1st Quarter, 2010
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1st Quarter, 2010 |
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Small Company Financial Reporting Issues Posted
By Larry Schultz, CPA, Audit PartnerOn December 22, 2009, the Security and Exchange Commission’s (SEC's) Division of Corporation Finance posted an updated version of its SEC Staff Review of Common Financial Reporting Issues Facing Smaller Issuers. The 52-page presentation addresses some of the issues the division's staff has frequently encountered in the past year while reviewing filings from smaller public companies. It also includes information on SEC rule making from the past year of interest to small companies. According to the presentation, the financial reporting issues include:
We have highlighted some of the common reporting issues below: The Effect of the Financial Crisis on Financial Reporting and Disclosures Goodwill - generally, the assumptions used to value goodwill should be consistent with assumptions used in valuing other assets allocated to the reporting unit such as long-lived assets, intangible assets, and deferred tax assets. GAAP requires that companies consider whether an event has occurred that "would more likely than not reduce the fair value of a reporting unit below its carrying value." These judgments are expected to be consistent with other disclosures throughout the filing including going concern, liquidity in Management’s Discussion & Analysis (MD&A), etc. Accounts Receivable, Inventory and Deferred Taxes - most companies have established policies for reserving and writing off accounts receivable based upon aging or a standard percentage. In this current time, delinquencies are on the increase. Consumer spending has been greatly affected as a result of the economic crisis. Inventory has been turning over more slowly. As a result, companies need to carefully consider their inventory valuations. Additionally, companies should consider the impact of the current economic environment on the realizability of their deferred tax assets. It is helpful disclosure to clearly explain the approach for determining whether a valuation allowance is appropriate. Management’s Discussion & Analysis (MD&A) MD&A has three general objectives: to provide a narrative explanation of a company’s financial statements through the eyes of management; to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and to provide information about the quality of, and potential variability of, a company's earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of the future. In accomplishing these objectives, SEC staff generally recommends that companies provide an overview highlighting BOTH financial and non-financial key performance indicators as background to understanding the company’s overall performance for the periods. Additionally, companies tend to overlook the importance of a discussion of liquidity and capital resources. A good discussion focuses on how the company has been able to meet its cash requirements in historical periods through a thorough analysis of the statements of cash flows and how they expect to meet them in the future through a discussion of commitments, debt covenants, and significant contractual obligations. Equity Transactions When smaller companies incorrectly determine fair value for equity issued to consummate certain transactions, such as compensation arrangements and business combinations, it can often lead to material misstatements. SEC staff will frequently comment if a registrant has used a value different from quoted market price to value its equity if it is determined that the stock trades in an active market. Because of the significant impact that fair value determinations can have on the financial statements, it is helpful for registrants provide disclosure surrounding how the fair value was determined and the impact that reasonable changes in assumptions could have on the measure and on the financial statements directly. Smaller Reporting Company Status The SEC adopted a new system of disclosure rules for smaller companies filing periodic reports and registration statements effective February 4, 2008. They are scaled to reflect the characteristics and needs of smaller companies and their investors. They replace the disclosure requirements formerly in the SEC’s Regulation S-B, which applied to “small business issuers.” This slide highlights the tests for transitioning in and out of smaller reporting company status. Some key items to highlight are as follows:
If it newly qualifies as a smaller reporting company based upon their second quarter public float, it may elect to provide scaled disclosure in its next quarterly report on Form 10-Q. Disclosure Controls & Procedures and Internal Control over Financial Reporting (ICFR) Staff continues to issue comments on the evaluation of disclosure controls and procedures in quarterly and annual reporting. Item 307 of Regulation S-K requires companies to clearly disclose whether disclosure controls and procedures are effective or ineffective. Registrants should be aware that the definition of disclosure controls and procedures is broader than the definition of internal control over financial reporting so it is possible that disclosure controls and procedures can be ineffective even while internal control over financial reporting is effective. However, the SEC staff may be highly skeptical in situations where internal control over financial reporting is ineffective but disclosure controls and procedures are effective. In such a situation, we may ask the company to support its conclusion. Current rules require that registrants explicitly state whether internal control over financial reporting is effective or ineffective with no qualifying language or scope limitations. The SEC staff generally asks companies that do not appear to have completed an assessment and/or have not disclosed their conclusion on effectiveness to amend their filings. As they relate to both accelerated and nonaccelerated filers, staff continues to comment on and observe areas where disclosures of material weaknesses can be improved. Disclosures of material weaknesses are most useful if they provide some transparency into the pervasiveness and impact a particular material weakness could have on the financial statements. It can be meaningful if registrants disclose current plans to remediate the weakness and provide disclosures of any changes to internal control over financial reporting as the result of remediation efforts in conjunction with the required disclosures under Item 308(c) of Regulation S-K. Registrants are required to disclose all material weaknesses identified so companies might consider the above guidance for each material weakness. Likewise, while the thoughts above discuss disclosures that are too narrow, the SEC staff recommends that companies not group multiple material weaknesses into the description of one general material weakness. Other articles in this newsletter:
New Revenue Recognition Guidance Financial Reporting Manual: An Alternative to Wandering in SEC Regulations Increased Proxy Disclosure Requirements |
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Larry has provided audit and accounting services to both public and private companies for over 15 years. In addition to SEC financial reporting requirements, he regularly assists public companies with other compliance matters, including registration statements and Section 404 of Sarbanes-Oxley (SOX 404) internal controls and reporting.