Accounting Guidance Issued in First Quarter 2020
Reference Rate Reform: Facilitation of the Effect of Reference Rate Reform of Financial Reporting (ASU 2020-04)
Helps ease the financial reporting burden expected to result from reference rate reform such as the planned cessation of the London Interbank Offered Rate (LIBOR). In particular, the guidance is intended to simplify accounting related to contract modifications and hedge accounting. The ASU provides for optional practical expedients and exceptions related to existing contract modification and hedge accounting guidance resulting from reference rate reform if certain criteria are met. The optional practical expedients and exceptions only apply to contract, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The guidance is effective for all entities for the period March 12, 2020 through Dec. 31, 2022.
Codification Improvements to Financial Instruments (ASU 2020-03)
Clarifies aspects of the financial instruments guidance and addresses specific issues that stakeholders have raised about the application of the guidance. The ASU addresses the following topics:
- Fair value option disclosures
- Applicability of the portfolio exception in Topic 820 to nonfinancial items
- Disclosures for depository and lending institutions
- Cross-references to line-of-credit or revolving-debt arrangements guidance in Subtopic 470-50
- Cross-references to net asset value practical expedient in Subtopic 820-10
- Interaction of Topic 842 and Topic 326
- Interaction of Topic 326 and Subtopic 860-20
Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2020-02)
Provides guidance from the SEC on the following topics:
- Interpretive guidance for entities adopting Topic 326.
- Clarifies that the SEC staff announced it would not object to a public business entity that otherwise would not meet the definition of a public business entity except for a requirement to include or the inclusion of its financial statements or financial information in another entity’s filing with the SEC adopting Topic 842 using the effective dates for nonpublic entities.
Investments — Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (ASU 2020-01)
Clarifies the interaction between the measurement alternative in Topic 321 for equity securities without a readily determinable fair value and the guidance in Topic 323 and Topic 815. The primary issue addressed in the ASU is clarification that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in Topic 321 immediately before applying or upon discontinuing the equity method.
Proposed Deferral of Effective Date of Lease Accounting Rules (“ASC 842”)
At its April 8, 2020 board meeting, the FASB voted to move forward with a proposal to offer an additional one-year deferral of the new lease standard for private companies and certain not-for-profit entities. This proposal is expected to extend the implementation date until years beginning on or after Dec. 15, 2021 (Dec. 31, 2022 for calendar year-end entities).
Regulatory update — COVID-19 related
The SEC has addressed certain financial reporting and accounting concerns related to COVID-19. The discussions below regarding key accounting and disclosure implications and assessment questions included in the Division of Corporate Finance Disclosures are also applicable to private companies. These sections offer information to assist management and governance committees in assessing potential accounting, financial reporting, and disclosures related to COVID-19.
SEC Stresses Importance of Financial Reporting in Light of COVID-19
On April 8, 2020, SEC Chairman, Jay Clayton, issued a statement regarding the importance of disclosures, with relevant excerpts below:
“In the coming weeks, our public companies will be issuing earnings releases and conducting analyst and investor calls. We urge companies to provide as much information as is practicable regarding their current financial and operating status, as well as their future operational and financial planning. Our collective national effort to mitigate the COVID-19 pandemic has caused a deep contraction in vast areas of our economy, with many workers and businesses facing profound challenges.
Company disclosures should reflect this state of affairs and outlook and, in particular, respond to investor interest in: (1) where the company stands today, operationally and financially, (2) how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing, and (3) how its operations and financial condition may change as all our efforts to fight COVID-19 progress. Historical information may be relatively less significant.
Providing detailed information regarding future operating conditions and resource needs is challenging, including because our response strategies are in their incipient stages (and are likely to change), but it is important on many levels. Updating and refining these estimates should become less difficult over time.
High-quality disclosure will not only provide benefits to investors and companies, it also will enhance valuable communication and coordination across our economy — including between the public and private sectors — as together we pursue the fight against COVID-19.”
On April 3, 2020, SEC Chief Accountant (OCA), Sagar Teotia, issued a Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19. Highlights of Teotia’s statement include:
- OCA recognizes that the accounting and financial reporting implications of COVID-19 may require companies to make significant judgments and estimates, which can be challenging in an environment of uncertainty. OCA has consistently not objected to well-reasoned judgments that entities have made, and they will continue to apply this perspective.
- OCA remains actively focused on auditor independence matters in these unprecedented times. OCA indicates that auditor independence is foundational to the credibility of the financial statements and is a shared responsibility among audit committees, management, and their auditors. Management and audit committees should be aware of how an auditor independence violation may affect the company’s required SEC filings.
- The challenges associated with many of the accounting issues in the current environment also exist internationally. OCA is actively engaged in discussions with the International Accounting Standards Board (IASB) on the impact of COVID-19, including through its involvement as the vice-chair of International Organization of Securities Commissions (IOSCO)’s Committee 1 on Issuer Accounting, Audit and Disclosure. Committee 1 is dedicated to improving the development of accounting and auditing standards and enhancing the quality and transparency of the information that investors receive from listed companies, including financial institutions.
The SEC has taken numerous actions to address registrant, investor, and market COVID-19 concerns, which are accumulated and discussed at the SEC COVID-19 Response site. We discuss some of the more important guidance and actions below and encourage companies to monitor the SEC website for current communications.
Key Accounting and Disclosure Implications of COVID-19
Accounting and financial reporting implications of COVID-19 may require companies to make significant judgments and estimates, which can be challenging in an environment of uncertainty.
Management, audit committees, and auditors should consider how recent events and changes in circumstances due to the COVID-19 crisis may impact financial reporting. In April 2020, the Center for Audit Quality (CAQ) issued a publication with key considerations for upcoming filings. The following list, while not exhaustive, includes certain accounts and disclosures that may be impacted and some questions for consideration.
a. Long-lived asset impairment (ASC 360)
- Are there indicators of impairment of long-lived assets such as oil and gas properties accounted for under the successful efforts method, equipment, buildings, or finite-lived intangible assets? If yes, consider if events have triggered the need for an impairment test.
- Are held-for-use assumptions of long-lived assets still appropriate? If the company changes its assertion about an asset group and concludes it meets the held-for-sale criteria, the order of impairment testing differs.
b. Goodwill impairment (ASC 350)
- Are there indications that it is more likely than not that goodwill or an indefinite-lived intangible asset is impaired? If yes, an interim impairment test is required.
a. Marketable securities and available-for-sale assertions for a public business entity with a fiscal year-end beginning after Dec. 15, 2019 (ASU 2016-13)
- Is management’s assertion to hold investments to maturity still appropriate?
- Have credit losses been appropriately recorded?
b. Equity method investments (ASC 323)
- Are there indicators that the carrying amount of equity method investments (including in joint ventures) might not be recoverable? If yes, investments are required to be reviewed for impairment.
Income taxes (ASC 740)
a. Deferred tax valuation allowance
- Has forecasted future taxable income in the carryback or carryforward period changed?
- Has the auditor considered the requirements of ASC 740 and the effect on the interim reporting period?
b. Indefinite reinvestment assertion
- If applicable, can the company continue to assert its intent and ability to indefinitely reinvest foreign earnings if their operations in such countries have been affected by current market conditions?
- If the company changes its reinvestment assertion during an interim period has management considered the requirements of ASC 740 and the impact of accounting for deferred tax accounts?
Inventory valuation (ASC 330)
- Is the allowance for inventory obsolescence appropriate?
- Have unplanned work stoppages affected inventory costing?
Debt modifications and loan covenants (ASC 470 and ASC 310)
- If applicable, do additional financing or amended terms of existing debt agreements meet the definition of debt modifications or extinguishments?
- Have any debt covenants been violated? If yes, have accounting and disclosure requirements been considered?
Restructuring and other employee-related accruals
- Have exit or disposal activities been accounted for accurately (ASC 420)?
- Have leasing arrangements changed (ASC 842)? See a recent FASB Q&A on accounting for lease concessions related to COVID-19.
- Have employee benefits changed that may require accrual?
- Have employees been terminated such that postemployment benefit obligations have been incurred (ASC 420, ASC 712, and ASC 715)?
Foreign currency: Intercompany transactions of a long-term investment nature (ASC 830)
- When intercompany foreign currency transactions are of a “long-term investment” nature, foreign currency transaction gains and losses are reported in other comprehensive income rather than through income during consolidation. If applicable, can the company continue to assert an intercompany transaction(s) is of a “long-term investment” nature, such that settlement is neither planned nor anticipated in the foreseeable future?
- Has a company reassessed its liquidity needs or planned restructuring or relocation of foreign operations such that settlement could be impacted?
Other considerations include but are not limited to:
- Fair value measurements
- Insurance recoveries
- Effects on contracts and commitments, including revenue and leases
- Hedge accounting
- Provisions, allowances, and loss contingencies
- Ability to continue as a going concern
The SEC’s Division of Corporation Finance issued guidance providing current views regarding disclosure and other securities law obligations. See discussion below.
Division of Corporate Finance Issues Disclosures Guidance for COVID-19
On March 25, 2020, the Division of Corporation Finance (Corp Fin) issued CF Disclosures Guidance: Topic No. 9, Coronavirus (COVID-19), to provide its current views regarding disclosure and other securities law obligations that companies should consider with respect to COVID-19 and related business and market disruptions. The disclosure guidance is not a rule, regulation, or a statement of the SEC, and the SEC has neither approved nor disapproved its content. As with all SEC staff guidance, it carries no legal force or effect, does not alter or amend applicable law, and does not create any new or additional obligations.
Corp Fin encourages timely reporting while recognizing that it may be difficult to assess or predict with precision the broad effects of COVID-19 on industries or individual companies. The actual impact will depend on many factors beyond a company’s control and knowledge; however, the effects COVID-19 has had on a company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties can be material to investment and voting decisions.
Companies should consider the need for COVID-19-related disclosures within the context of the federal securities laws. The staff guidance reminds companies that disclosure requirements can apply to a broad range of evolving business risks even in the absence of a specific line item requirement that names the particular risk presented and also a number of existing rules or regulations require disclosure about the known or reasonably likely effects of and the types of risks presented by COVID-19. As a result, disclosure of these risks and COVID-19-related effects may be necessary or appropriate in management’s discussion and analysis (MD&A), the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting (ICFR), and the financial statements.
Assessing the evolving effects of COVID-19 and related risks will be a facts and circumstances analysis so disclosure about these risks and effects, including how the company and management are responding to them, should be specific to a company’s situation. The staff guidance provides a list (not all-inclusive) of questions for companies to consider with respect to their present and future operations when assessing their disclosure obligations:
- How has COVID-19 impacted your financial condition and results of operations? In light of changing trends and the overall economic outlook, how do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition? Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
- How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? Has your cost of or access to capital and funding sources, such as revolving credit facilities or other sources changed, or is it reasonably likely to change? Have your sources or uses of cash otherwise been materially impacted? Is there a material uncertainty about your ongoing ability to meet the covenants of your credit agreements? If a material liquidity deficiency has been identified, what course of action has the company taken or proposed to take to remedy the deficiency? Consider the requirement to disclose known trends and uncertainties as it relates to your ability to service your debt or other financial obligations, access the debt markets, including commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral, and counterparty or customer risk. Do you expect to disclose or incur any material COVID-19-related contingencies?
- How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets? For example, will there be significant changes in judgments in determining the fair value of assets measured in accordance with U.S. GAAP or IFRS?
- Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
- Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures? If so, what changes in your controls have occurred during the current period that materially affect or are reasonably likely to materially affect your internal control over financial reporting? What challenges do you anticipate in your ability to maintain these systems and controls?
- Have you experienced challenges in implementing your business continuity plans, or do you foresee requiring material expenditures to do so? Do you face any material resource constraints in implementing these plans?
- Do you expect COVID-19 to materially affect the demand for your products or services?
- Do you anticipate a material adverse impact of COVID-19 on your supply chain or the methods used to distribute your products or services? Do you expect the anticipated impact of COVID-19 to materially change the relationship between costs and revenues?
- Will your operations be materially impacted by any constraints or other impacts on your human capital resources and productivity?
- Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve your business goals?
The above list is illustrative but not exhaustive, and each company will need to carefully assess COVID-19’s impact and related material disclosure obligations. Corp Fin encourages disclosure that is tailored and provides material information about the impact of COVID-19 to investors and market participants; encourages companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management; and, that companies proactively revise and update disclosures as facts and circumstances change.
Corp Fin recognizes that much of the disclosure noted above will involve forward-looking information that may be based on assumptions and expectations regarding future events. Staff reminds companies that providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding COVID-19, can be undertaken in a way to avail companies of the safe harbors in Section 27A of the Securities Act and Section 21E of the Exchange Act for this information.
Refrain from Trading Prior to Dissemination of Material Nonpublic Information
As a reminder, companies and other related persons need to consider their market activities, including the issuance or purchase of securities, in light of their obligations under the federal securities laws. For example, where COVID-19 has affected a company in a way that would be material to investors or where a company has become aware of a risk related to COVID-19 that would be material to investors, the company, its directors and officers, and other corporate insiders who are aware of these matters should refrain from trading in the company’s securities until such information is disclosed to the public. When companies disclose this material information related to the impacts of COVID-19, they are reminded to consider and adhere to Regulation FD 17 CFR 243.100. Also, companies should consider whether they may need to revisit, refresh, or update previous disclosure to the extent that the information becomes materially inaccurate.
Reporting Earnings and Financial Results
Ongoing and evolving COVID-19 impact will likely make it more difficult for companies and their auditors to complete the work required to maintain timely filings and encourages companies to proactively address financial reporting matters earlier than usual. For example, to the extent a company or its auditors will need to consult with experts to determine how the evolving COVID-19 situation may impact its assets, including impairment of goodwill or other assets, it should consider engaging with those experts promptly so that its reporting remains as timely as possible, as well as complete and accurate.
Companies are reminded of their obligations under Item 10 of Regulation S-K and Regulation G with respect to the presentation of non-GAAP financial measures, as well as the SEC’s recent guidance with respect to performance metrics disclosure (see later discussion). To the extent a company presents a non-GAAP financial measure or performance metric to adjust for or explain the impact of COVID-19, the staff advise it would be appropriate to highlight why management finds the measure or metric useful and how it helps investors assess the impact of COVID-19 on the company’s financial position and results of operations.
SEC staff noted that it understands that there may be instances where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by COVID-19-related adjustments that may require additional information and analysis to complete. In these situations, the staff would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results. For example, under this position, if a company intends to disclose on an earnings call its earnings before interest, taxes, depreciation and amortization (EBITDA), it could reconcile that measure to either its GAAP earnings, a reasonable estimate of its GAAP earnings that includes a provisional amount, or its reasonable estimate of a range of GAAP earnings. The provisional amount or range should reflect a reasonable estimate of COVID-19-related charges not yet finalized, such as impairment charges. The SEC reminds companies that (1) a non-GAAP financial measure should not be disclosed more prominently than the most directly comparable GAAP financial measure or range of GAAP measures, and (2) in filings where GAAP financial statements are required, such as filings on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.
The SEC also stated:
- If a company presents non-GAAP financial measures that are reconciled to provisional amount(s) or an estimated range of GAAP financial measures in reliance on the above position, it should:
- Limit the measures in its presentation to those non-GAAP financial measures it is using to report financial results to the Board of Directors.
- Explain, to the extent practicable, why the line item(s) or accounting is incomplete, and what additional information or analysis may be needed to complete the accounting.
- It is inappropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company. Companies should use non-GAAP financial measures and performance metrics for the purpose of sharing with investors how management and the Board are analyzing the current and potential impact of COVID-19 on the company’s financial condition and operating results.
The SEC acknowledged that many companies are facing operational and other challenges as a result of COVID-19 and that this guidance does not address all disclosure considerations relating to the impact of COVID-19. As events evolve, they will provide additional guidance, if appropriate. Companies and their representatives should contact the SEC staff with questions or if they believe there are additional areas where guidance or temporary relief may be necessary.
SEC Provides Conditional Regulatory Relief from Reporting and Proxy Delivery Requirements for Public Companies, Funds, and Investment Advisors Affected By COVID-19
On March 25, 2020, the SEC extended the filing periods covered by its earlier March-enacted-conditional reporting relief for certain public company filing obligations under the federal securities laws, and it also extended regulatory relief previously provided to funds and investment advisors whose operations may be affected by COVID-19. The relief order also exempted companies and certain persons from furnishing proxy statements, information statements, annual reports, and other soliciting materials when mail delivery is not possible.
The SEC provided a 45-day extension to file certain Exchange Act of 1934 (Exchange Act) filings, such as quarterly and annual reports, beneficial ownership reports, proxy solicitations and information statements, that would otherwise have been due between March 1 and July 1, 2020, subject to the satisfaction of certain conditions described below. This extension will allow a company with a December 31 fiscal year-end to delay filing its first quarter 2020 Form 10-Q report if necessary due to the outbreak of COVID-19. The relief does not extend to Schedule 13D filings, amendments to Schedule 13D filings, and Section 16 filings (e.g., Form 3 and Form 4).
The order explicitly states that amendments required to be filed under the Exchange Act fall within the scope of the relief. In cases where a company omits Part III information from its Form 10-K filing, the company is required to file an amendment to Form 10-K with the definitive proxy statement within 120 days after its fiscal year-end. However, the order conditionally extends the deadline for filing such a Form 10-K amendment to add Part III information.
A company relying on the relief order must furnish to the SEC a Form 8-K or Form 6-K, as applicable, by the original filing deadline of the report stating: (1) that it is relying on the relief order, (2) a description of the reasons why it could not file such report on a timely basis, (3) the estimated date by which the report is expected to be filed, and (4) if material, a risk factor explaining the impact of COVID-19 on its business. Additionally, if the reason that the subject report cannot be filed timely relates to the inability of any person, other than the registrant, to furnish any required opinion, report, or certification (e.g., an auditor’s opinion on audited financial statements), the Form 8-K or Form 6-K must attach as an exhibit a statement signed by such person stating the specific reasons why such person is unable to furnish the required opinion, report, or certification in time.
The company must then file the subject report no later than 45 days after the original filing deadline. The subject report, when filed, must disclose that the company is relying on the relief order and state the reasons why it could not file such report on a timely basis.
The SEC press release also noted that:
- For purposes of eligibility to use Form S-3 (and for well-known seasoned issuer status, which is based in part on Form S-3 eligibility), a company relying on the exemptive order will be considered current and timely in its Exchange Act filing requirements if it was current and timely as of the first day of the relief period, and it files any report due during the relief period within 45 days of the filing deadline for the report.
- For purposes of the Form S-8 eligibility requirements and the current public information eligibility requirements of Rule 144(c), a company relying on the exemptive order will be considered current in its Exchange Act filing requirements if it was current as of the first day of the relief period, and it files any report due during the relief period within 45 days of the filing deadline for the report.
- Companies that receive an extension on filing Exchange Act annual reports or quarterly reports pursuant to the order will be considered to have a due date 45 days after the filing deadline for the report. Those companies will be permitted to rely on Rule 12b-25 if they are unable to file the required reports on or before the extended due date and are not required to file a Form 12b-25. (Also see updated Compliance and Disclosure Interpretation (C&DI), Exchange Act Rules (Questions 135.12 and 135.13) to reflect additional guidance on the interaction of Form 12b-25 and the relief order).
- Companies providing forward-looking information in an effort to keep investors informed about trends or uncertainties regarding COVID-19 can avail themselves of the Exchange Act’s safe harbor for forward-looking statements.
Some companies and other affected persons may continue to require additional or different assistance in their efforts to comply with the requirements of the federal securities laws and therefore are encouraged to contact SEC staff. Companies facing administrative difficulties in the filing process (e.g., inability to obtain a required signature due to an executive officer being located in a quarantined zone) are encouraged to contact the staff who will be available to help address these issues. The SEC staff will continue to address these and any issues on a case-by-case basis in light of their fact-specific nature.
The SEC intends to monitor the current situation and may, if necessary, extend the time period during which the relief applies, with any additional conditions it deems appropriate and/or issue other relief.
Other Regulatory Relief
On March 26, 2020, the SEC provided additional temporary regulatory relief to market participants in response to the effects of COVID-19. The relief, subject to certain conditions, includes the following:
- Extended the filing deadlines an additional 45 days for certain disclosure reports that would otherwise have been due between March 26, 2020 and May 31, 2020, pursuant to Regulation A and Regulation Crowdfunding.
- Provided affected municipal advisors with an additional 45 days to file annual updates to Form MA that would have otherwise been due between March 26, 2020 and June 30, 2020.
The SEC staff will continue to closely track developments, and, if appropriate, consider additional relief from other regulatory requirements for those affected by COVID-19.
Internal Controls and Disclosure Controls
Companies may have changes to their processes and internal controls as they adapt to the new conditions necessitated by COVID-19 such as working remote, personnel losses, and other constraints. These changes may require disclosure in the Forms 10-K and 10-Q. Management and audit committees should consider the disclosure requirements related to the establishment of new controls, redesigning of controls and processes.
Regulatory update — other
SEC Clarification on Management’s Discussion and Analysis (MD&A) Third Year Comparison
In January 2020, the SEC issued a Compliance and Disclosure Interpretation (C&DI) with guidance for companies intending to omit the Third Year Comparison in MD&A. The 2020 annual reporting season will be the first annual reporting season in which companies are permitted (but not required) to omit a discussion of the earliest of three years of their financial statements (Third Year Comparison) in MD&A, so long as the discussion was included in an earlier SEC filing and there is a statement in MD&A identifying the location of the discussion in the prior filing.
The C&DI addressed the guidance as it relates to the following issues:
- Companies are not permitted to omit the Third Year Comparison if the company believes it would be necessary to understand the company’s financial condition, changes in financial condition, and results of operations.
- A statement in MD&A identifying the location of an omitted Third Year Comparison in a prior SEC filing will not have the effect of incorporating the Third Year Comparison into a 10-K (or any registration statement that incorporates the 10-K by reference). A company needs to expressly incorporate the Third Year Comparison by reference if it wants to include it in the 10-K. While a company is not required to include a Third Year Comparison in MD&A, it may choose to incorporate it by reference if it believes the Third Year Comparison would be necessary to understand the company’s financial condition, changes in financial condition, and results of operations.
Disclosure of Key Performance Indicators and Metrics in MD&A
In January 2020, the SEC provided guidance on the disclosure of key performance indicators (KPIs) and metrics in MD&A. The guidance is effective Feb. 25, 2020.
Item 303(a) of Regulation S-K requires disclosure of information not specifically referenced in the item that the company believes is necessary to an understanding of its financial condition, changes in financial condition, and results of operations. The item also requires discussion and analysis of other statistical data that in the company’s judgment enhances a reader’s understanding of MD&A. In particular, any KPIs that a company already includes in earnings releases should also be considered for inclusion in the company’s MD&A.
Some companies also disclose nonfinancial and financial metrics when describing the performance or the status of their business and those metrics can vary significantly from company to company and industry to industry, depending on various facts and circumstances. For example, some of these metrics relate to external or macroeconomic matters, some are company- or industry-specific, and some are a combination of external and internal information. Some companies voluntarily disclose specialized, company-specific sales metrics, such as same-store sales or revenue per subscriber. Some companies also voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.
The SEC staff reminds companies that, when including metrics in their disclosure, they should consider existing MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading. A company should first consider the extent to which an existing regulatory disclosure framework applies, such as GAAP or, for “non-GAAP measures,” Regulation G or Item 10 of Regulation S-K and then consider what additional information may be necessary to provide adequate context for an investor to understand the metric presented. SEC staff generally expect, based on the facts and circumstances, the following disclosures to accompany the metric:
- A clear definition of the metric and how it is calculated.
- A statement indicating the reasons why the metric provides useful information to investors.
- A statement indicating how management uses the metric in managing or monitoring the performance of the business.
The company should also consider whether there are estimates or assumptions underlying the metric or its calculation, and whether disclosure of such items is necessary for the metric not to be materially misleading.
If a company changes the method by which it calculates or presents the metric from one period to another, the company should consider the need to disclose, to the extent material: (1) the differences in the way the metric is calculated or presented compared to prior periods, (2) the reasons for such changes, (3) the effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported, and (4) such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company’s performance or prospects. Depending on the significance of the change(s) in methodology and results, the company should consider whether it is necessary to recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context.
Additionally, KPIs should be subjected to disclosure controls and procedures to ensure consistency and accuracy.
SEC Expands Qualifications for Nonaccelerated Filer Status
In March 2020, the SEC adopted amendments to the accelerated filer and large accelerated filer definitions. When classified as an accelerated or large accelerated filer, an issuer is subject to, among other things, the requirement that its outside auditor attest to and report on management’s assessment of the effectiveness of the issuer’s ICFR.
1. Exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a Small Reporting Company (SRC) and had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. Business development companies will be excluded in analogous circumstances.
As amended, an accelerated filer will have to be ineligible to be an SRC and also meet the three existing conditions:
- Public float: at least $75 million, but less than $700 million, as of the last business day of the latest second fiscal quarter.
- Subject to the Exchange Act continuous reporting system for a period of at least 12 calendar months.
- Previously filed at least one Exchange Act annual report.
As amended, a large accelerated filer must meet the same conditions as that of an accelerated filer, except that its public float must be equal to or greater than $700 million.
2. Increase the transition thresholds for an accelerated and a large accelerated filer becoming a nonaccelerated filer from $50 to $60 million and for exiting large accelerated filer status from $500 to $560 million.
3. Add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status.
4. Add a check box to the cover pages of annual reports on Forms 10-K, 20-F, and 40-F to indicate whether an ICFR auditor attestation is included in the filing.
Accordingly, the SEC has issued final rules to amend the quantitative thresholds in the definitions of an accelerated filer and a large accelerated filer to tailor the types of issuers that are more appropriately included in the categories of accelerated and large accelerated filers. Note, though, that under the revised rules, some SRCs would become nonaccelerated filers (i.e., the SEC has not fully aligned the SRC and nonaccelerated filer definitions).
Following the adoption of the amendments, SRCs with less than $100 million in revenues will continue to be required to establish and maintain effective ICFR, to have principal executive and financial officers certify that, among other things, they are responsible for establishing and maintaining ICFR and have evaluated and reported on the effectiveness of the company’s disclosure controls and procedures, and to be subject to financial statement audit by an independent auditor, who is required to consider ICFR in the performance of that audit. Also, the amendments would allow SRCs that have been public for more than five years, but have not yet reached $100 million in revenues, to continue to benefit from the JOBS Act exemption.
The final amendments apply to an annual report filing that is due on or after the effective date of April 27, 2020. In cases where the annual report covers a fiscal year ending before the effective date, the final amendments may still be applied to determine an issuer’s status. For example, an issuer with a March 31, 2020 fiscal year-end would be due to file its Form 10-K after the effective date of the amendments; however, it may apply the final amendments to determine its filing status even though its fiscal year-end date precedes the effective date. This benefits an accelerated filer that determines that it now qualifies as a nonaccelerated filer because it will not be required to obtain an auditor’s attestation of ICFR for its annual report and it can take advantage of the filing deadlines that apply, as well as and other accommodations available to nonaccelerated filers.
Proposed MD&A Simplification Rules
In January 2020, the SEC proposed amendments to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K. The proposed amendments would eliminate duplicative disclosures and modernize and enhance MD&A disclosures for the benefit of investors, while simplifying compliance efforts for companies.
The proposed amendments would:
- Eliminate Item 301 (selected financial data)
- Eliminate Item 302 (supplementary financial data)
- Amend Item 303 (MD&A), to among other things:
- Add a new Item 303(a), Objective, to state the principal objectives of MD&A.
- Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction to prompt companies to discuss off-balance sheet arrangements in the broader context of MD&A.
- Eliminate Item 303(a)(5), Tabular disclosure of contractual obligations, given the overlap with information required in the financial statements and to promote the principles-based nature of MD&A.
- Add a new disclosure requirement to Item 303, Critical accounting estimates, to clarify and codify existing SEC guidance in this area.
- Revise the interim MD&A requirement in Item 303(b) to provide flexibility by allowing companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.
The proposal also includes certain conforming amendments, including to Forms 20-F and 40-F, as appropriate.
The guidance provides that, where companies disclose metrics, they should consider whether additional disclosures are necessary and give examples of such disclosures. The guidance also reminds companies of the requirements in Exchange Act Rules 13a-15 and 15d-15 to maintain disclosure controls and procedures and that companies should consider these requirements when disclosing metrics.
The comment period ended May 1, 2020. The guidance will be then be effective upon publication in the Federal Register.
Comment Period Extended for SEC Proposal for Resource Extraction Disclosure Rules
In December 2019, the SEC voted to propose rules that would require resource extraction issuers to disclose payments made to foreign governments or the U.S. federal government for the commercial development of oil, natural gas, or minerals. We discussed the proposal in our 2019 year-end publication. As part of the COVID-19 relief, the comment period was extended until May 1, 2020, to allow commenters additional time if needed.
If you have any questions, please give our oil and gas team a call.