In this update, we highlight some of the more important 2020 fourth-quarter accounting, financial reporting, and regulatory developments that may impact oil and gas companies. The content is not meant to be all-inclusive.
Accounting guidance issued in fourth quarter 2020
ASU 2020-10, Codification Improvements, is intended to conform, clarify, simplify, and/or provide technical corrections to certain topics, including moving certain presentation and disclosure guidance to the appropriate codification section. The amendments in this update are broken up into two sections: B and C. The provisions of these sections are summarized below:
- Section B: These updates are to improve consistency by including all disclosure guidance in the disclosure section of the codification.
- Section C: These updates primarily clarify application guidance in various subtopics where the original guidance is unclear.
Changes to SEC debt disclosure requirements
ASU 2020-09, Debt (Topic 470): Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762, updates disclosure requirements for SEC registrants based on the provisions included in SEC Release No. 33-10762. These amendments were effective upon issuance.
Codification improvements – Receivables – Nonrefundable fees and costs
ASU 2020-08, Codification Improvements to Subtopic 310-20 Receivables – Nonrefundable Fees and Other Costs, clarifies that an entity should reevaluate each reporting period whether a callable debt security is within the scope of paragraph 310-20-35-33. The standard is effective for fiscal years beginning after Dec. 15, 2020, for public business entities and for fiscal years beginning after Dec. 15, 2021, for all other entities.
Paycheck Protection Program loans
After the issuance of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, many oil and gas companies took advantage of the Paycheck Protection Program loans (PPP loans) offered as part of the Act. Given that these loans were granted by the government and have the potential to be forgiven if certain criteria are met, there are two potential options for public companies to elect for accounting for these loans. For the option other than the debt approach, the borrower must be able to conclude at all times, from initial receipt of the funds until final notification of SBA forgiveness, that loan forgiveness is probable. The two different approaches are summarized below. For additional information on the different accounting approaches for PPP loans, see Paycheck Protection Program loans accounting: What are the options?
- Debt approach. Given the legal and contractual status of the PPP loan as a debt obligation, it is acceptable for all companies in all circumstances to account for the PPP loan as debt (the debt approach). Under the debt approach, interest is accrued at the contractual rate of 1%, and the liability is classified in the balance sheet based on the required repayment dates. Should the loan be forgiven in the future, the loan and related accrued interest will be removed from the balance sheet when notice of loan forgiveness has been received from the SBA.
- IFRS government grant (IAS 20) approach. Under the IAS 20 approach, government grants should be recognized in income when there is reasonable assurance that the terms of the grant will be met. “Reasonable assurance” is interpreted to be a threshold similar to “probable.” Funds received prior to meeting the terms of the grant are reported as a deferred income liability on the balance sheet. Under the IAS 20 approach, grant income is recognized using a systematic basis over the period the related expenditures are incurred. This generally results in the recognition of grant income over the period the covered expenditures are made (either eight or 24 weeks, depending on the terms of the PPP loan). The ability to recognize grant income proportionately is dependent on the continued ability to assert that loan forgiveness is reasonably assured (probable) at all times.
Tax deductibility of expenses funded by PPP loans
In December 2020, the Consolidated Appropriations Act (CCA) was signed into law. One of the key provisions of the CCA was that it clarified the tax treatment of expenses funded with PPP loans. The CCA allows companies to claim a tax deduction for expenses funded with PPP loan proceeds.
Regulatory update – COVID-19-related
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. The Center for Audit Quality (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 encourage companies to monitor both websites for current communications and resources.
Regulatory update – Other
Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information
In November 2020, the SEC adopted amendments, to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K, and related rules and forms, in a manner that reduces the costs and burdens on companies while continuing to provide material information to investors. The amendments are also designed to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information.
The changes to Items 301, 302, and 303 of Regulation S-K focus on material information:
- Eliminate Item 301 (Selected Financial Data)
- Revise Item 302(a) to replace the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes
- Revise Item 303 (MD&A) to specifically:
- Require disclosure of the principal objectives of MD&A.
- Modernize disclosure requirements for liquidity and capital resources, and results of operations.
- Clarify and codify SEC guidance on critical accounting estimates.
- Replace current disclosure requirements for off-balance sheet arrangements, with discussion of such obligations in the broader context of MD&A.
- Eliminate the contractual obligations table.
- Amend disclosure requirements for interim periods to modernize, clarify, and streamline the item and allow for flexibility in the comparison of interim periods to help companies provide a more tailored and meaningful analysis relevant to their business cycles.
In addition, the SEC adopted certain parallel amendments to the financial disclosure requirements applicable to foreign private issuers, including to Forms 20-F and 40-F, as well as other conforming amendments to the related rules and forms, as appropriate.
The amendments will become effective 30 days after they are published in the Federal Register (effective date) and must be applied by companies beginning with the first fiscal year ending on or after the date that is 210 days after publication (mandatory compliance date). Companies will be required to apply the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. Companies may voluntarily comply with the amendments on an item-by-item basis any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety. (Ex: a company could elect to eliminate Selected Financial Data under Item 301 but not the amendments to Item 303.)
The amendments were published in the Federal Register on Jan. 11, 2021, and must be published 30 days prior to the Form 10-K filing date in order to be eligible for early compliance.
Disclosure of payments by resource extraction issuers
In December 2020, the SEC adopted final rules to implement Section 13(q) of the Exchange Act, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC adopted rules to implement Section 13(q) in 2016, but the 2016 rules were disapproved pursuant to the Congressional Review Act by a joint resolution of Congress. The 2020 rules will require resource extraction issuers (defined as oil, natural gas, and mining companies that are required to file reports under Section 13 or 15(d) of the Securities Exchange Act of 1934) to file a Form SD on an annual basis that includes information about payments related to the commercial development of oil, natural gas, or minerals that are made to a foreign government or the federal government.
The final rules will, among other things:
- Require public disclosure of company-specific, project-level payment information.
- Define the term “project” to require disclosure at the national and major subnational political jurisdiction, as opposed to the contract level, recognizing that more granular contract-level disclosure could be used to satisfy the rule.
- Add two new conditional exemptions for situations in which a foreign law or a preexisting contract prohibits the required disclosure.
- Add a conditional exemption for smaller reporting companies and emerging growth companies.
- Define “control” to exclude entities or operations in which an issuer has a proportionate interest.
- Limit the liability for the required disclosure by deeming the payment information to be furnished to, but not filed with, the Commission.
- Add relief for issuers that have recently completed their U.S. initial public offerings.
- Extend the deadline for furnishing the payment disclosures.
The final rules will be effective 60 days following publication in the Federal Register. Following a two-year transition period, a resource extraction issuer will be required annually to submit Form SD no later than 270 days following the end of its most recently completed fiscal year.
SEC hot topics
Calendar-year oil and gas companies should consider certain SEC concerns and suggestions when preparing 2020 annual financial statements and disclosures. At the 2020 AICPA Conference on Current SEC and PCAOB Developments, SEC staff discussed matters related to accounting, financial reporting, and disclosures. A summary of some of the matters follows.
Not surprisingly, COVID-19 was the common topic throughout the conference.
Sagar Teotia, chief accountant of the SEC, reminded conference participants that GAAP and audit standards compliance remains a requirement even in light of the COVID-19 pandemic, and he noted that we should consider the following statements:
- Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (April 3, 2020)
- Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19 (June 23, 2020)
- Statement on OCA’s Focus on High-Quality Financial Reporting During an Unusual Year and a Discussion of our Upcoming Priorities (Dec. 7, 2020)
These statements provide guidance on various accounting areas, including the use of accounting judgments, ICFR, and disclosures in light of COVID-19. He also reminded companies that “OCA staff has consistently not objected to well-reasoned judgments made by companies, and we will continue to apply this perspective. Companies should also ensure that significant judgments and estimates are disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects and is consistent with the company’s specific facts and circumstances.”
Public companies are required to maintain both internal control over financial reporting (ICFR) and disclosure controls and procedures (DCP). Mr. Teotia reminded companies that “management is required to evaluate the effectiveness of its ICFR at the end of each fiscal year, and DCP at the end of each fiscal quarter. We understand that many registrants made changes during the past year to their financial reporting processes in a remote work environment. As we have said in the past, we remind preparers that if any change materially affects, or is reasonably likely to materially affect, an entity’s ICFR, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred (or fiscal year in the case of a foreign private issuer).”
The Division of Corporation Finance (Corp Fin) discussed its response to COVID-19, including the previous release of CF Disclosure Guidance Topic 9: Coronavirus (March 25, 2020) and CF Disclosure Guidance Topic 9A: COVID-19 Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (June 23, 2020). This guidance provides additional Corp Fin views regarding operations, liquidity, and capital resources disclosures companies should consider with respect to business and market disruptions related to COVID-19, and is clear that it is expected for companies to include appropriate disclosures of current or expected impacts in light of COVID-19, including how the company has responded and what management is doing to plan for future impacts. These disclosures are company-fact and circumstance-specific and should not be boilerplate language and should be updated based on new facts and circumstances each reporting period. In addition, companies should disclose both short-term and long-term considerations. Also, some companies are discussing COVID-19 impacts in earnings releases or other investor communications. Companies should consider whether this same information should also be included in SEC filings.
Corp Fin also discussed non-GAAP financial measures that include COVID-19 items — see discussion under “Non-GAAP measures and metrics” below.
Non-GAAP measures and metrics
Corp Fin indicated that it is looking at COVID-19-related adjustments to ensure that they are: (1) directly attributable to COVID-19; (2) incremental to normal operations; and (3) based on actual amounts and not estimates or hypothetical amounts. Companies should consider whether an adjustment is incremental in future periods as some adjustments may be a normal operating expense in the future that should not be adjusted for in non-GAAP measures. It would not be appropriate to make adjustments for lost revenue, as these adjustments would be based on hypothetical amounts considering if COVID-19 had not occurred rather than on known amounts. Corp Fin also stated that adjustments for non-GAAP measures attributed to COVID-19 should be consistently applied between periods.
Adjustments to Revenue
The SEC continues to challenge any adjustments to GAAP revenue such as a presentation of “gross or adjusted revenue” that adds back sales discounts, return allowances, or other concessions to revenue as an adjusted gross sales measure. In some cases, Corp Fin has noted measures that appear to be more of an adjusted gross margin or a non-GAAP contribution margin. Corp Fin cautioned that SEC staff will likely comment if a company identifies something as revenue that is not revenue. Companies may disclose certain operational metrics if the amounts are not labeled as revenue or sales metrics.
Corp Fin also noted that some companies have presented non-GAAP measures of segment items that reflect revenue not in accordance with GAAP.
Key performance indicators (KPIs)
Corp Fin reminded participants that when providing KPIs certain disclosures must be included such as a definition of the metric, how it is calculated, reason the metric is useful to investors, and how management uses it to manage the performance of the business. These disclosures are very important this year as new KPIs, such as liquidity measures, may be added as a result of COVID-19. Also, companies disclosing or discussing a metric in an earnings release or other investor communication, should consider including the KPI disclosures in those communications as well.
Reference rate reform
The FASB continues to monitor global developments associated with the transition away from the London Interbank Offered Rate (LIBOR) and other rates that are due to be phased out as a result of reference rate reform. An ASU was issued in January 2021 to expand the scope of guidance issued in 2020 on reference rate reform. SEC staff also stated their expectations for clear and transparent disclosures in MD&A about plans for the transition from LIBOR, if material.
Corp Fin continues to focus on revenue recognition disclosures around performance obligations, timing of revenue recognition, and the determination of whether the company is acting as a principal or as an agent.
The new leases standard was effective 2019 for calendar-year public companies. The Office of the Chief Accountant (OCA) continues to help with implementation questions, including questions on the scope of the standard, accounting for certain leasing costs, and transition concerns.
Special-purpose acquisition company (SPAC) transactions
SEC staff discussed the recent popularity of the use of special-purpose acquisition companies (SPACs) to go public in contrast to a traditional initial public offering (IPO). A SPAC is a newly created shell company that raises cash in an IPO with the intention to acquire an operating company within the period specified in its governing documents (e.g., 24 months). Craig Olinger, senior advisor to the chief accountant, stated that the SEC staff’s review process for both the IPO registration statement of a SPAC and its subsequent merger proxy or registration statement is consistent with the review process for a traditional IPO.
The following documents were recently updated related to SPAC transactions:
- Compliance and Disclosure Interpretation (C&DI), Securities Act Forms - Question 115.18 of the C&DI provides guidance that the resulting combined company in a SPAC transaction may meet the registrant requirements to use Form S-3 if it has at least 12 calendar months of Exchange Act reporting history after the business combination transaction.
- Corp Fin’s Financial Reporting Manual (FRM) - Paragraphs 1140.5, 2200.7, and 4110.5 of the FRM clarify the financial statements requirements related to a SPAC merger and that the private operating company financial statements included in a SPAC’s merger proxy or registration statement must be audited in accordance with PCAOB standards.
Human capital disclosures
In August 2020, the SEC adopted amendments 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. These amendments are effective for calendar-year reporting and were discussed in our previous newsletter.
The amendments, among other things, require a description of the registrant’s (other than smaller reporting companies) human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business taken as a whole, including any human capital measures or objectives that the registrant focuses on in managing the business. A registrant will need to disclose, to the extent material to an understanding of its business, the number of persons employed by the registrant.
The term “human capital” is not defined, and there is not a prescribed disclosure standard or framework to be used in developing the disclosures. Each registrant’s disclosure must be tailored to its unique business, workforce, and facts and circumstances.
The amendments are principle-based and identify various human capital measures and objectives that address the attraction, development, and retention of personnel as nonexclusive examples of subjects that may be material, depending on the nature of the registrant’s business and workforce. The amendments do not include more prescriptive requirements because the SEC recognizes that the exact measures and objectives included in human capital management disclosure may evolve over time and may depend, and vary significantly, based on factors such as the industry, the various regions or jurisdictions in which the registrant operates, the general strategic posture of the registrant, including whether and the extent to which the registrant is vertically integrated, as well as the then-current macroeconomic and other conditions that affect human capital resources, such as national or global health matters.
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.
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