Oil and gas companies: 2020 Q3 accounting, financial reporting, and regulatory developments
The Financial Accounting Standards Board (FASB) issues several Accounting Standards Updates (ASUs) that impact oil and gas organizations. Key ASUs for all organizations are discussed in depth in the Accounting and Financial Reporting Developments for Public and Private Companies Newsletters.
Accounting Guidance Issued in Third Quarter 2020
ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, was issued to address the complexity associated with the accounting for convertible instruments, including application of the guidance on the derivatives scope exception for contracts in an entity’s own equity. The ASU reduces the number of accounting models for convertible debt instruments and convertible preferred stock, which will result in fewer embedded features being separately recognized from the host contract as compared with current practice. The new guidance will also enhance transparency by making improvements to the disclosures for convertible instruments and their effects on earnings-per-share (EPS). The guidance in the ASU is effective for SEC filers (except smaller reporting companies) for fiscal years beginning after December 15, 2021, including interim periods within those years. For all other entities, the new guidance is effective for fiscal years beginning after December 15, 2023, including interim periods within those years. Early application is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those years. The new guidance must be adopted as of the beginning of an entity’s annual fiscal year.
Regulatory Update — COVID-19-Related
SEC COVID-19 Response
The SEC has taken numerous actions to address registrant, investor, and market COVID-19-related concerns, which are accumulated and discussed at the SEC COVID-19 Response site. We encourage companies to monitor the SEC website for current communications.
Center for Audit Quality (CAQ) COVID-19 Resources
The CAQ has developed a resource page to help auditors, management, and audit committees understand the impact of COVID-19 on financial reporting and oversight. We discuss some of the publications in the third quarter below and encourage companies to monitor the CAQ website for current resources.
Understanding Cybersecurity and the External Audit in the COVID–19 Environment
In July 2020, the CAQ issued a publication to provide a high-level overview of the impact of COVID-19 on cybersecurity with respect to financial reporting, including the financial statement and internal control over financial reporting (ICFR) audits.
Many oil and gas companies have shifted to remote working and have moved the majority of their activity to a virtual environment. This new way of working could expose companies to new or different cyber vulnerabilities, and many have been focused on maintaining security and business continuity. As a result, companies may be instituting new or making changes to existing cybersecurity-related processes and controls.
The SEC’s Office of Compliance, Inspections and Examinations recently issued a Risk Alert in response to an apparent increase in the sophistication of ransomware attacks on SEC registrants and also ransomware attacks impacting service providers to registrants.
Auditors, management, and audit committees should consider the information in the Risk Alert and resources when this CAQ publication in considering and revising risk assessments and disclosures related to any new or different risks of material misstatement that could impact the financial statements and/or ICFR. This information is also useful for private companies in assessing their cybersecurity risks.
Public Company Accounting Oversight Board (PCAOB) COVID-19 Insights
In August 2020, the PCAOB published additional insights regarding its latest conversations with audit committee chairs, Conversations with Audit Committee Chairs: COVID-19 and the Audit (Summary). The update supplements the highlights shared regarding conversations that the PCAOB held in 2019 with nearly 400 audit committee chairs of U.S. issuers whose audits were inspected by the PCAOB.
Recent discussions involved a number of questions about the effects of COVID-19 on financial reporting and auditing. The level and nature of the impact of COVID-19 varies across different industries and issuers. This Summary is also useful for auditors in planning the audit and assessing the risks. Highlights from the Summary include:
- Increased risks associated with remote work. The most common theme among audit committee chairs dealt with risks regarding remote work arrangements. Given the greater reliance on cloud computing in remote work environments, a number of audit committee chairs noted that they have been discussing cyber-related controls within the scope of the audit and increasing the focus on the controls’ effectiveness. The Summary includes a list of example questions that audit committees may want to discuss with their auditors regarding risks related to remote work arrangements.
- Increased audit committee communications with the auditor. A majority of audit committee chairs cited COVID-19 as a basis for more frequent communication between auditors and audit committees. Among the topics audit committees may want to discuss with auditors, the Summary lists considerations, including challenges to completion of the audit, the cadence of communication with auditors and management, changes in the audit plan and potential disclosure changes resulting from the COVID-19 pandemic.
Regulatory Update — Other
MODERNIZATION OF SHAREHOLDER PROPOSAL RULE
In September 2020, the SEC adopted amendments to modernize its shareholder proposal rule, which governs the process for a shareholder to have its proposal included in a company’s proxy statement for consideration by all of the company’s shareholders.
The amendments will facilitate engagement among shareholder-proponents, companies, and other shareholders, including preserving the ability of smaller shareholders to access the proxy statements of the companies in which they have demonstrated a continuing interest. Under the rules, any shareholder may submit an initial proposal after having held $2,000 of company stock for at least three years, or higher amounts for shorter periods of time. The rules also provide for a transition period so that shareholders who are currently eligible at the $2,000 threshold will remain eligible to submit a proposal for inclusion in the company’s proxy statement so long as they continue to maintain at least their current holdings through the date of submission (and through the date of the relevant meeting).
The amendments also update, for the first time since 1954, the levels of shareholder support a proposal must receive to be eligible for resubmission at future shareholder meetings, so as to relieve companies and their shareholders of the obligation to consider, and spend resources on, matters that had previously been voted on and rejected by a substantial majority of shareholders without sufficient indication that a proposal could gain traction among the broader shareholder base in the near future.
Disclosures of Business, Legal Proceedings, and Risk Factors Under Regulation S-K
In August 2020, the SEC adopted amendments, essentially the first time in 30 years, to modernize the description of business (Item 101), legal proceedings (Item 103), and risk factor disclosures (Item 105) that registrants are required to make pursuant to Regulation S-K. Many of the amendments reflect the Commission's long-standing commitment to a principles-based, registrant-specific approach to disclosure and are designed for this information to be presented on a basis consistent with the lens that management and the board of directors use to manage and assess the registrant's performance. The amendments are also intended to improve the readability of disclosure documents, as well as discourage repetition and reduce the disclosure of information that is not material.
The amendments will, among other things:
Amend Item 101(a) by:
- Making it largely principles-based, requiring disclosure of information material to an understanding of the general development of the business;
- Replacing the previously prescribed five-year time frame with a materiality framework; and
- Permitting a registrant, in filings made after a registrant's initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference.
Amend Item 101(c) by:
- Clarifying and expanding its principles-based approach, with a nonexclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c);
- Including, as a disclosure topic, a description of the registrant's human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
- Refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws.
Amend Item 103 by:
- Expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
- Implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or 1% of the current assets of the registrant; and
Amend Item 105 by:
- Requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
- Refining the principles-based approach of Item 105 by requiring disclosure of material risk factors; and
- Requiring risk factors to be organized under relevant headings in addition to the sub captions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
Accredited Investor Definition
In August 2020, the SEC adopted amendments to the “accredited investor” definition, one of the principal tests for determining who is eligible to participate in our private capital markets. Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to invest in private markets. The amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.
The amendments and order become effective 60 days after publication in the Federal Register.
Critical Audit Matters (CAMs)
As a reminder, auditors must include a discussion of CAMs in audit reports of fiscal years ending on or after Dec. 15, 2020 (large accelerated filers reflected the disclosures in audit reports last year). We recommend that auditors, management, and audit committees consider and discuss the identification and disclosure of potential CAMs now and also factor in the potential impact of COVID-19.
If you have any questions, please give our energy team a call.