures should be
considered in the financial statements that discuss the various criteria
management evaluated in the determination of recording those
revenues on a gross or net basis.
While 7 and 8 are considered to be weak indicators because they
relate to lower risks that are often easily mitigated by insurance or
common business practices. The SEC staff has consistently asked for
an analysis of all of the indicators contained within the principal agent
considerations guidance.
SEC Comments and Trends October 2009
31
Pension and other post-retirement
employee benefit plans
Critical accounting policies and estimates
Discussion of issues noted
The SEC staff frequently comments on critical accounting policy
disclosures surrounding the historical assumptions, such as
discount rates, used in estimating defined benefit pension and other
postretirement benefit plan costs and obligations.
Analysis of current issue
Registrants have often been asked to disclose an analysis of
the subjective judgments used to estimate pension and other
postretirement benefit plan costs and obligations. In addition, the SEC
staff has requested registrants to disclose a sensitivity analysis for the
underlying assumptions. For example, if changes in the long-term rate
of return, discount rate or other assumptions used in accounting for a
registrant’s pension plan would have a material effect on a registrant’s
financial condition, those changes should be disclosed and quantified.
32
When a percentage of a registrant’s plan assets were held in equity
securities, the SEC staff has issued comment letters requesting
registrants to discuss the effect that current market conditions have
had on the plan assumptions and net periodic benefit cost. In addition,
registrants have been asked to disclose the expected effect on future
operations of a decrease in plan assets, changes in expected rates of
return, discount rates and amortization of actuarial gains/losses.
Resources
E&Y Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
SEC Comments and Trends October 2009
Income taxes
Realizability of deferred tax assets
Discussion of issues noted
The SEC staff frequently requests registrants to provide further
information and request enhanced disclosures regarding a
registrants’:
• Assessment of the realizability of deferred tax assets, particularly
when negative evidence exists suggesting that a valuation
allowance might be necessary
• Use of similar assumptions and projections of future income to
assess the realizability of deferred tax assets as those used to
assess long-lived assets for impairment
• Reversal of a previously recorded valuation allowance when the
positive evidence that led to this decision is not readily apparent
• Deferred tax asset valuation allowance when positive evidence
exists suggesting it is not necessary
Overall, the questions raised by the SEC staff generally are the result
of inadequate or overly general disclosures in the financial statements
and MD&A (see “MD&A” section for further discussion) regarding
how a registrant assessed both positive and negative evidence to
determine the realizability of deferred tax assets.
Analysis of current issues
The SEC staff will likely continue to question registrants about the
realizability of deferred tax assets and the related disclosures both
within the financial statements and in MD&A. In particular, the
SEC staff has questioned the realizability of deferred tax assets
recorded by registrants that have recognized consecutive annual
losses or recognized a significant loss in the current year. As
such, registrants should carefully assess the realizability of their
deferred tax assets and make transparent and requisite disclosures
in their financial statements and MD&A regarding the deferred tax
asset’s recoverability.
A valuation allowance is required if, based on the weight of available
evidence (both positive and negative), it is more likely than not
(likelihood of more than 50 percent) that some portion, or all, of
the deferred tax asset will not be realized. There are four sources
of taxable income to be considered in determining whether a
valuation allowance is required (ASC 740-10-30-18).31 Ultimately,
the realizability of deferred tax assets depends on the existence of
sufficient taxable income of the appropriate character in either the
carryback or carryforward period under the tax law.
Recent cumulative losses constitute significant negative evidence.
At a minimum, positive evidence of equal or greater significance
is needed to overcome that negative evidence before a tax benefit
is recognized for deductible temporary differences and loss
carryforwards based on a projection of future taxable income. In
evaluating the positive evidence available (that is, the four sources
of taxable income), expectations as to future taxable income
would rarely be sufficient to overcome the negative evidence of
recent cumulative losses, even if supported by detailed forecasts
and projections. In such cases, expectations about future taxable
income are generally overshadowed by a registrant’s historical loss
experience in recent years. Estimating future taxable income in
such cases often necessitates the prediction of a turn-around or
other change in circumstances, which typically is not susceptible
to the objective verification requirement of ASC 740. Conversely,
taxable income available in carryback years (which generally would
be limited in circumstances where pretax losses were incurred for the
last few years), reversals of existing taxable temporary differences,
and qualifying tax planning strategies can provide positive evidence
in these cases.
FASB ASC Topic 740, Income Taxes
31
SEC Comments and Trends October 2009
33
In addition, when assessing the realizability of deferred tax assets,
registrants should keep in mind that the assumptions and projections
used to analyze the realizability of assets under GAAP generally
should not change based on the nature of the asset being analyzed.
That is, registrants should not have one set of projections for
evaluating the need for a valuation allowance on deferred tax assets,
while using different projections for evaluations of impairment of
long-lived assets (e.g., property, plant and equipment, goodwill and
other intangible assets). Noteworthy, however, is that ASC 740
does have instances that are more restrictive than other standards
for which it is appropriate to rely on projections of future taxable
income. That is, ASC 740 requires the weight of all available evidence
(both positive and negative) to be considered when evaluating
the realizability of deferred tax assets. That means that while a
registrant’s projections have not changed, negative evidence may be
substantive enough such that projections cannot be relied on as a
source of future taxable income.
Disclosure is required in financial statements when known information
available prior to issuance of the financial statements indicates that
both (a) it is at least reasonably possible that the estimate of the
effect on the financial statements of a condition, situation or set of
circumstances that existed at the date of the financial statements will
change in the near term due to one or more future confirming events,
and (b) the effect of the change would be material. MD&A disclosure
requirements are contained in various SEC rules and include, but are
not limited to, the following:
• A discussion of the basis by which management determined that it
was more likely than not the deferred tax asset would be realized
• Disclosure of the types of uncertainties that might affect the
ultimate realization of deferred tax assets
• In instances where the implementation of tax planning strategies
is the basis for not recognizing a valuation allowance for all or
some portion of the deferred tax asset, entities should consider
disclosing the uncertainties that might affect the realization of
deferred tax assets, as well as the factors that led management
to conclude that it was more likely than not the deferred tax asset
would be realized
• If a material net deferred tax asset’s realization is dependent on
improvements over present levels of consolidated pre-tax income,
changes in the present relationship between income reported for
financial and tax purposes, or asset sales or other non-routine
transactions, a description of these assumed future events,
quantified to the extent practicable
In addition, when assessing the realizability of deferred tax assets, registrants
should keep in mind that the assumptions and projections used to analyze the
realizability of assets under GAAP generally should not change based on the
nature of the asset being analyzed. That is, registrants should not have one set
of projections for evaluating the need for a valuation allowance on deferred tax
assets, while using different projections for evaluations of impairment of long-lived
assets (e.g., property, plant and equipment, goodwill and other intangible assets).
34
SEC Comments and Trends October 2009
Disclosures of uncertain tax positions
• The amount of future taxable income required to realize the
deferred tax assets
• If significant objective negative evidence indicates uncertainty
regarding realization of the deferred asset, the countervailing
positive evidence relied on by management in its decision not to
establish a full allowance against the asset
• The effect of a future change in valuation allowance on the entity’s
compliance with debt covenants and related liquidity issues
In addition, disclosures in MD&A and other sections of filings that
contain audited financial statements should be consistent with the
projections used in the realization analysis required by GAAP.
Resources
Discussion of issues noted
The SEC staff has continued to question whether registrants have
appropriately considered and included all of the disclosures required
by ASC 740-10-50-15 and 50-19 in their financial statements.
Analysis of current issues
The SEC staff expects registrants to provide all of the disclosures
required by ASC 740-10-50-15 and 50-19. Therefore, registrants
are encouraged to challenge the completeness of their current
disclosures and make any necessary revisions. In summary, the
disclosures required by ASC 740-10-50-15 and 50-19 are as follows:
• A tabular rollforward of the beginning and ending aggregate
unrecognized tax benefits
EY Publication, Financial Reporting Developments, Accounting For
Income Taxes (Revised June 2009) (SCORE No. BB1150)
• Total amount of unrecognized tax benefits that, if recognized,
would affect the effective tax rate
EY Publication, Hot Topic, Valuation Allowance Considerations
(SCORE No. BB1473)
• Total amounts of interest and penalties recognized in the financial
statements
• Disclosure of specific detail related to tax uncertainties for which it
is reasonably possible the amount of unrecognized tax benefit will
significantly increase or decrease within twelve months
• A description of tax years that remain subject to examination for
significant jurisdictions
• The policy for classifying interest and penalties
These disclosures are required to be included in a registrant’s
annual financial statements. In addition, registrants should
disclose any significant changes to these disclosures in their
interim financial statements.
Resources
EY Publication, Financial Reporting Developments, Accounting For
Income Taxes (Revised June 2009) (SCORE No. BB1150)
SEC Comments and Trends October 2009
35
Consolidation
Variable interest entities
Discussion of issues noted
The SEC staff continues to issue a significant number of comments
with respect to registrants’ application of the Variable Interest Entities
(VIEs) sections of ASC 810-10. While the SEC staff’s questions on VIEs
may have historically centered around special purpose entities and
the financial services industry, the SEC staff’s interest has expanded
to encompass more substantive entities and registrants across all
industries. Consistent with investors’ concerns over potential liabilities
associated with structured and certain off-balance sheet entities, the
SEC staff continues to challenge registrants’ accounting and disclosure
for involvement with and consolidation of VIEs. Even when financial
statement disclosures meet the requirements pursuant to the VIE
sections of ASC 810-10, the SEC staff is requesting the registrant’s
detailed analyses addressing its conclusions as to whether an entity is
a VIE and, if so, whether the registrant is the primary beneficiary.
Analysis of current issue
ASC 810-10 provides guidance on determining whether an enterprise
should consolidate certain entities in which the equity investors do
not have the characteristics of a controlling financial interest (i.e.,
they lack certain decision-making ability) or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. These entities are known as VIEs.
The primary beneficiary of a VIE is the enterprise that absorbs the
majority of expected losses, receives the majority of expected returns
or both.
The application of the VIE accounting model is complex and often
dependent on specific facts and circumstances. As a result, the SEC
staff is interested in and frequently requests a complete analysis
addressing the VIE and primary beneficiary assessments. The requests
often are broad in their scope. For example, the SEC staff may request
a registrant to “provide us with your complete analysis behind your
conclusion” or “tell us in detail how you considered ASC 810-10” or
“provide us with a more detailed analysis.” As such, it is important for
registrants to contemporaneously document the transactions and
arrangements that they enter into and related accounting conclusions
pursuant to ASC 810-10. In addition, registrants should ensure
that they have adequate controls to determine whether events or
circumstances have occurred that would require a reconsideration of
the previous accounting conclusions with respect to whether an entity
is a VIE and if so, whether the registrant is the primary beneficiary.
On 12 June 2009, the FASB issued Statement 16732 (not yet codified).
Statement 167 (1) addresses the effects of eliminating the qualifying
special-purpose entity (QSPE) concept from ASC 86033 and (2)
responds to concerns about the application of certain key provisions
of ASC 810, including concerns over the transparency of enterprises’
involvement with VIEs. Statement 167 is effective as of the beginning
of an enterprise’s first annual reporting period that begins after
15 November 2009 and for interim and annual reporting periods
thereafter. That is, Statement 167 is effective for calendar year-end
enterprises beginning on 1 January 2010. While Statement 167
follows a more principled approach to the VIE accounting model, it
The requests often are broad in their scope. For example, the
SEC staff may request a registrant to “provide us with your
complete analysis behind your conclusion” or “tell us in detail
how you considered ASC 810-10” or “provide us with a more
detailed analysis.” As such, it is important for registrants
to contemporaneously document the transactions and
arrangements that they enter into and related accounting
conclusions pursuant to ASC 810-10.
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R)
FASB ASC Topic 860, Transfers and Servicing
32
33
36
SEC Comments and Trends October 2009
Fair value measurements
Accounting and disclosures
will require registrants to apply significant judgments. It will be critical
for registrants to completely document these judgments as it can
be expected that the SEC staff will continue to challenge registrants’
application of the VIE accounting model subsequent to the adoption of
Statement 167.
Resources
EY Publication, Financial Reporting Developments, FASB
Interpretation No. 46, Consolidation of Variable Interest Entities
(Revised April 2009) (SCORE No. BB1112)
EY Publication, Technical Line: FASB Statement No. 167,
Amendments to FASB Interpretation No. 46(R) (SCORE No. BB1812)
Discussion of issues noted
The SEC staff frequently asks for supplemental information pertaining
to the application of, and disclosures related to ASC 820. Often, the
request for additional information originates when a registrant’s
required fair value disclosures are aggregated at such a level that
the SEC staff has difficulty understanding the significant inputs
and assumptions used in the measurement of particular assets and
liabilities. Many of the SEC staff’s inquiries relate to items outlined in
the “Dear CFO Letters” issued by the Division of Corporate Finance
in March and September of 200834. The purpose of the “Dear CFO
Letters” was to highlight certain additional MD&A disclosures that
registrants should consider in order to enhance the transparency of
the determination and effects of fair value measurements on their
financial statements. While the letters were primarily sent to financial
institutions that reported a significant amount of asset-backed
securities, loans carried at fair value or the lower of cost or market and
derivative assets and liabilities in the financial statements, the SEC staff
noted that the suggested disclosures were applicable to any registrant.
The March 2008 letter emphasized disclosures related to assets and
liabilities that require the use of unobservable inputs to determine
fair value (i.e., Level 3 measurements). The October 2009 letter
reiterated the need for registrants to evaluate whether they
could provide clearer, more transparent disclosures pertaining to
information about the judgments and assumptions underlying their
fair value measurements, the sensitivity of those measurements
to the assumptions made and details about the methodology and
inputs used. In addition, the September 2008 letter identified certain
additional disclosure considerations associated with the fair value
measurement of financial instruments related to classification in the
fair value hierarchy, incorporation of credit risk (particularly as it
pertains to derivatives), the determination of active markets, impact
of liquidity and the use of broker quotes or pricing services.
The comments received by registrants related to fair value
measurements indicate that the SEC staff continues to focus on the
need for enhanced transparency regarding the valuation techniques
and inputs used by registrants to estimate fair value, particularly for
those instruments that are not traded in active markets. A common
request asks for additional clarification on the extent to which, and
how, information provided by third parties (such as independent
brokers and pricing services) was used to assist registrants in
Both “Dear CFO Letters” are available on the SEC website at http://www.sec.gov/
divisions/corpfin/guidance/fairvalueltr0908.htm and http://www.sec.gov/divisions/
corpfin/guidance/fairvalueltr0308.htm, respectively.
34
SEC Comments and Trends October 2009
37
determining fair value. The consideration of own credit risk when
estimating the fair value of over-the-counter derivative instruments
is another area of focus. The SEC staff has also probed into the
valuation methodologies and assumptions used to value specific
financial instruments, such as credit default swaps (CDS) and auction
rate securities (ARS). In addition, inquiries regarding classification
within the fair value hierarchy and the reasons for any movements
between hierarchy levels were noted. Finally, the SEC staff has
challenged certain registrants on the presentation of money market
investments with redemption restrictions as cash equivalents.
The SEC staff’s comments in this area generally focused on the need
for registrants to provide additional information on the extent to
which broker or pricing service quotes were used in estimating fair
value and the processes used by management to evaluate this data.
The SEC staff requested that registrants revise their disclosures to
address items such as:
• The nature and amount of assets valued using broker quotes or
prices obtained from pricing services
• The number of quotes or prices generally obtained per instrument,
and how the registrant ultimately determined fair value in those
instances where multiple quotes or prices were received
Analysis of current issues
Valuation techniques and inputs
The SEC staff questioned registrants on the rationale behind the use
of specific valuation methods and inputs to estimate the fair value
of different asset classes. In certain instances, the staff requested
that registrants separately disclose the dollar amounts of Level 2 and
Level 3 assets that were fair-valued using (i) industry standard pricing
methodologies, (ii) internally developed models and (iii) indicative
prices. While some inquiries were general in nature and seemed to
address consistency across assets classes, others were focused on
specific instruments. For example, a number of registrants received
inquiries pertaining to the valuation methodology and inputs used
to estimate the fair value of their CDS. The questions posed by the
SEC staff pertaining to CDS valuations were technically detailed and
addressed the contractual terms of the instruments, the specific
inputs used in the valuation (e.g., credit spreads, default probabilities,
severity of loss assumptions, correlation factors related to index
prices, etc.) and the determination of the principle exit market
by certain types of registrants. In addition, in situations where
written CDS were recognized as assets, the SEC staff requested an
analysis demonstrating that the instruments satisfied the required
characteristics of an asset as defined in Concepts Statement No. 6,
Elements of Financial Statements.
The SEC staff also requested clarification regarding the criteria
registrants used in determining whether the market for certain
financial instruments was deemed to be active or inactive, how the
lack of liquidity impacted the valuation technique used, and how
illiquidity was incorporated into the fair value measurement.
38
Use of broker quotes and pricing service data
• Whether, and if so, how and why the registrant adjusted quotes or
prices obtained from third parties
• The extent to which quotes or prices provided by third parties
were determined based on market information as opposed to
unobservable inputs and proprietary models
• Whether broker quotes obtained were binding or non-binding
• The procedures performed by management to validate the quotes
or prices obtained and ensure proper classification in the fair
value hierarchy
Consideration of own credit risk
The SEC staff has inquired about the approaches used by registrants
to incorporate the effects of “own credit risk” in the valuation of
liabilities measured at fair value, particularly derivative liabilities. In
addition to requesting that registrants disclose additional information
regarding the methods used to determine the effect of own credit, the
SEC staff has suggested that registrants with significant derivative
balances disclose the amount of change (both during the period and
cumulatively) in the fair value of their derivatives that is attributable
to changes in the registrant’s own credit risk. While this is not a
mandatory disclosure for derivative instruments required to be
measured at fair value under ASC 815 (as it is for those liabilities
where the fair value option has been elected in accordance with
ASC 825), when significant, the SEC staff believes this disclosure is
important in providing transparency into a registrant’s earnings.
SEC Comments and Trends October 2009
Fair value hierarchy classification
Resources
In situations where a registrant’s fair value disclosures identify a shift
in the fair value hierarchy classification (e.g., a change in classification
from Level 2 to Level 3) for a particular class of instruments, the SEC
staff has requested that additional disclosures be provided to explain
the circumstances that resulted in such a transfer. In addition, the
SEC staff has made inquiries regarding perceived inconsistencies in
a registrant’s hierarchy classification of similar instruments, as well
as the rationale for concluding on a particular hierarchy level. For
example, the SEC staff has requested that some registrants provide
additional information on the nature of the observable inputs used to
measure certain asset classes (e.g., ARS, trust preferred securities,
mortgage and asset-backed securities) that support a Level 2
classification in the fair value hierarchy.
EY Publication, Financial Reporting Developments, Fair Value
Measurements – FASB Statement No. 157 (SCORE No. BB1462)
EY Publication, Accounting & Auditing News of 2 April 2008, SEC
issues illustrative letter of fair value disclosures in MD&A
EY Publication, Accounting & Auditing News of 17 October 2009, SEC
issues second illustrative letter of fair value disclosures in MD&A
EY Publication, Hot Topic, FASB issues FSPs 157-4 and 107-1 on fair
value measurements and disclosures (SCORE No. BB1740)
Cash equivalents
In light of the current market conditions, the SEC staff has questioned
registrants on the presentation of investments in certain money
market funds as cash equivalents. Registrants were asked to provide
further information on whether these funds experienced any declines
in fair value resulting from deterioration in the creditworthiness
of their assets and/or general illiquidity conditions and how they
accounted for such declines. In addition, registrants were asked to
explain how these investments continued to be deemed “highly liquid”
and “readily convertible to known amounts of cash” in situations
where the fund had imposed restrictions on redemptions.
To date, many of the SEC staff’s inquiries pertaining to fair value
measurements and disclosures have related to financial instruments.
Although ASC 820 became effective for fiscal years beginning
after 15 November 2007, its application to non-recurring fair value
measurements of nonfinancial assets and liabilities was delayed by
one year. As such, the principles and disclosure requirements of ASC
820 were not applied to nonfinancial items by most calendar-year
registrants until 1 January 2009. Based on the SEC staff’s emphasis
on robust disclosures around valuation techniques and inputs to
promote transparency and comparability of financial statements, it is
likely that the number of inquiries regarding fair value measurements
and disclosures of nonfinancial items is likely to increase. Given the
level of judgment involved in determining the fair value of many
nonfinancial assets and liabilities (for which active markets often
do not exist), registrants should provide robust disclosures that
satisfy the requirements of ASC 820 and enable financial statement
users to understand and assess the methodologies, inputs, and key
assumptions used in developing the fair values reported.
SEC Comments and Trends October 2009
39
SAB Topic 11.M – Disclosures on the Impact of
recently Issued Accounting Pronouncements
Discussion of issues noted
The SEC staff often focuses on SAB Topic 11-M disclosures related to
accounting standards to be adopted when it is expected that those
standards will have a significant effect on the financial statements.
The SEC staff frequently asks registrants to include disclosures in
MD&A and the financial statements regarding the impact that recently
issued accounting standards will have on the financial statements
when adopted.
Analysis of current issues
SAB Topic 11-M requires that if a public company has not yet adopted
a newly issued accounting principle that is expected to materially
affect its financial position or results of operations, the registrant
should disclose that fact and other information known to the
registrant that would help financial statement users understand the
expected effects. Specifically, SAB Topic 11-M requires registrants to
consider disclosing the following:
• A brief description of the new standard, the date that adoption is
required and the date that the registrant plans to adopt, if earlier
• A discussion of the methods of adoption allowed by the standard and
the method expected to be utilized by the registrant, if determined
• A discussion of the impact that adoption of the standard is
expected to have on the financial statements of the registrant,
unless not known or reasonably estimable. In that case, a
statement to that effect may be made
• Disclosure of the potential impact of other significant matters
that the registrant believes might result from the adoption of
the standard (such as technical violations of debt covenant
agreements, planned or intended change in business practices,
etc.) is encouraged
A registrant should consider disclosing this information in both MD&A
and the footnotes to the financial statements. The SEC staff often
issues comments if the above disclosures are not provided.
The SEC staff expects a registrant to disclose more specific details in
filings as the effective date of a new standard approaches.
40
SEC Comments and Trends October 2009
Appendix A
Industry Supplements
The observations discussed in the forepart of this publication
are broadly applicable, across industries. However, the SEC staff
often focuses certain comments to specific industry sectors. This
appendix identifies and discusses SEC comments that are unique or
significantly concentrated in certain industry sectors. This appendix
does not repeat comments addressed in the general section.
SEC Comments and Trends October 2009
41
Oil and gas
Reserves
Classification and disclosures
Discussion of issues noted
• Oil and gas registrants continued to receive comments surrounding
reserves disclosures. Although the SEC Rule: Modernization of
Oil and Gas Reporting Requirements (SEC Rule), will be effective
for annual reports filed after 31 December 2009, several of the
comments received in the past year related to those disclosure
requirements will continue to be applicable under the new rules.
In addition to the areas discussed below, the SEC staff has historically
looked for consistency with:
• Disclosure information included in the financial statements and
that included in Management Discussion and Analysis
• Certain quantified statistics, such as the ability to recalculate, one
thousand cubic feet (of gas) equivalent (MCFE) and barrel of oil
equivalent (BOE)
• Prior filings (that is, the current year versus the prior year)
• (1) Other available information (for example, if information is
publicly available elsewhere (such as a website), the SEC staff asks
that it be disclosed in and be consistent with the document) and (2)
market data (for example, market prices)
The SEC staff has requested registrants with a large percentage
of undeveloped reserves to expand their disclosure to include the
amount and percentage of undeveloped reserves that were converted
to developed reserves in each of the last three years. In some cases,
the SEC staff has requested registrants with significant proved
undeveloped reserves (PUDs) to provide future production information
and conversion tables in their filings until the PUDs are not material.
The SEC staff has questioned, and will likely continue to question,
registrants that have a development plan in excess of five years and
whether they have a basis for having reasonable certainty in assuming
that reserves will not be depleted by existing well bores prior to
additional wells being drilled. The SEC staff not only looks to see that a
plan is in place, but also that the registrant will be able to execute the
plan. The SEC staff will be looking for specific documentation regarding
any proved undeveloped reserves that do not meet or have exceeded
the five-year development criterion. Registrants should challenge
whether it is reasonably certain that projects will be completed and the
classification as proved undeveloped reserves remains appropriate.
Disclosures should include a detailed discussion of the projects,
including an explanation of why the reserves remain undeveloped, the
estimated time to production and why the reserves remain proved.
Capitalization of costs of unproved properties
Current analysis
The SEC staff will likely expect improved disclosure throughout
financial statements as a result of replacing the previous “rules-based
approach” with the more principles-based approach in the SEC Rule.
Proved undeveloped reserves
• Reserves classification as “proved undeveloped” and “proved
developed non-producing” continue to be a focus of the SEC
staff. For example, the SEC staff challenges proved classification
in areas where permits, agreements or additional investment are
required and have not yet been obtained, renewed or approved, as
well as reserves in locations with political instability (for example,
Venezuela and Bolivia). In the past, the SEC staff has requested
registrants to supplementally provide specific information to the
SEC staff on certain proved undeveloped locations for purposes of
their evaluation of the appropriate classification of reserves.
The SEC staff has commented on the adequacy of disclosures
surrounding capitalized costs of unproved properties, specifically for
registrants applying the full cost method of accounting. Rule 4-10(c)(7)
(ii) of Regulation S-X requires registrants following the full cost method
to state separately on the face of the balance sheet the aggregate of
the capitalized costs of unproved properties and major development
projects that are excluded from the capitalized costs being amortized.
It also requires additional disclosures in the notes to the financial
statements that include the current status of properties and projects
for which costs are excluded from amortization, the anticipated timing
of the inclusion of such costs in the amortization computation and a
table indicating the nature of costs by category and identifying the
periods in which the costs were incurred. Registrants should also
disclose the frequency of their impairment assessment of properties
and projects for which costs are excluded from amortization (taking
into account the annual assessment requirement under Rule 4-10(c)
(3)(ii)(A) of Regulation S-X). If significant, capitalized costs of unproved
properties must be separately disclosed (ASC 932-235-50-14).35
FASB ASC Topic 932, Extractive Activities – Oil and Gas
35
42
SEC Comments and Trends October 2009
Changes to proved reserves
• Changes in the net quantities of an enterprise’s proved reserves
of oil and of gas during the year should be disclosed
(ASC 932-235-50-5)
The SEC staff has requested additional discussion around the
nature of changes to proved reserves that are presented in the
year-over-year reserves table. SEC staff comments have requested
that registrants include in their filings a discussion of the amount
of reserves added in each field or major basin, the number of
wells drilled that are associated with those reserve additions and
explanations for significant reserve changes such as revisions,
extensions and discoveries. The SEC staff also has indicated that
reserves additions that are a result of “infill” drilling should be
included in revisions rather than extensions and discoveries. In
addition, when the term “other” is used to describe a change in the
proved reserves, the SEC staff expects additional information about
what “other” represents.
The SEC staff has questioned whether the inputs to the reserves
replacement ratio and finding costs metrics come directly from
the GAAP financial statements and disclosures and whether future
development costs for proved undeveloped reserves are included
in the finding cost calculation. Registrants should, prior to finalizing
their next filing, revisit their current disclosures and, where
appropriate, expand the discussion on significant inputs used in
calculating the metrics, how the metrics are used and the limitations
of the metrics that have been made. In addition, registrants should
consider reconciling the calculations to the closest GAAP measure
(ASC 932-235-50).
Definition of proved reserves
The SEC staff has requested that registrants include the definition
of proved reserves in filings. The definition should be consistent
with the definition in Rule 4-10(a) of Regulation S-X. In cases where
the definitions are abbreviated, registrants should reference and
state that the only definition of proved oil and gas reserves for SEC
registrants is in Rule 4-10(a) of Regulation S-X.
Non-GAAP measures
The SEC staff challenges metrics presented in filings that are not
defined in GAAP. For example, the SEC staff has requested that
the presentation of future net cash flows from proved reserves,
discounted at an annual rate of 10% before income taxes (PV-10),
generally presented in Item 1. Business of the Form 10-K, be
reconciled to the discounted future net cash flows calculated
in accordance with ASC 932-235-50-35 and included in the
Supplemental Oil and Gas Disclosures. In addition, as it is not defined
in GAAP, the SEC staff has requested that future net cash flows
before income taxes be removed from filings when it is included as
part of the Supplemental Oil and Gas Disclosures.
SEC Comments and Trends October 2009
43
Improved recovery costs
Proportionate consolidation
Classification and disclosures
Accounting
Discussion of issues noted
Discussion of issues noted
Many registrants are utilizing improved recovery techniques to
recover the remaining, or residual, oil that cannot be produced by
natural reservoir pressure or by conventional recovery methods
such as pumping. This remaining oil can be recovered only by using
recovery methods that restore pressure and fluid through the
introduction of water, gas, chemicals or heat into the reservoir. The
SEC staff has challenged the accounting for the cost of improved
recovery injectants, such as carbon dioxide.
The SEC staff has questioned registrants that use proportionate
consolidation when their interests in the unincorporated legal entities
exceed 50% (that is, where they would not otherwise qualify for equity
method accounting).
Analysis of current issues
Accounting principles require an asset to be recorded when future
economic benefits are obtained from past transactions. There is no
direct guidance in GAAP to determine whether expenditures related
to the use of improved recovery techniques provide future economic
benefit. Accordingly, practice in this area is mixed.
The SEC staff has recognized that there is diversity in practice for this
issue. However, the SEC staff has generally accepted capitalization
of expenditures that enhance future value with any remaining costs
recorded as expense. In some cases, management may determine
that the costs of the injectants are not recoverable and thus expense
all costs. In other cases, the injectants serve as a benefit over the
life of the entire project, and therefore, the costs are capitalized
and amortized based on the accounting policy of the registrant. The
classification of improved recovery costs as exploration, development
or production also should follow the accounting policy of the registrant.
Analysis of current issues
ASC 810-10-45-14 applies only to investments in unincorporated
legal entities in the extractive or construction industry that otherwise
would be accounted for under the equity method (which are not
controlled investees). Because equity method accounting is a
condition for the use of proportionate consolidation of unincorporated
legal entities under ASC 810-10-45-14 and other GAAP does not
permit the use of the proportionate consolidation method when an
entity is controlled (and thus required to be consolidated), the SEC
staff (based on their comments) does not believe ASC 810-10-45-14
should be used as a basis for the proportionate consolidation of a
controlled entity.
The SEC staff has requested that registrants expand their disclosures
to indicate that diversity exists in the oil and gas industry regarding
the accounting for the cost of injected materials and related activities.
Registrants also should consider disclosing that others in the industry,
including those that follow the same method of accounting for oil and
gas activities (i.e., full cost or successful efforts) as the registrant,
may account for these costs differently. In addition, a registrant’s
accounting policy disclosure should explain in detail why the costs are
classified, for example, as production costs rather than development
or exploration costs.
44
SEC Comments and Trends October 2009
Regulatory assets
Evidence to support cost recovery
Discussion of issues noted
The SEC staff has continued to challenge the basis for recording
regulatory assets under ASC 980.36
Analysis of current issues
The best evidence of a regulatory asset is a rate order. However, the
scheduling and length of the regulatory process sometimes does not
allow a registrant to obtain a rate order on a timely basis. The SEC
staff has informally suggested evidence that could support future
recovery and management’s representation to include:
• Rate orders from the regulator specifically authorizing recovery of
the costs in rates
• Previous rate orders from the regulator allowing recovery for
substantially similar costs
• Written approval from the regulator approving future recovery in
rates
• Analysis of recoverability from internal or external legal counsel
• A combination of the other types of evidence listed above to support
cost-recovery
Evidence that a regulatory asset is probable of recovery is a matter
of professional judgment based on the facts and circumstances of
each case.
FASB ASC Topic 980, Regulated Activities
36
SEC Comments and Trends October 2009
45
Real estate
Redeemable financial
instruments
Classification and measurement
Discussion of issues noted
The SEC staff has focused renewed attention on the application of
EITF Topic D-98 due to changes in the underlying accounting for noncontrolling interests issued by consolidated subsidiaries under ASC
810. In fact, several registrants, structured as real estate investment
trusts (REITs), have received comments from the SEC staff challenging
the registrants’ classification and measurement of redeemable
financial instruments. The SEC staff has specifically requested
explanations of registrants’ evaluation of redeemable financial
instruments and the considerations given to reflecting redeemable
financial instruments at their redemption amount outside of
permanent equity pursuant to EITF Topic D-98. Additionally, the SEC
staff has requested expanded disclosures regarding an instrument’s
redemption provisions and whether it is redeemable at the option of
the holder or solely within the control of the issuer.
Analysis of current issue
REIT structures typically have a consolidated operating partnership
(OP) which has issued ownership units to noncontrolling parties as
well as the parent, typically a public REIT that also serves as the
general partner. The ownership units are typically redeemable into
cash or REIT common stock at the option of either the REIT or the
OP (but generally not at the option of the non-controlling interest
holder). ASC 810 requires that noncontrolling interests be presented
as a component of shareholders’ equity in the consolidated financial
statements separately from the parent’s equity. However, because of
the redemption features of the ownership units, the SEC’s guidance
in EITF Topic D-98 must be considered to determine whether
the instruments should be classified as a separate component of
permanent equity or in the mezzanine (also referred to as temporary
equity in EITF Topic D-98) section of the balance sheet. The SEC
staff has requested additional disclosures to clarify the terms of
the redemption feature and challenged registrants’ conclusion that
classification of the non-controlling interest in equity is appropriate.
The SEC staff has also challenged REITs measurement of redeemable
noncontrolling interests when the amounts are classified at their
carrying value in the mezzanine section of the balance sheet and
the instruments carrying value is less than its market value. If
the OP units held by third parties are deemed to be redeemable
noncontrolling interests under EITF Topic D-98, the REIT will need to
determine how such an interest is to be measured at each reporting
date in the consolidated financial statements. Paragraph 16 of
EITF Topic D-98 provides two models for subsequent measurement:
an accretion model and a current redemption model. For OP units
that are redeemable at any time, the current redemption model is
the most appropriate. The application of that model requires the
noncontrolling interest to follow normal noncontrolling interest
accounting and then be marked to the redemption value at the
reporting date if higher (but never adjusted below that normal
noncontrolling interest accounting amount). The offset to the
adjustment to the carrying amount of the OP units is reflected in
retained earnings. The measurement of the redemption value should
be relatively simple for most REITs given the OP unit can be converted
or exchanged for a parent REIT share or redeemed for cash equal to
the then-fair value of a parent REIT share. Therefore, the redemption
value of the OP unit would be equal to the fair value of a REIT share.
When the redeemable instrument is not redeemable for a fair value
equivalent, as may be the case in some Down REIT structures,
registrants will need to consider the measurement provisions in
EITF Topic D-98 each reporting period.
Resources
EY Publication, Financial Reporting Developments, FASB Statement
No. 160, Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51 (SCORE No. BB1577)
A key determinant for whether EITF Topic D-98 requires mezzanine
presentation is whether the REIT has both the contractual and the
actual ability to settle the redemption in cash or common stock. If cash
can be required by the non-controlling interest holder, or the REIT
cannot be assured it will always be able to deliver shares as allowed
under the contract, then the redeemable OP units will be classified
in the mezzanine section. All of the criteria in paragraphs ASC 81540-25-7 through 25-35 and ASC 815-40-55-2 through 55-6 are
considered in making this assessment.
46
SEC Comments and Trends October 2009
Life sciences
Revenue recognition
Disclosures related to revenue deductions
Discussion of issue noted
Revenue is often a key financial performance metric used by investors.
In life sciences in particular, the SEC staff has continued to request
that registrants provide enhanced disclosure of items that reduce
gross revenue (e.g., estimates of product returns, rebates, distributor
chargebacks and distributor incentives) in their critical accounting
policies and estimates section of MD&A.
Analysis of current issue
Registrants offering rights of return or providing rebates, chargebacks
or incentives must determine whether they may recognize revenue
upon delivery of products to customers. The use of one or more
of these types of programs is common for registrants in the life
sciences industry. Among the criteria that must be met to recognize
revenue on delivery, registrants must be able to reasonably estimate
the amount of future product returns and the usage of rebates,
chargebacks and incentives by customers.
Given that the judgments and assumptions involved in the estimation
of product returns and other revenue deductions may have a material
effect on a registrant’s reported financial condition and operating
performance and on the comparability of such reported information
over different reporting periods, the SEC staff has continued to
request registrants to provide more robust disclosure around revenue
deductions in their critical accounting estimates disclosures in MD&A
(see “MD&A” section for further discussion of critical accounting
policies and estimates disclosures), including the following:
• Expanded disclosure as to the nature and amount of each revenue
deduction as of each balance sheet date along with information
as to the key terms of material arrangements/agreements that
influence the estimation of each deduction
• Roll-forward information for each revenue deduction as of and for
the financial statement periods presented including:
• Additional disclosure of the qualitative factors that management
considers in estimating each revenue deduction. For example,
the SEC staff has asked registrants to address how management
considers factors such as levels of inventory in distribution
channels, estimated remaining product shelf lives, price changes
from competitors, shipments of product made as a result of
incentives or in excess of the customers’ ordinary course of business
inventory and introductions of new products. The SEC staff also has
requested that registrants discuss the extent, availability and use of
information from external sources, such as prescription data from
third parties or distributor inventory reports
• Disclosure of quantitative information related to those qualitative
factors considered in estimating each revenue deduction. For
example, the SEC staff has asked registrants to enhance their
disclosure by including a discussion detailed by: product and, in
tabular format, the total amount of product in sales dollars that
could potentially be returned as of the most recent balance sheet
date, disaggregated by expiration period, if any
• Disclosure of the effects that could result from using other
reasonably likely assumptions in estimating each revenue
deduction. For example, the SEC staff has requested registrants to
disclose a range of reasonably likely estimates or another type of
sensitivity analysis
• Disclosure of the underlying business reasons for material periodto-period fluctuations in a registrant’s revenue deductions
Resources
EY Publication, Technical Line, Accounting for product returns in the
life sciences industry (SCORE No. BB1596)
EY Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
• The beginning and ending balances
• The current provision related to sales made in the current
period and sales made in prior periods (presented separately)
• The actual returns or credits in the current period related to
sales made in the current period and sales made in the prior
periods (presented separately)
SEC Comments and Trends October 2009
47
Multiple-element arrangements
Discussion of issue noted
The SEC staff continues to ask registrants to expand their disclosure
of revenue recognition policies for all revenue streams, and in
particular, how registrants determined the units of accounting in
multiple-element arrangements and whether objective and reliable
evidence of fair value existed for the specific deliverables in such
arrangements.
Analysis of current issue
Registrants in the life sciences industry often enter into arrangements
with counterparties that include multiple elements, such as the
license of intellectual property, research and development (R&D)
services, manufacturing services and commercialization activities.
Consideration received under these arrangements can be significant
and is often the primary source of revenue for registrants in the life
sciences industry without commercial products of their own. Because
of the uniqueness of the products and services delivered under these
arrangements, the significance of the consideration transferred and
the level of judgment involved in determining the units of accounting
and allocation of arrangement consideration, disclosures provided
by life sciences registrants should provide sufficient information
to understand the relevant factors considered by management in
accounting for significant arrangements.
Vendors with multiple-element arrangements must disclose (1) the
accounting policy for the recognition of revenue from multipleelement arrangements (i.e., whether deliverables included in such
arrangements are separable into differing units of accounting) and
(2) a description of the types of multiple-element arrangements used,
including discussion of performance, cancellation, termination or
refund provisions (ASC 605-25-50-1). These disclosures would be in
addition to those required for general policies on revenue recognition.
The SEC staff also has issued various publications that include
disclosures that may be particularly important for registrants that
have entered into multiple-element arrangements. For example, the
30 November 2006 SEC staff publication, Outline of SEC Current
Accounting and Disclosure Issues in the Division of Corporation
Finance, sets forth the SEC staff’s belief that each registrant should
disclose, in its critical accounting policies and estimates section
of MD&A, a description of its major revenue generating products
and services and the arrangements (including multiple-element
48
arrangements) used to deliver those products and services to its
customers. It also includes other disclosures that may be applicable to
multiple-element arrangements, including:
• Whether multiple contracts with a single counterparty are combined
and accounted for as one arrangement or as separate arrangements
• Whether deliverables included in a multiple-element arrangement
can be accounted for as separate units of accounting and how such
determination is made
• When multiple deliverables can be separated into different
units of accounting, whether the arrangement consideration is
allocated among the units of accounting using the relative fair
value or residual method. Additionally, registrants should consider
disclosing how fair value has been determined for purposes of
allocating arrangement consideration (that is, based on vendorspecific objective evidence or third-party evidence)
• When revenue is recognized for deliverables included in a multipleelement arrangement. For deliverables included in multipleelement arrangements that cannot be separated into different
units of accounting, registrants should consider disclosing the
revenue recognition policy selected for the combined unit of
accounting, and the reasons therefore. For deliverables included
in multiple-element arrangements that can be separated into
different units of accounting, disclosure that revenue is recognized
when the separate elements are delivered and the other
general revenue recognition criteria have been satisfied may be
appropriate
In addition, registrants should evaluate whether the assumptions used
to separate deliverables and allocate multiple element arrangement
consideration should be considered significant judgments that require
disclosure as part of the critical accounting policy disclosures included
in MD&A.
Resources
EY Publication, Emerging Issues Task Force Issue No. 00-21,
Implementation Matters for Life Sciences Companies
(SCORE No. P00072)
EY Publication, Financial Reporting Developments Booklet, Revenue
Arrangements with Multiple Deliverables — EITF Issue No. 00-21
(SCORE No. BB1185)
SEC Comments and Trends October 2009
Collaborations
Disclosures related to collaboration arrangements
Discussion of issue noted
The SEC staff has requested registrants to expand the existing
disclosures related to collaboration arrangements referenced within SEC
filings but not filed with SEC. These requests have focused on including a
discussion on the overall nature of the arrangement, the amounts of any
payments the registrant may receive or be required to make under the
arrangement (e.g., milestone or royalty payments) and factors impacting
amounts received or paid. Further, when considered significant, the SEC
staff has requested registrants to file such agreements as an exhibit
to the SEC filing or, alternatively, provide an analysis supporting the
determination that the agreement is not required to be filed as an exhibit.
pursuant to the SEC’s final rule to implement Section 401(a) of the
Sarbanes-Oxley Act of 2002. The SEC staff has indicated that potential
payments should be included within the contractual obligations table
to the extent the payments are reasonably possible of occurring. In
circumstances where registrants determine that potential payments
are not reasonably possible of occurring, the SEC staff has requested
disclosure of the reason(s) for excluding such payments from the table.
Analysis of current issue
Furthermore, if registrants have omitted disclosure of certain aspects
of collaboration arrangements (e.g., specific royalty rates or the
possibility that milestones might be achieved) for confidentiality
purposes, the SEC staff has generally pressed for such disclosures
as they believe the needs of financial statement users outweigh
concerns related to confidentiality.
Disclosures
Exhibits
Financial statement disclosures for each individually significant
collaboration arrangement should include information about the
nature and purpose of the collaboration arrangement, a description
of the deliverables under the arrangement, the accounting policy for
recognizing revenue for payments received under the arrangement
and a discussion of the material terms of the arrangement (for
example, rights and obligations, performance, cancellation,
termination or refund provisions). Registrants also should clearly
describe any payment obligations under collaboration arrangements
and their accounting policy with respect to those items, as well as
the income statement presentation and amounts attributable to
collaboration arrangements for each applicable period.
Item 601 of Regulation S-K contains instructions for the preparation
of exhibits and identifies the exhibits to be included in each SEC filing.
Generally, contracts entered into in the ordinary course of business are
not required to be filed as an exhibit. However, Item 601(b)(10)(ii)(B)
requires that certain contracts entered into in the ordinary course of
business be filed as an exhibit if the registrant’s business is substantially
dependent on the contract (e.g., sales contracts with significant
customers, contracts with suppliers for significant components to a
registrant’s products or services or other agreements to use, license or
franchise a patent, formula, trade secret, process or trade name upon
which a registrant’s business depends to a material extent).
In its comments to registrants, the SEC staff has identified the following
specific items for disclosure related to collaboration arrangements:
• The identity of the other party in the arrangement
• For R&D collaborations, the products being developed
• Any amounts paid or received to date under the arrangement
(including upfront licensing fees and milestone payments)
• Aggregate potential milestone payments to be made or received under
the arrangement and the triggering events underlying the milestones
• The existence of royalty provisions, any sales thresholds related to
royalty rates and the actual royalty rates or range of royalty rates
(if tiered)
• Annual maintenance fees
• Duration and termination provisions, including payments the
registrant may be required to make in the event of termination
Registrants with payment obligations under collaboration arrangements
should also consider whether those obligations should be included
within the contractual obligations table required to be included in MD&A
When a registrant provides disclosures in other parts of an SEC filing
indicating the significance of a collaboration arrangement but has
not filed the arrangement as an exhibit, the SEC staff has specifically
challenged the registrant to explain why they are not “substantially
dependent” on the arrangement (as provided in criterion (B) above).
This determination is generally qualitative in nature and registrants
should consider all relevant facts and circumstances including:
• Whether the company’s future success depends on a successful
development outcome for those items covered by the arrangement
• The existence of other counterparties that would be able to fulfill
the obligations required under the arrangement
• The existence of collaborative arrangements related to the
company’s other development projects
• The significance of the R&D arrangement to the overall
development project
Resources
EY Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
SEC Comments and Trends October 2009
49
Research and development assets
acquired in business combinations
Disclosures related to acquired in-process research
and development (IPR&D) assets
Discussion of issue noted
The SEC staff concerns appear to be focused on identification and
valuation of the specific IPR&D projects. When the staff is unable to
clearly comprehend the existing disclosures regarding IPR&D assets
acquired in business combinations accounted for pursuant to ASC
805, it issues comments to registrants in the life sciences industry
requesting additional information and disclosures.
The TPA includes the following suggested financial statement and
MD&A disclosures:
• Specific nature and fair value of each significant IPR&D project
acquired
• Completeness, complexity and uniqueness of the projects at the
acquisition date
• Nature, timing and estimated costs of the efforts necessary to
complete the projects and the anticipated completion dates
Analysis of current issue
Intangible assets acquired in business combinations that are used in
research and development activities (that is, acquired IPR&D assets)
are initially recognized as assets at fair value, irrespective of whether
the acquired assets have an alternative future use. These assets are
classified as indefinite-lived assets until completion or abandonment.
Previously, under pre-codification standards Statement 14137 and
FIN 438, IPR&D assets without an alternate future use were written off
upon acquisition.
The SEC staff has recently issued comment letters requesting
registrants in the life sciences industry that have completed business
combinations subject to ASC 805 to provide additional disclosures
about acquired IPR&D assets. Specifically, the SEC staff has
requested registrants to continue providing the disclosures included
in the AICPA’s Technical Practice Aid, Assets Acquired in a Business
Combination to Be Used in Research and Development Activities: A
Focus on Software, Electronic Devices and Pharmaceutical Industries
(the “TPA”). The TPA39 identifies best practices related to defining,
valuing, accounting for, disclosing and auditing IPR&D assets acquired
in business combinations. Although the TPA is not authoritative
GAAP, there is little other guidance regarding the measurement of
and disclosure for IPR&D assets.
• Risks and uncertainties associated with completing development
on schedule and consequences if it is not completed timely
• Appraisal method used to value projects
• Significant appraisal assumptions, such as:
• Period in which material net cash inflows from significant
projects are expected to commence
• Material anticipated changes from historical pricing, margins
and expense levels
• The risk adjusted discount rate applied to the project’s cash flows
• In periods subsequent to the acquisition, the status of efforts to
complete the projects and the impact of any delays on the expected
investment return, results of operations and financial condition
Resources
EY Publication, Financial Reporting Developments Booklet, FASB
Statement No. 141(R), Business Combinations (SCORE No. BB1616)
FASB Statement No. 141, Business Combinations
FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business
Combinations Accounted for by the Purchase Method – an interpretation of of FASB
Statement No. 2
39
ASC 805 and ASC 820, supersede certain of the recognition and measurement
guidance included in the TPA. At the time of publication of this document, the TPA has
not been updated for the guidance. As such, until the TPA is updated, the guidance
included therein that conflicts with ASC 805 and ASC 820 should not be considered in
the accounting for acquired IPR&D assets.
37
38
50
SEC Comments and Trends October 2009
Other reporting issues
Research and development expenses
Discussion of issue noted
SEC staff comment letters have also asked registrants in the life
sciences industry to provide more detailed disclosures in MD&A
regarding their R&D activities. Specifically, the SEC staff has focused
on the status of major R&D projects and the related costs incurred to
date as well as the estimated completion dates, completion costs and
capital requirements.
Analysis of current issue
Most registrants in the life sciences industry incur significant expense
for R&D activities, with R&D often being the single largest expense on
the income statement. Accordingly, the SEC staff has focused on the
MD&A disclosures surrounding R&D expenses for registrants in the
life sciences industry. FRR 501.0140 states, “The MD&A requirements
are intended to provide, in one section of a filing, material historical
and prospective textual disclosure enabling investors and other users
to assess the financial condition and results of operations of the
registrant, with particular emphasis on the registrant’s prospects
for the future.” In light of this release and the significance of R&D
expense to registrants in the life sciences industry, the SEC staff has
issued comment letters asking registrants to provide more specific
MD&A disclosures, such as:
The SEC staff has further commented that if registrants do not
track R&D costs by project, that fact should be disclosed along
with an explanation as to why that is the case. In these situations,
the SEC staff also has requested other quantitative or qualitative
disclosures that describe the amount of the registrant’s resources
being used on each project. Similarly, the SEC staff has commented
that if registrants cannot estimate the completion dates or costs to
complete the projects, registrants should disclose the circumstances
or uncertainties precluding the estimates.
As part of these comments, the SEC staff has referred registrants
to the Division of Corporation Finance’s 2001 “Current Issues and
Rulemaking Projects Quarterly Update” (section VIII – Industry
Specific Issues – Accounting and Disclosure by Companies Engaged
in Research and Development Activities), which provides suggested
disclosures about R&D activities.
• The current status of each project
• The costs incurred during each period presented and to date on
each project
• The nature, timing and estimated costs of the efforts necessary to
complete each project
• The anticipated completion dates of each project
• The risks and uncertainties associated with completing
development on schedule, and the consequences to operations,
financial position and liquidity if each project is not completed
timely
• The period in which material net cash inflows from significant
projects are expected to commence for each project
Financial Reporting Release No. 501.01, Information Outside of Financial Statements,
Evaluation of Disclosures – Interpretive Guidance
40
SEC Comments and Trends October 2009
51
Retail
Management’s discussion and
analysis
Disclosure of comparable store sales
Critical accounting policies and estimates
Discussion of issue noted
Discussion of issue noted
The SEC staff has recently requested retailers to clarify their
definition of “comparable store sales,” an important performance
metric, when that measure is disclosed within MD&A.
The SEC staff has recently issued comments to registrants regarding
critical accounting policy disclosures for key financial statement
items common in the retail and wholesale industry, such as inventory,
allowances for sales returns and self insurance reserves.
Analysis of current issue
Comparable store sales is an indicator commonly used by retailers
and retail investors to assess the performance of a mature store from
year to year and is often disclosed within MD&A. The SEC staff has
recently asked registrants to provide further disclosure regarding
the definition of comparable store sales, such as the point at which
a store becomes comparable and whether internet and catalog sales
are included.
Resources
EY Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
Analysis of current issue
Given the recent economic conditions and the guidance in FR-72, the
SEC staff has focused on critical accounting estimates related to financial
statement items that are common in the retail industry. Recent comments
issued by the SEC staff have requested registrants to provide more robust
disclosures within their critical accounting policies about such items as the
underlying assumptions used in the estimates, how the estimates were
determined, how accurate the estimates have been in the past and how
likely the estimates are to change in the future. Additionally, the SEC staff
has requested registrants to include a qualitative and quantitative analysis
of the sensitivity of the reported results to changes in assumptions,
judgments and estimates, including the likelihood of obtaining materially
different results if different assumptions were applied.
Specifically with regard to inventory, the SEC staff also has requested
retailers to disclose further information about the cost complement
percentages, markups and markup cancellations, markdowns and
markdown cancellations, promotional price changes and valuation
adjustments that are used in the application of the retail inventory
method. In addition, registrants have been requested to expand the
disclosure of the estimates made in the valuation of inventories,
particularly as it relates to permanent markdowns and shrinkage.
Retailers also have been asked to provide further disclosure regarding
accounting policies for product returns and the basis for their
conclusions that product returns can be reasonably estimated.
In addition to inventory and allowances for sales, registrants with
significant self insurance reserves also have been requested to disclose
their policy for incurred-but-not-reported claims and the limits of stop-loss
insurance coverage, if any, as well as the reasons for significant changes
in the reserve balance as compared to the prior year. Additionally,
registrants have been requested to include a roll-forward of the reserve
balances including the beginning and ending balances and the additions,
deductions and adjustments recorded during the year, to the extent that
the registrants did not include this information in Schedule II (Valuation
and Qualifying Accounts) pursuant to Rule 5-04 of Regulation S-X.
For further information, including a detailed analysis of the SEC staff
comments related to the critical accounting policies, please refer to
the “MD&A” discussion in the general section.
Resources
EY Publication, 2008 SEC annual reports — Report to shareholders
Form 10-K (SCORE No. CC0267)
52
SEC Comments and Trends October 2009
Consideration given by
(or received from) a vendor
Disclosures of vendor/supplier allowances
Discussion of issue noted
Due to the importance of the revenue metric, the SEC staff continues
to issue comments regarding the recognition and disclosure of
consideration given by or received from a vendor.
Analysis of current issue
Registrants in the retail and wholesale industry commonly offer
rebates and allowances to customers as well as receive such incentives
from their suppliers. Cash consideration given to a customer should
be recognized as a reduction of revenue in the vendor’s income
statement, unless the benefit received by the vendor is separately
identifiable and fair value of that benefit can be determined.
Conversely, a customer should recognize cash consideration received
from a vendor as a reduction in the price of products or services. It
must also be shown as a reduction of the cost of sales, unless the
benefit received by the vendor is separately identifiable and fair value
of that benefit is determinable (ASC 605-50).
The SEC staff has frequently requested that registrants disclose in
the financial statements how they account for rebates and allowances
offered to customers. The requested disclosures include: the
applicable accounting literature followed, the amounts recognized
in the income statement and whether those amounts have been
recognized as a reduction of revenue or as an expense.
Additionally, the SEC staff has requested that registrants that receive
rebates and allowances (vendor allowances) in connection with the
purchase of products from others, including amounts related to
the promotion of such products, make similar disclosures for such
receipts. The SEC staff has indicated that registrants receiving vendor
allowances should disclose:
• The amount of vendor allowances received
• The amount of advertising reimbursements netted against gross
advertising expenses
• The amount of vendor allowances accounted for as a reduction of
cost of sales
• The number of vendors from which vendor allowances are received
and the length of time of the related agreements
• The terms and conditions of significant agreements with vendors
The SEC staff also has requested that registrants discuss the effect
that vendor allowances have on their results of operations in MD&A.
SEC Comments and Trends October 2009
53
Gift cards
Accounting for and disclosure of breakage
Discussion of issue noted
The SEC staff continues to request that registrants, primarily in the
retail industry, expand their disclosures related to the recognition
of gift card revenue in the financial statements. The requested
disclosures include the amount of revenue related to gift cards
and the manner in which registrants recognize revenue related to
the portion of the gift card that ultimately will not be used by the
customer for the purchase of goods or services (commonly referred
to as “breakage”). The SEC staff also is interested in expanding the
disclosure addressing the amount of the breakage recognized to the
extent it is material to the registrant.
Analysis of current issue
Many retailers sell gift cards that entitle the holder of the card to
redeem it for goods and/or services during a redemption period, which
may be specified or unspecified in duration. However, customers often
do not redeem gift cards, resulting in breakage. When a retailer is not
statutorily required to escheat the unused amounts to a state or other
taxing authority, a question often arises as to how to account for the
breakage that is expected to and/or does occur.
Currently, there is no authoritative literature with respect to the
accounting for gift card breakage. A liability should be derecognized
only if it has been extinguished through payment of the obligation or
by legal release from the liability (ASC 860). Technically, this could
result in the indefinite deferral of unused gift card balances that
do not otherwise have to be escheated to a state or other taxing
authority. However, the SEC staff has stated it would not object to
derecognizing the liability by analogy to ASC 450, to the extent there
is a remote possibility that the registrant will have to perform under
the terms of the gift card. In these situations, breakage could be
recorded to the extent the registrant has specific historical evidence
that can be used to calculate reasonable and reliable estimates.
Methods of breakage estimation and recognition
The lack of authoritative guidance has led to diversity in practice with
respect to accounting for breakage. Most retailers generally use one
of the following methods to account for gift card breakage:
(1) Breakage is not estimated and recognized and therefore carried
on the balance sheet as deferred revenue indefinitely
(2) Retailers charge a service fee, subject to applicable laws, that
serves to amortize the unused balance of the gift card over time.
Such fees are recognized as charged
54
(3) Breakage is estimated and recognized in income as part of the
normal accounting process taking into account company-specific
historical evidence of redemption rates. Breakage is estimated
and recognized either as gift cards are used for the purchase
of goods or services (the “redemption recognition” method) or
when it is apparent, based upon an aging of gift card balances,
that the likelihood of redemption of the outstanding gift card
balances is remote (the “delayed recognition” method)
Of the methods described above, method (1) — not estimating
and recognizing breakage and method (2) — charging a service fee
that serves to amortize the unused amount of gift cards over time
are analogous to the guidance provided in ASC 860. Both of these
methods result in amounts remaining in deferred revenue until the
registrant’s legal performance obligation has been extinguished.
To the extent breakage is estimated and recognized in income as a
normal part of the accounting process, the use of the redemption
recognition method is generally preferable; however, the delayed
recognition method may also be appropriate in certain situations.
If a retailer wishes to estimate and recognize breakage, the
assumptions used to estimate amounts that ultimately will not be
used by customers must be reasonable, reliable and objectively
determinable. Whether such assumptions can be developed will
be dependent upon a retailer’s specific facts and circumstances;
however, consideration must be given to:
• T
 he existence of sufficient company-specific information on which
to base the assumptions
• W
 hether breakage assumptions are based on a large population of
homogenous transactions
• W
 hether the retailer’s historical experience with gift card
redemption rates is predictive of future redemption rates
• T
 he ability to make a reliable estimate of breakage on a timely
basis
• T
 he specific terms of the gift cards (e.g., are the unused balances
refundable, do the cards have expiration dates, does the registrant
have the right to charge maintenance fees on unused balances)
Registrants should routinely refine and evaluate estimates of gift card
redemption rates, particularly when changes in policies related to gift
card redemption occur. The SEC staff would also expect registrants
to verify past breakage rates with current actual redemption rates.
Recurring, significant differences between the actual breakage rates
SEC Comments and Trends October 2009
Customer loyalty programs
Disclosures
and estimated rates could be an indication of the registrant’s inability
to objectively and reliably estimate breakage, therefore calling into
question the appropriateness of recognizing breakage in income.
Based on public comments41 by the SEC staff, they believe it is not
appropriate to estimate and recognize breakage at the point of gift
card issuance.
Income statement presentation
Breakage, once recognized, should generally be classified as revenue
or other income depending on the recognition method employed by
the registrant. Service fees that serve to amortize the outstanding
balances on unused gift cards into income over time should be
classified in other income when recognized. The classification
of breakage as revenue is generally more appropriate when the
recognition method is tied to the delivery of goods or services (i.e., if
retailers estimate breakage as part of the normal accounting process
using the redemption recognition or delayed recognition methods).
Regardless of the method used, it is not appropriate to recognize
breakage as a reduction of cost of sales, SG&A expense or any other
expense line item.
Discussion of issue noted
The SEC staff continues to comment on the disclosures surrounding
registrants’ customer loyalty programs, as there continues to be
a lack of specific authoritative guidance on accounting for such
programs.
Analysis of current issue
Many retailers sponsor membership-based loyalty programs to
build brand loyalty, increase sales volumes and retain their most
valuable customers. These programs typically allow customers to
accumulate award credits that may be redeemed, once certain levels
are achieved, for free or discounted products or services. The SEC
staff has frequently requested that registrants disclose how they
account for the benefits and discounts offered to customers through
sponsored point and loyalty programs.
Disclosures
The SEC staff expects that registrants that estimate and recognize
breakage should disclose in the financial statements the method used
to estimate and recognize breakage, the key assumptions used in
establishing the estimate, the sensitivity of the estimates to changes
in the underlying assumptions, the income statement classification
(revenue or other income) of amounts recognized and the balance
sheet classification of deferred revenue related to the gift card liability.
If the amount of breakage recognized is significant to the results
of operations, registrants should consider disclosing the amount of
breakage reported and also consider whether the estimates used
to determine breakage should be discussed as a critical accounting
policy in MD&A.
Speech by SEC Staff: Remarks Before the 2005 AICPA National Conference on Current SEC and PCAOB Developments.
41
SEC Comments and Trends October 2009
55
Deferred rent
Construction period
Discussion of issue noted
The SEC staff has recently requested that registrants in the retail
industry explain and provide additional disclosure, if necessary,
regarding how the construction period prior to commencing store
operations is considered when determining the lease term of
operating leases and whether any rental expense is recognized during
the construction period.
Analysis of current issue
Retailers often take possession of leased property prior to the
commencement of the lease term stipulated in the lease agreement
(i.e. the date rents become due and payable) to build out the store
space (i.e. to construct leasehold improvements – lessee assets).
The lease term for accounting purposes begins when the lessee
takes possession of or controls the physical use of the property
and there is no distinction between the right to use a leased asset
during construction and the right to use that asset after construction
(ASC 840-20-25-10 through 25-11).42 If a lessee has the right to
use or control physical access to the leased property prior to opening
for business (e.g., during the leasehold improvement construction
period), the lease term has commenced even if the tenant is not
required to pay rent and/or the lease arrangement asserts the lease
commencement date is a later date. Thus, a leasehold improvement
construction period during which a lessee is not required to make rent
payments is considered a deemed rent holiday.
For operating leases that include uneven rental payments (i.e.
increases or decreases in scheduled rent payments) or rent holidays,
rental expense should be recognized by a lessee on a straight-line
basis over the lease term unless another systematic and rational
allocation basis is more representative of the time pattern in which
the leased property is physically employed. As a result, retailers
with operating leases that include deemed rent holidays should
generally recognize rental expense on a straight-line basis over the
lease term, which would include the deemed rent holiday period
(ASC 840-20-25-1 through 25-3).
Resources
EY Publication, Financial Reporting Developments, Lease accounting –
a summary (Revised June 2009) (SCORE No. BB1793)
FASB ASC Topic 840, Leases
42
56
SEC Comments and Trends October 2009
Telecommunications
Segment reporting
Impairments
Determination of operating segments
Access line losses
Discussion of issues noted
Discussion of issues noted
The SEC staff frequently questions telecommunications (telecom)
operators about how the operating segments disclosed were
determined by management. The staff is particularly focused on
this when other information presented in or along with the financial
statements or to the public provides information regarding multiple
components of an operating segment, suggesting that additional
operating segments should have been identified and disclosed.
Recently, the SEC staff has asked telecom operators how they have
considered the effects of access line losses in their impairment
assessments of long-lived assets and whether they expect impairment
charges to affect future results.
Analysis of current issue
For further information including a detailed analysis of the SEC staff
comments related to the determination of operating segments, please
refer to the “Segment reporting” discussion in the general section.
Resources
EY Publication, Financial Reporting Developments, Disclosures
about Segments of an Enterprise and Related Information – FASB
Statement 131 (Revised June 2008) (SCORE No. BB0698)
Analysis of current issue
Telecom operators have experienced significant declines in the number
of their access lines, primarily as a result of wireless substitution
and competition from other providers, such as cable operators. The
decline in access lines has been a persistent trend over the last several
years and is expected to continue, although perhaps at a slower
pace than previously. As described in the general section, long-lived
assets should be reviewed for impairment when events or changes
in circumstances indicate that the carrying amount of the long-lived
assets might not be recoverable. Examples of impairment indicators
include a significant adverse change in the extent or manner in which a
long-lived asset is being used (ASC 360-10-35-21). Access line losses
may indicate that the underlying telecom network assets are no longer
being used to the same extent as they were previously. The SEC staff
has questioned whether these access line losses represent impairment
indicators for the telecom network assets and whether the assets
should be tested for recoverability. On occasion, the SEC staff has
requested that registrants provide their impairment analysis of such
access lines.
Generally, access line losses are attributable to customers who had
purchased traditional voice services. The telecom network that
supports these traditional voice services is also used to provide data
services, such as internet and television. Most telecom operators are
rapidly growing their data services, and the growth in data services
often exceeds the declines in voice services. When testing network
assets for recoverability, telecom operators should consider both
the negative trends associated with voice services and the positive
trends associated with data services. They should also consider the
combination of these trends when assessing whether they expect any
future impairment.
Resources
EY Publication, Financial Reporting Developments, Accounting for the
Impairment or Disposal of Long-Lived Assets — FASB Statement 144
(SCORE No. BB0997)
SEC Comments and Trends October 2009
57
Media and entertainment
Goodwill and intangible assets
Revenue recognition
Impairment and disclosures
Accounting and disclosures
Discussion of issues noted
Discussion of issues noted
The SEC staff frequently questions registrants regarding their
impairment tests of goodwill and intangible assets. Specifically, the
SEC staff requested that registrants provide supplemental information
and include more robust disclosures regarding the following:
• Details on how indefinite-lived intangible assets were assessed
for impairment
M&E registrants received comments on revenue recognition and
related disclosures. In particular, the SEC staff requested that
registrants expand their revenue recognition disclosures with respect
to specific products or services. For example, when registrants
earn revenue from multiple types of transactions the SEC staff
requested revisions to the accounting policy footnote to clarify
revenue recognition policies with regards to all types of revenue and
to address when the criteria of SAB Topic 13 has been met for each
revenue type. Additionally, when the revenue related to emerging
technologies, such as on-line play functionality for video games,
registrants in the M&E industry were asked to clarify the nature of the
revenue (e.g. were they derived from multi-element arrangements,
product sales or support service obligations), the relative significance
of the on-line feature to the product and the materiality of the
associated revenues.
Analysis of current issue
Analysis of current issue
Registrants in the media and entertainment (M&E) industry have
not been immune to the recent challenging market conditions, and
consequently, there has been a significant number of comments
that addressed impairment testing, particularly in sub-sectors that
have been impacted by the weaker economy and resulting declining
advertising revenue, such as newspapers, magazines and radio and
television broadcasting companies.
For further information including a detailed analysis of the SEC
staff comments related to revenue recognition, please refer to the
“Revenue” discussion in the general section.
The SEC staff has requested that registrants provide additional
disclosures related to estimates and assumptions used to assess the
fair value of goodwill and intangible assets within the critical accounting
policy section of the MD&A and in the financial statement footnotes.
Other observations
• The accounting policies relating to the goodwill impairment
tests, including when the two-step impairment test is performed,
identification of reporting units and how goodwill is assigned to
reporting unit
• The types of events that could result in a goodwill impairment,
specifically, a reduction in market capitalization
• The facts and circumstances leading to an impairment
For further information including a detailed analysis of the SEC staff
comments related to impairment testing, please refer to the “Intangible
assets” and “Goodwill” discussion in the general section.
Resources
EY Publication, Revenue Recognition, Lessons Learned from
Restatements and Enforcement Actions (SCORE No. BB1158)
In addition to the item noted above, registrants in the in the M&E
industry have frequently received SEC staff comments requesting
expanded disclosures pertaining to the following:
• Liquidity and capital resources
• Non-GAAP measures
Resources
• Disposal of assets and discontinued operations
EY Publication, Financial Reporting Developments, Intangibles –
Goodwill and Other (SCORE No. BB1499)
For further information and a detailed analysis of the SEC staff
comments related to the items noted above, please refer to the
respective topics in the general section.
EY Publication, Financial Reporting Developments, Accounting for the
Impairment or Disposal of Long-Lived Assets — FASB Statement 144
(SCORE No. BB0997)
EY Publication, Hot Topic: Asset Impairment Considerations in the
Current Economic Environment (SCORE No. BB1522)
58
SEC Comments and Trends October 2009
Technology
Revenue recognition
Accounting for hosting arrangements
Consideration of customer acceptance clauses
Discussion of issues noted
Discussion of issues noted
Many registrants in the technology industry engage in selling software as a
service (SaaS). SaaS, also referred to as “on-demand” software, describes
a business model that enables subscribers to access a wide variety of
application services that are developed specifically for delivery over the
Internet on an as-needed basis. The SEC staff has sought clarification
on policies around revenue recognition for these ‘hosted’ products.
The SEC staff has also sought additional details regarding a registrant’s
analysis of whether the customer has the right to take possession of
the software. The analysis of whether a customer has the right to take
possession of the software requires judgment and careful consideration
of the facts and circumstances surrounding the arrangement. Registrants
should consider documenting their accounting judgments and conclusions
surrounding significant hosting arrangements.
The SEC staff frequently asks registrants in the technology industry
whether their standard agreements contain customer acceptance
clauses and, if so, how the existence of those clauses affects the
timing of revenue recognition. In addition, the SEC staff has asked
registrants to expand their revenue recognition policy disclosures to
specifically discuss these matters.
Analysis of current issue
Since the SaaS model involves the delivery of software-enabled services
via the Internet, it differs from other software license business models. As
the majority of SaaS arrangements contain a license to use proprietary
software, a question arises as to whether such arrangements are subject
to the scope of ASC 985-605.43 The fact that a SaaS arrangement
conveys to the customer a license to use software hosted by the vendor
is not, in and of itself, a sufficient basis to conclude that the arrangement
is subject to the scope of ASC 985-605. Although software is essential
to a SaaS vendor’s ability to meet its obligations to its customers, the
substance of the arrangement must be evaluated to determine whether
a service based on software is being delivered, or whether the software
itself is being delivered. If one determines that the software itself is being
delivered, an arrangement is subject to the scope of ASC 985-605.
A hosting arrangement is within the scope of ASC 985-605 only if the
customer has the contractual right to take possession of the software at
any time during the hosting period without significant penalty and it is
feasible for the customer to either run the software on its own hardware or
contract with another party unrelated to the vendor to host the software.
Registrants should ensure that their policies and related accounting policy
disclosure give thought to the authoritative guidance in determining the
appropriate accounting for hosting arrangements and should clearly
document their considerations to support their conclusions.
Analysis of current issue
Customer acceptance provisions may be included in a contract as a
means to enforce a customer’s rights to 1) test the delivered product,
2) require the seller to perform additional services subsequent to
delivery of an initial product or performance of an initial service
(e.g., implementation services) or 3) identify other work necessary
to be done before accepting the product (ASC 605-10-S99-1). When
such clauses exist in arrangements, they should be presumed to be
substantive, bargained-for terms, and the seller generally should not
recognize revenue until formal acceptance occurs (generally through
formal customer sign-off that they have accepted the delivered
products or services) or the provisions lapse. However, formal customer
sign-off is not required in all cases before revenue can be recognized.
When entities disclose these arrangements, the SEC staff frequently
asks the registrant to enhance its critical accounting policy
disclosure to provide more clarity into how revenue is recognized
for such arrangements.
Resources
EY Publication, Financial Reporting Developments, Software
Revenue Recognition, an Interpretation (Revised October 2008)
(SCORE No. BB1357)
EY Publication, Financial Reporting Developments, Revenue
Arrangements with Multiple Deliverables – EITF Issue No. 00-21
(Revised October 2009) (SCORE No. BB1185)
Resources
EY Publication, Financial Reporting Developments, Software Revenue
Recognition, an Interpretation (Revised October 2008) (SCORE No. BB1357)
EY Publication, Accounting for revenue arrangements for software as
service vendors (SCORE No. BB1503)
FASB ASC Topic 985, Software
43
SEC Comments and Trends October 2009
59
Banking and capital markets
Management’s discussion and
analysis
Lending disclosures
Discussion of issue noted
The SEC staff has asked registrants to provide more discussion about
lending activities in MD&A. Given the current challenging business
and economic environment, the SEC staff has specifically focused on
enhanced disclosures surrounding registrants’ allowance for credit
losses and commercial real estate loan portfolios.
Analysis of current issue
As it relates to disclosures around risks and uncertainties and the
allowance for credit losses, the SEC staff has requested:
• Detailed explanations of the methodology and assumptions used
by management to determine and evaluate the adequacy of the
allowance for credit losses
• An explanation of changes in the allowance, including
consideration of charge-offs, non-performing loans, level of
delinquency and types of loans comprising the portfolio
• That information be provided regarding the allocation of the
allowance as well as the reason for any reallocation of the
allowance among different parts of the portfolio or different
elements of the allowance
• Additional information regarding the collateral supporting portions
of the loan portfolio, including type of collateral and dates of the
most recent appraisals
The SEC staff has commented that given the increased risks
associated with commercial real estate lending, the well publicized
deterioration and stresses in certain commercial real estate
markets and the large concentrations of commercial real estate
risk in certain bank portfolios, registrants should provide detailed
disclosures regarding their risk management practices with respect
to commercial real estate lending. Such disclosures should include
clarification of the significant terms of the real estate products
offered and the underwriting standards applied to such products,
information on how often appraisals are updated, a description of
risk mitigation strategies, the degree to which management performs
portfolio-level stress tests or sensitivity analysis and any trends noted
in the portfolio that may affect the registrant’s financial results.
In August 2009, the SEC staff issued a “Dear CFO” letter on MD&A
Disclosure Regarding Provisions and Allowances for Loan Losses.44
In the letter, the staff states that the current economic environment
may require registrants to reassess whether the information
supporting their accounting decisions remains accurate, re-examine
their accounting for the provision and allowance for loan losses and
reevaluate the related MD&A disclosures. The letter sets out several
suggested MD&A disclosure items. They are:
• Additional information regarding higher-risk loans, such as option
ARM products, junior lien mortgages, high loan-to-value ratio
mortgages, interest only loans, subprime loans, and loans with
initial teaser rates, including:
• An explanation as to why a provision was recorded in a particular
quarter, including any specific triggering events that occurred in
that quarter and
• The carrying value of higher-risk loans by loan type and to the
extent feasible, allowance data for these loans
• Current loan-to-value ratios by higher-risk loan type, further
segregated by geographic location to the extent the loans are
concentrated in any area as well as information on how the ratios
were calculated and the source of the underlying data used
• Information surrounding individually large credits
• The amount and percentage of refinanced or modified loans by
higher-risk loan type
• Asset quality information and measurements, such as delinquency
statistics and charge-off ratios by higher-risk loan type
The “Dear CFO Letter” is available on the SEC website at http://www.sec.gov/divisions/corpfin/guidance/loanlossesltr0809.htm
44
60
SEC Comments and Trends October 2009
• The policy for placing loans on non-accrual status when a loan’s
terms allow for a minimum monthly payment that is less than
interest accrued on the loan and information on how this policy
impacts the non-performing loan statistics
• The expected timing of adjustment of option ARM loans
and the effect of the adjustment on future cash flows and
liquidity, taking into consideration current trends of increased
delinquency rates of ARM loans and reduced collateral values
due to declining home prices
• The amount and percentage of customers that are making the
minimum payment on their option ARM loans
• Discussion of any changes in the practice of determining the
allowance for loan losses, including:
• The historical loss data used as a starting point for estimating
current losses
• How economic factors affecting loan quality were incorporated
into the allowance estimate
• The level of specificity used to group loans for purposes of
estimating losses
• Non-accrual and charge-off policies
• Description of any risk mitigation transactions used to reduce
credit risk exposure, such as insurance arrangements, participation
in the U.S. Treasury Home Affordable Modification Program, credit
default agreements or credit derivatives and the impact of those
transaction on the financial statements
• The reasons why key ratios (such as non-performing loan ratio)
changed from period to period, and how this information and other
relevant credit statistics were considered in determining whether
the allowance for loan losses was appropriate
• Discussion of how an acquisition accounted for under
Subtopic 805-20 (formerly FAS 141 (R)) or accounting for loans
under Subtopic 310-3045 (formerly SOP 03-3) affects trends in the
allowance for loan losses, including non-performing asset statistics,
charge-off ratios, and allowance for loan loss to total loans
Resources
EY Publication, Current Economic Conditions: Accounting and Reporting
Considerations (Score No. BB1785)
EY Publication, Accounting & Auditing News of 19 April 2009, SEC
staff issues letter on loan loss disclosures in MD&A
• Application of loss factors to graded loans
• Any other estimation methods and assumptions used
• Discussion of declines in collateral values, including:
• The approximate amount (or percentage) of residential mortgage
loans as of the end of the reporting period with loan-to-value
ratios above 100%
• How housing price depreciation, and the homeowners’ loss
of equity in the collateral affects the allowance for loan losses
for residential mortgages, including the basis for assumptions
regarding housing price depreciation
• The timing, frequency, and source of appraisals for collateraldependent loans
FASB ASC Subtopic 310-30, Receivables – Loans and Debt Securities Acquired with
Deteriorated Credit Quality
45
SEC Comments and Trends October 2009
61
Federal Home Loan Bank stock
Non-GAAP measures
Impairment and disclosures
Tangible common equity
Discussion of issue noted
Discussion of issue noted
In recent comment letters, the SEC staff has requested that
registrants provide additional disclosures regarding their investment
in Federal Home Loan Bank (“FHLB”) stock.
The SEC staff has issued comment letters reminding registrants that
tangible common equity (TCE) is considered an internally derived nonGAAP measure. The letters have also requested that all disclosures
required for a non-GAAP measure be made.
Analysis of current issue
The FHLB system is a cooperative of twelve regional banks that
United States financial institutions use to finance housing in their
regions. Institutions that are members of the FHLB system are
required to maintain a minimum investment in FHLB stock. FHLB
stock is capital stock that is bought from and sold to the FHLB at
par. It cannot be sold to other market participants. Although FHLB
stock represents an equity interest in a FHLB, it does not have a
determinable fair value for purposes of ASC Topic 320 because its
ownership is restricted and it lacks a market. FHLB stock should be
classified as a restricted investment security, carried at cost, and
evaluated for impairment (ASC 942-325-25-1 and 35-1).46
In the current economic environment, a number of the FHLBs have
experienced a deterioration of value in their securities portfolios,
specifically as it relates to their investment in mortgage backed
securities and home equity loans. Additionally, some FHLBs have
suspended dividend payments and repurchases of excess stock. For
some FHLBs, concerns exist regarding their ability to comply with
regulatory capital minimums. These factors have raised questions
as to whether an institution’s investment in FHLB stock should be
considered impaired.
Analysis of current issue
TCE is the book value of the registrant less intangible assets (including
goodwill) and preferred equity. TCE represents an approximation of
the value that would be available to the common stock holders should
the registrant be forced to liquidate. Given the current economic
environment instability and uncertainty, this measure has recently
become a focal point for investors, analysts, and regulators.
When a registrant provides non-GAAP measures in a SEC filing,
the SEC requires certain disclosures including clearly labeling the
disclosure as a non-GAAP measure, stating of the fact that other
entities may calculate this measure differently than the registrant and
providing a reconciliation to the most comparable GAAP measure.
For further information and a detailed analysis of the SEC staff
comments related to the MD&A non-GAAP measures, please refer to
the “MD&A” discussion in the general section.
The SEC staff has issued comment letters requesting that registrants
disclose additional information regarding their investment in FHLB
stock, including information regarding the specific FHLB stock owned
by the registrant and the registrants’ policies for identifying and
measuring impairment in their investment in FHLB stock.
FASB ASC Topic 942, Financial Services – Depository and Lending
46
62
SEC Comments and Trends October 2009
Insurance
Fair value
Other-than-temporary
impairments
Accounting and disclosure
Accounting and disclosure
Discussion of issues noted
Discussion of issues noted
Insurance companies’ balance sheets include significant assets and
liabilities that are carried at fair value; many of which are valued
using inputs that are not observable. The SEC staff will often issue
comment letters to entities with significant assets and liabilities
carried at fair value when the accompanying disclosures do not, in
their view, provide adequate, clear or sufficient discussion of the
valuation policies, including the selection of valuation models and the
identification of significant inputs and assumptions.
The SEC staff has continued to question and request additional
analysis of investments’ whose carrying value exceeds their
respective fair value. These comments are frequently provided when
the amount and magnitude of securities where the fair value is below
the carrying value and the relating disclosure may not adequately
communicate why such investments are not other-then temporarily
impaired.
Analysis of current issue
Analysis of current issue
For further information including a detailed analysis of the SEC staff
comments related to fair value accounting and disclosures, please
refer to the “Fair value” discussion in the general section.
For further information including a detailed analysis of the SEC staff
comments related to other-than-temporary impairments, please refer
to the “Financial instruments” discussion in the general section.
SEC Comments and Trends October 2009
63
Investments guaranteed by
third parties
Property and casualty loss
and loss adjustment expense
reserves
Third party guarantees
Critical accounting estimates
Discussion of issues noted
Discussion of issue noted
The SEC staff has asked registrants in the insurance industry to
provide more detail about the amount and types of investments
that are guaranteed by third parties. Specifically, the SEC staff has
requested that registrants in the insurance industry disclose the total
amount of securities that are guaranteed by third parties by type of
security, the credit rating of the securities both with and without the
guarantee and any significant concentrations related to a particular
guarantor, both direct (i.e., investment with a guarantor) and indirect
(i.e., investments guaranteed by a guarantor).
The SEC staff continues to focus on improving the quality and content
of the Critical Accounting Estimate section of MD&A, specifically in
regards to the discussion of the estimation of reserves for property and
casualty loss and loss adjustment expenses. In their comments, the
SEC staff frequently requests that registrants provide a greater level of
information regarding the process for developing the estimate, changes
in this process and information about the subjectivity of the estimate.
Analysis of current issue
Many registrants in the insurance industry have state and municipal
bond holdings in which the principal and interest payments are
guaranteed by third parties. In conjunction with the current economic
environment, many of these guarantors have experienced significant
credit downgrades and the ability of the third party guarantors to
fulfill the obligation has been called into question.
Such disclosures are intended to provide financial statement users
with better insight into possible loss exposures. Disclosures are
required about the nature and amount of guarantees even when there
is a remote possibility of loss (ASC 460-10-50-2).47 As a registrant
determines the fair value and makes disclosures of investments
guaranteed by third parties, it is important to consider the effects
that the guarantee has on the investment, even though the required
disclosures do not specifically reference third party guarantor
arrangements.
Analysis of current issue
For property & casualty loss reserves, most registrants include
disclosure of the methods used and changes in reserve estimates.
However these disclosures tend to include only general information
about reserve development as it relates to severity trends, reserve
releases or strengthening. When unfavorable development occurs,
the SEC staff has requested that registrants disclose more specific
information regarding changes in reserve estimates (e.g., changes
on the catastrophe estimate for updates to the model as information
becomes available), including an explanation why the change
occurred in the current period(s) and why recognition was not
required in an earlier period.
The SEC staff has specifically commented that registrants should
disclose how management has adjusted each of the key assumptions
used in calculating the current period reserves and why they were
changed. In addition, the SEC staff continues to request that
registrants provide quantitative disclosures about reasonably likely
future changes in key assumptions, as opposed to changes based on
arbitrary percentages (e.g., plus or minus 5%).
For further information and a detailed analysis of the SEC staff
comments related to the MD&A critical accounting policies, please
refer to the “MD&A” discussion in the general section.
FASB ASC Topic, Guarantees
47
64
SEC Comments and Trends October 2009
Appendix B
SEC Review Process
The SEC’s Division of Corporation Finance
review process
The Division of Corporation Finance (DCF) of the Securities and
Exchange Commission (SEC) selectively reviews filings made under
the Securities Act of 1933 and the Securities Exchange Act of 1934
to monitor and enhance compliance with the applicable disclosure
and accounting requirements. In its filing reviews, DCF concentrates
its resources on critical disclosures that appear to conflict with the
SEC rules, applicable accounting standards or on disclosure that
appears to be materially deficient in explanation or clarity.
Required and Selective Review
As required by the Sarbanes-Oxley Act of 2002, the DCF undertakes
some level of review of each reporting company at least once every
three years and reviews a significant number of companies more
frequently. In addition, the DCF selectively reviews transactional
filings — documents companies file when they engage in public
offerings, business combination transactions, and proxy solicitations.
Based on its preliminary review, the DCF decides whether to
undertake any further review of the company’s filings or whether the
company’s disclosure appears to be substantially in compliance with
the applicable accounting principles and the federal securities laws
and regulations.
Levels of Review
If DCF selects a filing for further review, the extent of that further
review will depend on many factors, including the results of the
preliminary review. The level of further review may be:
• A full cover-to-cover review in which the staff will examine the
entire filing for compliance with the applicable requirements of the
federal securities laws and regulations
• A financial statement review in which the staff will examine the
financial statements and related disclosure, such as Management’s
Discussion and Analysis of Financial Condition and Results
of Operations, for compliance with the applicable accounting
standards and the disclosure requirements of the federal securities
laws and regulations
• A targeted issue review in which the staff will examine the filing
for one or more specific items of disclosure for compliance
with the applicable accounting standards and/or the disclosure
requirements of the federal securities laws and regulations
When the staff notes instances where it believes a company can
enhance its disclosure or improve its compliance with the applicable
disclosure requirements, it provides the company with comments.
The range of possible comments is broad and depends on the issues
that arise in a particular filing review. The staff completes many filing
reviews without issuing any comments.
In addition to a first level examiner, in nearly all cases a second
person reviews a filing and proposes comments to help achieve
consistency in comments across filing reviews. This person is
referred to as the reviewer.
Staff Comments
The DCF views the comment process as a dialogue with a company
about its disclosure. The DCF’s comments are in response to a
company’s disclosure and other public information and are based on
the staff’s understanding of that company’s facts and circumstances.
In issuing comments to a company, the staff may request that a
company provide additional supplemental information so the staff
can better understand the company’s disclosure, revise disclosure
in a document on file with the SEC, provide additional disclosure in
a document on file with the SEC or provide additional or different
disclosure in a future filing with the SEC.
Company Response to Comments
A company generally responds to each comment in a letter to
the staff and, if appropriate, by amending its filings. A company’s
explanation or analysis of an issue will often satisfactorily resolve a
comment. Depending on the nature of the issue, the staff’s concern,
and the company’s response, the staff may issue additional comments
following its review of the company’s response to its prior comments.
This comment and response process continues until the DCF and the
company resolves the comments.
While the staff and the company may ultimately disagree with the
final outcome of a staff comment, a company should, in any instance
it wishes to, seek reconsideration of a staff comment by other DCF
staff members.
SEC Comments and Trends October 2009
65
Closing a Filing Review
When a company has satisfactorily resolved all the DCF comments on
an Exchange Act registration statement, a periodic or current report,
or a preliminary proxy statement, the DCF provides the company with
a “no further comment” letter to confirm that its review of the filing
is complete.
Further discussion of the procedures for consulting with the
Commission’s Office of Chief Accountant are set forth on the SEC’s
website at http://www.sec.gov/info/accountants/ocasubguidance.htm.
To increase the transparency of the review process, when the DCF
completes a filing review it makes its comment letters and company
responses to those comment letters public on the SEC’s EDGAR
system. The DCF makes this correspondence public no earlier than 45
days after it has completed its review of a periodic or current report
or declared a registration statement effective.
Reconsideration Process
The DCF staff members, at all levels, are available to discuss
disclosure and financial statement presentation matters with a
company and its legal, accounting and other advisors. A company
may request that the staff reconsider a comment it has issued or
reconsider a staff member’s view of the company’s response to a
comment at any point in the filing review process.
The DCF does not have a formal protocol for companies to follow
when seeking reconsideration of a staff comment; a request for
reconsideration may be oral or written.
Disclosure requirements
The SEC requires that all entities defined as accelerated filers and
well-known seasoned registrants disclose, in their annual reports on
Form 10-K or Form 20-F, written comments the SEC staff has made in
connection with a review of Exchange Act reports that:
• The issuer believes are material
• Were issued more than 180 days before the end of the fiscal year
covered by the annual report
• Remain unresolved as of the date of the filing of the Form 10-K or
Form 20-F
The disclosure must be sufficient to disclose the substance of the
comments. Staff comments that have been resolved, including those
that the staff and registrant have agreed will be addressed in future
Exchange Act reports, do not need to be disclosed. Registrants can
provide other information, including their position regarding any such
unresolved comments.
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SEC Comments and Trends October 2009
Appendix C
Abbreviations used in this publication
Abbreviation
FASB Accounting Standard Codification
ASC 205
FASB ASC Topic 205, Presentation of Financial Statements
ASC 210
FASB ASC Topic 210, Balance Sheet
ASC 230
FASB ASC Topic 230, Statement of Cash Flows
ASC 250
FASB ASC Topic 250, Accounting Changes and Error Corrections
ASC 260
FASB ASC Topic 260, Earnings Per Share
ASC 280
FASB ASC Topic 280, Segment Reporting
ASC 310
FASB ASC Topic 310, Receivables
ASC 320
FASB ASC Topic 320, Investments — Debt and Equity Securities
ASC 323
FASB ASC Topic 323, Investments — Equity Method and Joint Ventures
ASC 330
FASB ASC Topic 330, Inventory
ASC 350
FASB ASC Topic 350, Intangibles — Goodwill and Other
ASC 360
FASB ASC Topic 360, Property, Plant, and Equipment
ASC 420
FASB ASC Topic 420, Exit or Disposal Cost Obligations
ASC 450
FASB ASC Topic 450, Contingencies
ASC 460
FASB ASC Topic 460, Guarantees
ASC 470
FASB ASC Topic 470, Debt
ASC 480
FASB ASC Topic 480, Distinguishing Liabilities from Equity
ASC 605
FASB ASC Topic 605, Revenue Recognition
ASC 718
FASB ASC Topic 718, Compensation — Stock Compensation
ASC 740
FASB ASC Topic 740, Income Taxes
ASC 805
FASB ASC Topic 805, Business Combinations
ASC 810
FASB ASC Topic 810, Consolidation
ASC 815
FASB ASC Topic 815, Derivatives and Hedging
ASC 820
FASB ASC Topic 820, Fair Value Measurement and Disclosures
ASC 825
FASB ASC Topic 825, Financial Instruments
ASC 840
FASB ASC Topic 840, Leases
ASC 860
FASB ASC Topic 860, Transfers and Servicing
ASC 932
FASB ASC Topic 932, Extractive Activities — Oil and Gas
ASC 942
FASB ASC Topic 942, Financial Services — Depository and Lending
ASC 980
FASB ASC Topic 980, Regulated Activities
ASC 985
FASB ASC Topic 985, Software
SEC Comments and Trends October 2009
67
Abbreviation
Other Authoritative Standards
FR-60
Financial Release 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies
FR-72
Financial Release 72, Commission Regarding Management's Discussion and Analysis of Financial Condition and
Results of Operations
FRR 501.01
Financial Reporting Release 501.01, Information Outside of Financial Statements, Evaluation of Disclosure –
Interpretive Guidance
IFRIC 13
IFRIC Interpretation 13, Customer Loyalty Programmes
SAB Topic 1-M
SEC Staff Accounting Bulletin (SAB) Topic 1-M, Financial Statements — Materiality
SAB Topic 5-M
SEC Staff Accounting Bulleting (SAB) Topic 5-M, Miscellaneous Accounting — Other Than Temporary Impairment
of Certain Investments In Debt And Equity Securities
SAB Topic 11-M
SEC Staff Accounting Bulletin (SAB) Topic 11-M, Miscellaneous Disclosures — Disclosures Of The Impact That
Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrants When Adopted
In A Future Period
SAB Topic 12-D.3.c
SEC Staff Accounting Bulletin (SAB) Topic 12-D.3.c, Oil and Gas Producing Activities — Application Of Full Cost
Method Of Accounting — Full cost ceiling limitation — Effect of subsequent events on the computation of the
limitation on capitalized costs
SAB Topic 13
SEC Staff Accounting Bulletin (SAB) Topic 13, Revenue Recognition
SAB Topic 14
SEC Staff Accounting Bulletin (SAB) Topic 14, Share-Based Payment
Abbreviation
Non-Authoritative Standards
EITF 00-22
EITF Issue No. 00-22, Accounting for Revenue Arrangements with Multiple Deliverables
EITF D-98
EITF Issue No. D-98, Classification and Measurement of Redeemable Securities
FIN 4
FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the
Purchase Method — an interpretation of FASB Statement No. 2
FSP FAS 115-2
FASB Staff Position FAS 115-2, Recognition and Presentation of Other-Than-Temporary Impairments
Statement 141
FASB Statement No. 141, Business Combinations
Statement 167
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R)
68
SEC Comments and Trends October 2009
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