Accounting Ch-Ch-Changes

FASB

Insurance Accounting

ASU 2018-12

Financial Services – Insurance: Targeted Improvements to the Accounting for Long-Duration Contracts (Topic 944)

August 15, 2018

December 15, 2022³
(1Q 2023)

What’s Changin’: Insurance accounting (two words that make most people want to get up and dance).

•Updating Liability Assumptions: Insurance liability assumptions, such as mortality rates, are reviewed and updated at least annually, with changes reflected in earnings. Old GAAP locks assumptions in at contract inception, only to update when a premium deficiency (future payouts > future premiums) exists.

•The New Discount Rate: Insurance liability discounted at upper-medium grade corporate bond yield (i.e., single A) with any changes due to discount rate (updated annually) reflected in OCI. Old GAAP requires companies to use their expected investment yield as the discount rate, the rosier the forecast, the lower the liability.

•Marking Market Risk Benefits (MRB): MRB (protect contract holders from “capital market risk”, think guaranteed minimum death benefits) are measured at fair value with changes in fair value run thru earnings (unless due to changes in the company’s own credit risk, which go to OCI).

•Simplifying Deferred Amortization Costs (DAC): DAC will be amortized on a “constant level basis” (i.e., straight line amortization vs. Old GAAP allowing multiple approaches) over the term of the related contracts.

•Lots of New Disclosures: Which include rollforwards of the insurance liability, info on significant inputs (e.g., discount rate) and judgements/assumptions used, etc.

Impact: Wow, that’s a lot to digest. Expect to see more volatility in earnings and book value (we hope that’s a beter reflection of the underlying economics). Additionally, the standardization of the liability discount rate and simplified amortization of DAC should result in better comparability across companies (we’ll have to wait and see).

• Financials (Insurance)

• Health Care (Managed Health Care)

FASB

Convertible Debt

ASU 2020-06

Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40)

August 5, 2020

December 15, 2021³
(1Q 2022)

What’s Changin’: A “simplification” of convertible debt accounting, to just two approaches (down from the five used today): (1) traditional convertible debt model (no bifurcation, single instrument) and (2) embedded derivative model (bifurcate, i.e., split the convert in two, a bond and derivative measured at fair value). Additionally, only the if-converted method will be used when calculating diluted EPS; no more treasury stock method.

Impact: The traditional convertible debt model would apply to most converts, increasing the amount of debt on the balance sheet and reducing interest expense (which would bring it closer to cash interest but move it further away from the economic cost of the debt). Additionally, the transition from treasury stock to if-converted method should result in more EPS dilution (assuming interest expense added back to the numerator is less than the impact from an increase in shares; keep in mind, interest expense would not be added back if the principal must be paid in cash). We appreciate the switch to the if-converted method, but think the FASB missed the mark as we’d prefer to scrap the bifurcate/don’t bifurcate debate and just fair value convertible debt so that investors have a more accurate picture of the convert claim on the balance sheet (that said, companies will be required to disclose the fair value).

• Communication Services

• Financials

• Health Care

• Information Technology

• 10-K Checklist: Get Behind the Numbers

SEC

Disclosures on Acquired and Disposed Businesses

S7-05-19

Amendments to Financial Disclosures about Acquired and Disposed Businesses

(Regulation S-X)

May 20, 2020

January 1, 2021
(1Q 2021)

What’s Changin’: Notable changes to significance tests (used to determine acquisition related reporting requirements), including looking at investment in target company (i.e., purchase price paid) as a % of acquirer’s market value (instead of total assets) under the investment test. Only two years of audited financials (previously three) now required for the most significant acquisitions (= 50% on significance test). Additionally, companies can now include “reasonably estimated synergies” (e.g., fewer back office employees) in their pro-forma results.

Impact: Most of the changes to the significance test will likely raise the threshold, meaning fewer disclosures related to acquisitions (less information = bad news for investors). Management has likely been presenting pro-forma results with synergies, so the only change is in location (now allowed in the pro-forma financials within SEC filings vs. previously in deal materials/PPT deck). Investors should be wary of rosy management forecasts about future “synergies”.

• Energy

• Health Care

• Information Technology

SEC

Description of Business (e.g., new human capital info), Risk Factors and More

S7-11-19

Modernization of Regulation S-K Items 101, 103, and 105

(Regulation S-K)

August 26, 2020

November 9, 2020
(2020 10-K)

What’s Changin’: Risk factors are going to get more organized with the factors grouped by relevant headings (e.g., cybersecurity) and a summary if the risk factor section exceeds 15 pages. Additionally, the SEC is replacing the number of employees disclosure with a broader human capital disclosure, including any related objectives and how management measures human capital (e.g., turnover rates, training hours, etc.), some of which may already be found in the proxy.

Impact: We are all for risk factor organization; now we just have to address how to make them more informative and less boilerplate. Additionally, the human capital disclosures could help with ESG analysis (e.g., employee turnover, hiring practices, training hours, etc.), assuming it’s not boilerplate.

• Human Capital Disclosures: The SEC Has Entered the ESG Arena

• 10-K Checklist: Get Behind the Numbers

SEC

Coronavirus Disclosures
(continued)

Corporate Finance Disclosure Guidance - Topic No. 9A⁵

(Regulation S-X)

June 23, 2020

June 23, 2020
(2Q 2020)

What’s Changin’: Another round of coronavirus-related disclosure guidance, primarily focusing on liquidity and capital resources, impact of government assistance (i.e., CARES Act) and companies’ ability to continue as a going concern. On liquidity, the SEC is interested in metrics used by management (e.g., cash burn), how companies are preserving cash (e.g., reducing CAPEX) and their ability to service debt. A few other noteworthy considerations, including whether companies are altering terms with customers (i.e., extending credit terms) and whether companies are using supply chain finance programs.

Impact: The SEC providing additional disclosure guidance (just 3 months later) makes it seem like current disclosures are lacking. We’re hoping for increased transparency on companies’ supply chain financing programs given we might be waiting a while for guidance from the FASB.

• RFF #4 : When the Bill Eventually Comes Due

• RFF #2: The Double L (Leverage and Liquidity)

SEC

SEC Filer Definitions

S7-06-19

Accelerated Filer and Large Accelerated Filer Definitions

(Regulation S-K)

March 12, 2020

April 27, 2020

What’s Changin’: Changed the definitions of accelerated and large accelerated filers, notably allowing companies with a public float of less than $700 million and less than $100 million in annual revenue (vs. old rule of less than $75 million public float, no revenue test) to be considered non-accelerated filers, therefore not requiring an auditor report on internal controls.

Impact: While this rule may benefit the IPO marketplace with one less hoop to jump through before going public; we’re concerned about a decline in investor protection. Our suggestion: be extra careful when investing in non-accelerated filers (remember those internal control requirements were put in place for a reason…Enron).

• Financials

• Health Care

SEC

Coronavirus Disclosures

Corporate Finance Disclosure Guidance - Topic No. 9⁵

(Regulation S-X)

March 25, 2020

March 25, 2020
(1Q 2020)

What’s Changin’: The SEC offered a whole list of potential disclosure considerations, including how the coronavirus impacts capital/financing resources (e.g., increase in financing costs, breaches of debt covenants, etc.), impairments, supply chain, etc. Additionally, the SEC reminded management teams to explain the reasoning for any coronavirus-related non-GAAP adjustment and how it helps investors better understand results of operations (i.e., can’t just make an adjustment to make results look better).

Impact: We’re hoping for useful coronavirus information, preferably quantified, such as change in the goodwill impairment buffer, impact to available credit/financing, as well as any secondary impacts (e.g., decline in air travel disrupting supply chain, etc.). At the very least, we should see some interesting SEC comment letters.

• RFF #3: The Impairments are Coming!(?)

• Accounting for the Coronavirus

FASB

Reference Rate Reform (i.e., LIBOR transition)

ASU 2020-04

Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Topic 848)

March 12, 2020

March 12, 2020⁴
(1Q 2020)

What’s Changin’: Companies replacing LIBOR (expires at the end of 2021) with a new rate within various hedging, debt, lease and other financial contracts may treat the change as a continuation of the existing contract (and not a new/modified contract, which would likely impact earnings). Additionally, companies have the one-time option to sell or transfer held-to-maturity (HTM) debt securities that reference LIBOR to available-for-sale or trading classification, resulting in an impact to earnings.

Impact: Assuming the rate is the only notable change in contracts, expect to see minimal income statement volatility (excluding the impact from HTM reclassifications/sales). Simplifying the transition and preserving existing contracts may come at a cost: investors may not see the impact LIBOR’s demise (e.g., decrease/increase in interest rate) until the contract expires or the financial instrument is sold. Watch out for companies playing games with the HTM reclass.

• Financials

• Real Estate

• 10-K Checklist: Get Behind the Numbers

FASB

Pensions: Disclosures

ASU 2018-14

Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans

August 28, 2018

December 15, 2020²
(2020 10-K)

What’s Changin’: Additions and eliminations to existing pension/OPEB disclosures, including a new disclosure on drivers of significant gains/losses from Pension/OPEB plans and the removal of the disclosure on the impact of a 1% change in health care cost trends.

Impact: A net negative to transparency. We expect accounting fluff for the new disclosures on significant gains and losses related to pension/OPEB plans (e.g., changes in interest rates and mortality rates). We’re also disappointed to see the removal of the disclosure on deferred gains/losses expected to be reversed out of AOCI and the effect of a 1% change in health care cost trends, both were useful in forecasting pension/OPEB expense. Sad!

• Communication Services

• Consumer Discretionary

• Industrials

• 10-K Checklist: Get Behind the Numbers

FASB

Fair Value: Disclosures

ASU 2018-13

Disclosures Framework - Changes to the Disclosure Requirements for Fair Value Measurement

August 28, 2018

December 15, 2019
(1Q 2020)

What’s Changin’: Additions and eliminations to existing fair value disclosures, including a new disclosure on movements in OCI from level 3 assets/liabilities and the removal of the disclosure on the valuation process for level 3 assets/liabilities.

Impact: All about that transparency. Insight into changes to OCI should help investors better understand the potential impact to the income statement and future cash flows. The removal of valuation process description for level 3 assets/liabilities (the most difficult to value stuff) is partially offset by a new requirement to disclose the range and wtd. average of “significant unobservable inputs” used to value level 3 assets/liabilities (e.g., discount rate used in cash flow model).

• Consumer Discretionary

• Financials

• Industrials

• 10-K Checklist: Get Behind the Numbers

FASB

Costs for Episodic TV Series

ASU 2019-02

Intangibles - Goodwill and Other: Improvements to Accounting for Episodic Television Series

March 6, 2019

December 15, 2019
(1Q 2020)

What’s Changin’: Similar to guidance for film production costs, episodic content production costs are capitalized (and amortized) without being subject to a constraint.

Impact: Capitalizing more costs means a bigger balance sheet and likely a temporary boost to earnings.

• Consumer Discretionary

• Information Technology

• 10-K Checklist: Get Behind the Numbers

FASB

Cloud Computing Costs

ASU 2015-05

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement

August 29, 2018

December 15, 2019
(1Q 2020)

What’s Changin’: Cloud computing implementation costs (e.g., customizing software to customer’s needs) are eligible for capitalization. Under Old GAAP, such costs are only eligible for capitalization if a customer acquires the software license (which doesn’t happen with cloud computing arrangements).

Impact: Temporary boost to margins and potential smoother earnings profile. Also provides a boost to EBITDA and maybe non-GAAP earnings (for those that add back amortization).

• Communication Services

• Consumer Discretionary

• Information Technology

• 10-K Checklist: Get Behind the Numbers

FASB

Goodwill: Impairment Testing

ASU 2017-04

Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350)

January 26, 2017

December 15, 2019
(1Q 2020)

What’s Changin’: Step 2 of the goodwill impairment test is eliminated. Under Topic 350, if the fair value of a reporting unit is less than its carrying value, the difference between the two is the impairment charge (up to the amount of goodwill on the balance sheet).

Impact: Impairments should happen faster and amounts could differ from Old GAAP.

• Financials

• Health Care

• Industrials

• Information Technology

• These Intangibles Smell a Bit Off: Did We See Kraft Heinz Impairments Coming? (Case Study-ish)

FASB

Credit Losses

ASU 2016-13

Measurement of Credit Losses on Financial Instruments (Topic 326)

June 16, 2016

December 15, 2019³
(1Q 2020)

What’s Changin’: Companies will book an allowance for loan losses based on the expected credit losses (CECL = Current Expected Credit Losses), meaning the potential recognition of a loss and a reduction in carrying value of a loan on Day 1. No more waiting until the loss is “probable”. Also applies to debt securities, trade receivables, etc.

Impact: Expect increased loan loss reserves, which will put pressure on earnings and book value.

• Consumer Discretionary

• Financials (notably Banks)

• Industrials

• CECL Disclosures: Trying to Understand Management’s Credit Loss Magic 8-Ball

• CECL is Here – and It Ain’t Just About Banks

SEC

Auditor Independence

S7-10-18

Auditor Independence with Respect to Certain Loans or Debtor-Creditor Relationships

(Regulation S-X)

June 18, 2019

October 3, 2019

What’s Changin’: Replaces the “10% bright-line test” (if an audit firm/covered person/family members owned 10% or more of audit client’s equity, than the firm is not independent) with a more subjective, “significant influence” test (using FASB guidance). Additionally, the definition of “audit client” for a fund no longer includes any other funds that would be an affiliate of the audit client (e.g., sister funds).

Impact: The removal of the 10% test is supposed to resolve situations in which auditors were technically not independent but remained objective/impartial. While this rule will help reduce auditor’s compliance costs, we can’t help but think the SEC is slowly chipping away at independence requirements, watch out!.

• Financials

FASB

Hedge Accounting

ASU 2017-12

Derivatives and Hedging (Topic 815)

August 28, 2017

December 15, 2018
(1Q 2019)

What’s Changin’: Easier to get hedge accounting treatment as the accounting rules are “simplified". Other changes include no longer requiring companies to separately measure and record hedge ineffectiveness. All changes in the fair value of derivatives eventually show up on the same income statement line item as hedged item.

Impact: Smoother earnings and fewer non-GAAP adjustments. Watch out for more hedging losses/gains hiding in OCI and more earnings management.

• Energy

• Financials

• Industrials

• Materials

• Red Flag Finder #5: The FX Mess - Explained

• 10-K Checklist: Get Behind the Numbers

FASB

Leases

ASU 2016-02

Leases (Topic 842)

February 25, 2016

December 15, 2018
(1Q 2019)

What’s Changin’: Most leases (excluding those with terms of one year or less) are coming on the balance sheet. No change to the income statement as operating leases will result in rent expense and finance leases (Topic 842’s version of capital leases) will result in interest expense and amortization.

Impact: Look for balance sheets to grow (the amounts may surprise you). Minimal expected impact on earnings.

• Communication Services

• Consumer Discretionary (notably Retail)

• Industrials (notably Airlines)

• The Leases Have Landed: Might be a Few Surprises Coming Your Way

FASB

Income Taxes: Intracompany Transactions

ASU 2016-16

Intra-Entity Transfers of Assets Other Than Inventory

October 24, 2016

December 15, 2017
(1Q 2018)

What’s Changin’: Companies must now recognize the tax impact of intra-entity transfers, other than inventory (e.g., Sub A sells Sub B a license for a $50 gain). Under Old GAAP, companies couldn’t recognize the tax impact until the transferred asset was sold to a third party (e.g., when Sub B sells license to customer).

Impact: Expect volatility in the bottom line, likely in the form of an increase in income tax expense for companies selling IP to a related party in a low tax jurisdiction. Question is whether you should adjust your model for the impact. Keep an eye on this going forward as it may provide a signal that some tax planning is taking place.

• Communication Services

• Health Care

• Information Technology

• 10-K Checklist: Reading a 10-K, It's Fannntastic!

FASB

Cash Flows: Restricted Cash

ASU 2016-18

Statement of Cash Flows - Restricted Cash (Topic 230)

November 17, 2016

December 15, 2017
(1Q 2018)

What’s Changin’: Transfers between restricted cash/cash equivalents and (unrestricted) cash/cash equivalents are no longer presented in the statement of cash flows. Prior to this ASU, the FASB wasn’t clear on this, meaning transfers between restricted cash/cash equivalents and (unrestricted) cash/cash equivalents would show up in different places on the cash flow statement (e.g., operating, investing or financing) for different companies.

Impact: Possible changes to cash flow metrics, such as FCF.

• Financials

• Health Care

• Information Technology

FASB

Cash Flows: Classification

ASU 2016-15

Classification of Certain Cash Receipts and Cash Payments (Topic 230)

August 26, 2016

December 15, 2017
(1Q 2018)

What’s Changin’: New guidance that clarifies the classification and location of specific cash receipts/payments in the statement of cash flows. Most notably, moving some of the proceeds received from receivable securitizations (the beneficial interest portion) from operating to investing cash flow.

Impact: Potential changes to cash flow from ops, free cash flow, free cash conversion, etc. Could see more non-GAAP cash flow metrics.

• Communication Services

• Consumer Discretionary

• Financials (notably Banks)

• Industrials

• New Rule Could Reduce Cash Flow from Ops and Free Cash Flow

FASB

Financial Instruments

ASU 2016-01

Recognition and Measurement of Financial Assets and Financial Liabilities

January 5, 2016

December 15, 2017
(1Q 2018)

What’s Changin’: Changes in the fair value of equity securities (typically where company owns less than 20%) now run through earnings. For non-marketable equity securities (e.g., pre-IPO), companies can choose to apply a new valuation method similar to cost. Changes in the fair value of liabilities (if elected) due to company’s own credit risk go to OCI.

Impact: Increased earnings volatility and more non-GAAP adjustments (watch out for those that only add back losses) for companies that invest in equities. It’s the opposite (less volatility, less non-GAAP) for own credit marks on liabilities.

• Financials

• Information Technology

• Accounting for a Drop in Stock Prices

FASB

Definition of a Business

ASU 2017-01

Clarifying the Definition of a Business (Topic 805)

January 5, 2017

December 15, 2017
(1Q 2018)

What’s Changin’: Narrows the definition of a business, which is used to determine whether a transaction is an asset acquisition or business combination.

Impact: Expect more transactions to be treated as asset acquisitions. Meaning less goodwill (less accretive), less disclosure but more deal costs capitalized.

• Energy

• Health Care

• Information Technology

• 10-K Checklist: Business in the Front, Party in the Back

FASB

Pensions: Income Statement

ASU 2017-07

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (Topic 715)

March 10, 2017

December 15, 2017
(1Q 2018)

What’s Changin’: Only service cost stays in operating income while the remaining pieces (e.g., interest cost, expected return, amortization of gains/losses/prior service) need to go somewhere else. Additionally, only service cost is eligible for capitalization as part of inventory or PP&E.

Impact: Changes to operating and gross margins.

• Communication Services

• Consumer Discretionary

• Industrials

• Pensions in Pictures V

FASB

Contract Costs (e.g., sales commissions)

ASU 2014-09, subtopic ASC 340-40

Other Assets and Deferred Costs

May 28, 2014

December 15, 2017
(1Q 2018)

What’s Changin’: Accompanying Topic 606 (new revenue standard), ASC 340-40 brought changes to accounting for contract costs, resulting in most incremental costs of obtaining a contract (e.g., sales commissions) being capitalized.

Impact: Capitalizing contract costs means bigger balance sheets and a boost to margins.

• Industrials

• Information Technology (notably Software)

• Top Lines They Are A-Changin' #5: Moving Revenue Fast and Capitalizing Things (Tech Sector)

FASB

Revenue Recognition

ASU 2014-09

Revenue from Contracts with Customers (Topic 606)

May 28, 2014

December 15, 2017
(1Q 2018)

What’s Changin’: One revenue standard for all sectors/industries. New five-step process that determines the amount and timing of revenue recognition. Contracts are broken into separate components (“performance obligations”) and revenue is recognized when “control” is transferred to the customer. New disclosures should help you assess management judgment calls (we have not been too impressed so far).

Impact: Causes revenue to be recognized faster in many cases (for others it slowed) and the patterns become lumpier for some and smoother for others. Brings more judgment to the top line.

• Consumer Discretionary (notably Retail)

• Health Care

• Industrials

• Information Technology (notably Software)

• Top Lines They Are A-Changin’ #8: RPO, The New, New Backlog

FASB

Going Concern

ASU 2014-15

Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern

August 27, 2014

December 15, 2016²
(2016 10-K)

What’s Changin’: Evaluating a company’s ability to continue as a going concern isn’t just an auditor thang anymore. Management must disclose if “substantial doubt” (>70% chance) exists about a company’s ability to continue as a going concern within one year after the date the financial statements are issued.

Impact: Having an insider (management) and outsider (auditor) perspective on a company’s ability to continue as a going concern is a net positive. Though, we don’t expect to see many of these new disclosures and investors (hopefully) already knew about the company’s dim prospects prior to reading them.

FASB

Stock Comp: Tax Benefits

ASU 2016-09

Improvements to Employee Share-Based Payment Accounting (Topic 718)

March 30, 2016

December 15, 2016
(1Q 2017)

What’s Changin’: All stock comp related tax benefits now run through the income statement and cash flow from operations (no more “excess” tax benefit).

Impact: Increase in earnings and operating cash flow volatility. Low quality boost to earnings and free cash flow. Higher diluted share count.

• Health Care

• Information Technology

• Accounting for a Drop in Stock Prices

FASB

Deferred Taxes

ASU 2015-17

Balance Sheet Classification of Deferred Taxes (Topic 740)

November 20, 2015

December 15, 2016
(1Q 2017)

20151215 What’s Changin’: All deferred tax assets and liabilities are classified as non-current.

Impact: Reduction in current assets/liabilities, making a few metrics/ratios out of whack (e.g., working capital, current ratio, operating cash flow ratio, etc.)

• The Case of the Missing Deferred Taxes

FASB

Debt: Issuance Costs

ASU 2015-03

Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs

April 7, 2015

December 15, 2015
(1Q 2016)

What’s Changin’: Debt issuance costs (e.g., fees or commissions paid to banks, lawyers, etc.) are no longer an amortizable asset, instead treated as direct reduction of debt (like how equity issuance costs are treated).

Impact: No income statement impact as the amortization of debt issuance costs continues to be treated as interest expense. Ratios such as ROA (increase) and leverage (decrease) may change minimally.

• Communication Services

• Consumer Discretionary

• Industrials

• Utilities

SEC

MD&A Disclosures and More

S7-01-20

Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information

(Regulation S-X)

November 19, 2020

August 9, 2021⁷
(2021 10-K)

What’s Changin’: A lot on the chopping block, including removing the contractual obligations table, eliminating the need to separately disclose off-balance sheet arrangements (instead, will be discussed throughout MD&A), as well as remove the requirement to disclose five years of selected financial information in MD&A. However, all is not lost as the SEC will now explicitly require companies to disclose critical accounting estimates (companies previously considered the need to disclose). Additionally, companies must discuss material cash requirements (e.g., cash commitments).

Impact: A big loss in transparency and information for investors. Instead of having items like contractual obligations and off-balance sheet arrangements in one uniform place, investors must perform a scavenger hunt to try and find the information (good luck!). We’re fans of the additional cash disclosures but that doesn’t make up for the loss of information.

• 10-K Checklist: Get Behind the Numbers

• RFF #2: The Double L (Leverage and Liquidity)

SEC

Auditor Independence

S7-26-19

Amendments to Rule 2-01, Qualifications of Accountants

(Regulation S-X)

October 16, 2020

June 9, 2021

What’s Changin’: Another round of auditor independence changes, including auditors now only need to be independent of their IPO audit clients as of the preceding fiscal year (previously had to be independent for all periods presented in IPO filing, typically 3 years) and added a materiality qualifier when assessing whether a sister entity is an affiliate of the audit client under common control (e.g., portfolio companies owned/backed by private equity or venture capital).

Impact: We take issue with shortening the IPO look-back period. The last thing you want with a new public company that may have complex accounting and likely doesn’t have strong internal controls is a too cozy relationship with the auditor. The materiality qualifier should avoid independence issues when an auditor provides non-audit services to one, arguably immaterial company while auditing another company under common control.

• Financials

FASB

Proposed - Income Taxes: Disclosures

Proposed

Income Taxes (Topic 740): Disclosure Framework - Changes to the Disclosure Requirements for Income Taxes

March 25, 2019⁶

N/A

What’s Changin’: A bundle of new (or modified) tax disclosures coming, including: a disaggregation of tax carryforwards broken out by expiration over the next five years and beyond (e.g., $100 million in DTA expires in 20X0, $50 million in 20X1, $75 million with no expiration, etc.), the requirement to disclose taxes paid quarterly and broken down between: federal, state and foreign (been on our wish list for a while, note: federal taxes paid on foreign income would be classified as federal)

Impact: The new tax carryforward disclosures should help with modeling out future book and cash tax rates. Notably missing: disaggregation of income tax expense, pretax income and cash taxes paid by major tax jurisdiction (i.e., individual countries and/or states).

• 10-K Checklist: Reading (a 10-K) is Fundamental

FASB

Government Assistance

ASU 2021-10

Disclosures by Business Entities about Government Assistance

November 17, 2021

December 15, 2021 ⁹
(2022 10-K)

What’s Changin’: A whole bunch of new disclosures on government assistance (e.g., grants, property tax reductions, low-interest loans, etc.), including: nature of assistance (e.g., a cash grant received), accounting policy (e.g., recognize it as a reduction in expense when received), and the financial statement line items impacted. Today, this type of info is hit or miss since the FASB didn’t have rules (some companies looked to IFRS standards, IAS 20, for guidance). It’s worth noting income taxes and contracts in which the government is the customer are excluded.

Impact: We’re all for the increase in transparency. Added info on the terms of government assistance, such as duration and contingencies, should help with your models/forecasts, assuming such agreements are material and the disclosures aren’t boilerplate (big assumption).

• Communication Services

• Consumer Discretionary (notably Autos)

• Energy

• Health Care

• Industrials

• Information Technology

FASB

Proposed - Supply Chain Finance Disclosures

Proposed

Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations

December 20, 2021 ⁶

N/A

What’s Changin’: New disclosures (currently there are none) on supply chain finance programs, i.e., Wall Street’s latest new toy that magically allows suppliers to get their cash earlier and buyers to pay later, all with the help of your friendly neighborhood financial institution (at a cost of course). Current Board disclosure proposals include:

•Key terms of the arrangement (e.g., buyer’s involvement in the program, whether the suppliers can get paid early and the buyers can extend payment terms, etc.)

•Size of the program (i.e., amount under the arrangement that is outstanding)

•Balance sheet classification (i.e., is it debt or a trade payable?)

Impact: New disclosures could (emphasis added) allow investors to create an apples-to-apples comparison, regardless of a company’s accounting policy for supply chain finance programs. We’re in support of current Board proposals, assuming management and investors have similar definitions of “key terms”.

• Consumer Discretionary

• Consumer Staples

• Industrials

• Information Technology

• RFF #4: When the Bill Eventually Comes Due

FASB

Initial Deliberations - Goodwill

*In initial deliberations stage, no current proposal*

N/A

N/A

What’s Changin’: For the ultimate accounting throwback, the FASB may reintroduce goodwill amortization (possibly with some form of impairment testing too). Since 2002, companies stopped amortizing goodwill and instead test it for impairment at least once a year, sometimes resulting in “one-time” write-offs.

Impact: A potentially smoother (though lower) earnings profile will result in even more non-GAAP adjustments and possibly less impairments (depending on amortization period). We think amortization may be double counting (companies are already spending $ to maintain the goodwill, in the form of things like R&D, training, etc.) and are worried about the potential disconnect with IFRS (the IASB seems to be going down the improved disclosures route).

• Financials

• Health Care

• Industrials

• Information Technology

• These Intangibles Smell a Bit Off: Did We See Kraft Heinz Impairments Coming? (Case Study-ish)

FASB

Initial Deliberations - Disaggregation of Performance Information

*In initial deliberations stage, no current proposal*

N/A

N/A

What’s Changin’: The FASB is focusing on disaggregating costs of sales and SG&A into their natural components based on how “management internally views the consolidated expenses” (e.g., SG&A would be further broken down into labor, rent expense, etc.). The information would either be provided in the income statement (as separate line items) or through disclosures. The Board is currently focusing on: (1) SG&A, (2) cost of services and other cost of revenues, and (3) cost of tangible goods sold.

Impact: Hooray for more information, but we don’t expect to see an exposure draft anytime soon. We’re a little skeptical on the management view approach (cue lack of information in segment reporting). Additionally, we’re disappointed to see the FASB’s “Structure of the Performance Statement” remain in research purgatory, along with any hopes of a GAAP definition of “operating” and “non-recurring”.

• Non-GAAP is Wack? #2: Finding Accounting Glitches in Software

FASB

Initial Deliberations - Segment Reporting

*In initial deliberations stage, no current proposal*

N/A

N/A

What’s Changin’: The Board is focusing on adding “significant expense” categories reviewed by management (on top of existing requirements), such as R&D and marketing expenses. Currently, required disclosures include segment profit/loss (can be non-GAAP), total assets and other metrics like revenue (if included in segment P&L or provided to chief operating decision maker). Companies must also reconcile segment revenues, P&L, assets, etc. to the consolidated totals.

Impact: We’re all for the additional segment metrics/increase in transparency, though we hope the FASB eventually addresses segment identification and aggregation of segments (there’s too few segments), specifically the amount of judgment involved (went down that path in 2018 but received pushback and seem to be back at the drawing board). Sadly, the Board is no longer interested in requiring specific disclosures, such as a measure of cash flow and inventory by segment.

• 10-K Checklist: Get Behind the Numbers

FASB

Acquired Contract Assets and Liabilities (i.e., deferred revenue)

ASU 2021-08

Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers

October 28, 2021

December 15, 2022
(1Q 2023)

What’s Changin’: Acquired contract assets (i.e., unbilled receivables) and contract liabilities (i.e., deferred revenue) will be initially measured under revenue recognition guidance (Topic 606) rather than at fair value.

Impact: Expect an increase in acquired deferred revenue, resulting in more post-acquisition revenue recognized (vs. previous accounting). Using fair value to measure acquired deferred revenue often resulted in it being “haircut”, which reduced the amount of future revenue recognized. Management may now have less of a need for non-GAAP adjustments. Though this may come at a cost: a drag on FCF conversion, a greater incentive for management to “purchase revenue” through acquisitions and increased goodwill balances.

• Industrials

• Information Technology

SEC

Key Performance Indicators (KPI) and Metrics

Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations⁵

(Regulation S-K)

January 30, 2020

February 25, 2020
(1Q 2020)

What’s Changin’: When it comes to KPI and other related metrics (e.g., sales per sq foot, page views, customer churn, etc.), the SEC reminded companies to:

•Define the metric and how it’s calculated

•Discuss why the metric is useful

•State how management uses and monitors the metric

The SEC also asked for additional disclosures if there’s a change in how the metric is calculated or presented, including the reason for the change and the impact (vs. prior calculation method).

Impact: We’re all for increased transparency on KPI’s, especially any info on how they are calculated and if that changed. We remind investors to be wary of potential disconnects between the metrics and underlying economics. Also, be careful when comparing KPI’s across companies, metrics that have the same label may be calculated differently.

• Communication Services

• Consumer Discretionary

• Industrials

• Information Technology

• 10-K Checklist: Get Behind the Numbers

SEC

Special Purpose Acquisition Companies (SPACs)

Corporate Finance Disclosure Guidance: Topic No. 11⁵

December 22, 2020

December 22, 2020

What’s Changin’: The SEC reminded SPACs of existing disclosure requirements, primarily focusing on potential conflicts of interest between SPAC insiders (i.e., sponsors, board members, etc.) and investors.

•Conflicts of Interest: Information on how SPAC insiders are compensated and how their incentives may differ from investors, differences in securities owned by insiders (e.g., convertible debt) vs. investors, and potential conflicts with acquisition target (e.g., SPAC insider owns existing shares in acquisition target).

•Target Acquisition: A list of information on the target, such as who initiated the contact (maybe the IPO underwriter?), why was the target selected (vs. peers) and how the purchase price was determined (lots of management judgment).

•Other: Additional disclosures include total ownership % SPAC insiders have in post-acquisition company, IPO underwriter compensation (which may be deferred until acquisition) and ability of SPAC insiders to extend acquisition timeline (typically 18-24 mos. after IPO).

Impact: Whole lotta disclosure reminders means SPACs are likely an area of interest for the SEC (comment letters/enforcement actions coming?). From SPAC insiders having different terms of ownership (vs. investors) and being incentivized to find a target company quickly, there’s a SPACtacular list of conflicts of interest to monitor!

SEC

Foreign Company Disclosures and Audits

S7-03-21

Holding Foreign Companies Accountable Act (HFCAA)

April 5, 2021

May 5, 2021

What’s Changin’: The SEC will identify companies that have an audit report issued by a PCAOB-registered audit firm with a foreign office⁸ that the PCAOB is unable to inspect/investigate (“Commission-Identified Issuers”). Being labeled as a Commission-Identified Issuer for three consecutive years will result in the company’s securities being banned from U.S. markets. Other requirements include:

•submission of documentation proving the company is not owned/controlled by a foreign government.

•new disclosures specific to foreign Commission-Identified Issuers, including % of shares owned by a foreign government and whether any Chinese Communist Party officials serve on the company’s board.

Impact: We’re all for increased transparency regarding work of foreign audit firms, though concerned the SEC has stepped foot in a political minefield and questions remain, such as how the SEC will go about identifying these impacted companies (we’re in support of an SEC-published list of issuers that the Commission is seeking comment on) and audit firms.

SEC

SPAC Warrants

Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”)⁵

April 12, 2021

April 12, 2021

What’s Changin’: The SEC addressed whether certain warrants issued by SPACs are considered equity (appears to be the favored accounting approach prior to the SEC statement) or a liability. The focus is on two aspects of warrant accounting:

•Indexation: if the warrant settlement amount is dependent on the type of shareholder (e.g., warrant owned by SPAC sponsor vs. warrant owned by public shareholder), the warrant is not indexed to the company’s stock and is therefore a liability.

•Tender offer provisions: if SPAC warrant holders receive cash and not all common shareholders are entitled to cash in the event of a tender offer, the warrant is treated as a liability.

Impact: Depending on the materiality of a SPAC’s warrants, there could be potential restatements, a material weakness in internal controls, increased leverage and additional income statement volatility if the SPAC’s warrants weren’t correctly accounted for…oh my! Another reminder of the SEC’s interest in SPACs and need for investor caution.

SEC

Proposed - Executive Comp Clawback

Proposed

Listing Standards for Recovery of Erroneously Awarded Compensation

July 14, 2015

(Proposal revived on October 14, 2021; it was originally issued in 2015 but not adopted)

N/A

What’s Changin’ : The proposed rule vastly expands existing executive compensation clawback rules (under SOX) by,

•expanding the clawback period to the three years prior to restatement date due to a material error (vs. one year under SOX),

•removing SOX’s requirement that misstatement must be due to misconduct, meaning executives would be accountable regardless of their own conduct and/or whether due to fraud and

•applying the rules to all executive officers (e.g., division heads, presidents, VP, etc.), not just the CEO and CFO.

Failure to comply with this rule would result in delisting (ouch!).

Impact: This rule comes with teeth, hitting management where it hurts: their wallets. It also holds more of management accountable for restatements and no longer allows execs to blame others to protect their payouts. We’re all for increased accountability and hope this improves management behavior (e.g., tightening up internal controls), though question how much this rule differs from existing voluntary clawback policies adopted by companies.

SEC

Stock Comp

Staff Accounting Bulletin No. 120⁵

November 24, 2021

December 1, 2021

What’s Changin’ : Companies must now incorporate material non-public information (MNPI) when valuing the stock comp related to “spring-loaded” awards (given when a company is in possession of MNPI that will likely boost the share price). Prior to this update, MNPI may not have been incorporated, thereby undervaluing the stock award and understating the related expense. Additionally, existing disclosures may need to be updated to reflect the new information (e.g., significant assumptions used to measure the fair value of stock options).

Impact: We’re all for increased transparency and accuracy when valuing spring-loaded awards though question whether management behavior will change, particularly if companies just add-back the increased stock comp in non-GAAP results.

• Health Care

• Information Technology

• Non-GAAP is Wack? #5: Hey Adjusted EBITDA, Stock Comp is Really Real

SEC

Proposed – Executive Comp vs. Performance

Proposed

Pay Versus Performance

May 7, 2015

(Proposal revived on January 27, 2022; it was originally issued in 2015 but not adopted)

N/A

What’s Changin’: The SEC is proposing additional disclosures around executive comp vs. company performance within proxy statements, including a new pay vs. performance table covering executive comp over the past five years. Notable metrics within the table include:

•Total compensation: includes stock comp and pension benefits

•Total shareholder return (TSR): both for the company and its peer group

•GAAP measures: pre-tax income/loss and net income/loss

•Company-selected measure: defined as “the most important performance measure” tied to executive comp

The SEC is also considering a tabular disclosure of the “five most important performance measures” tied to executive comp (decided by management).

Impact: We’re all for increased transparency on executive comp, particularly having everything in an easy-to-read table and the five most important performance measures tied to compensation (how do those compare with what the company reports to investors?), though there may be some comparability issues (looking at you adjusted EBITDA).

• Non-GAAP is Wack? #5: Hey Adjusted EBITDA, Stock Comp is Really Real

SEC

Proposed – Cybersecurity

Proposed

Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure

March 9, 2022

N/A

What’s Changin’: The SEC is requiring new cybersecurity disclosures, including:

•Material incident filings: companies must file a Form 8-K within four days after determining a cyber incident is “material”, disclosing information on the event including, a description of incident, when it was discovered, data impacted, etc.

•10-K disclosures: additional info on companies’ cybersecurity programs, use of third-parties for cybersecurity help, how cyber risks/incidents impact operations (e.g., consumer fines and legal costs) and management’s role.

•Governance disclosures: information on the board’s oversight of cybersecurity risks, including the process for informing the board about cyber risks/incidents and whether any board member has cybersecurity expertise.

Impact: Timely and improved disclosures around cyber incidents are much appreciated, though we’re curious how long it will take management to determine an incident is “material”. We’re also wondering whether management will now beef up their cybersecurity teams and bring cyber experts on the board.

• 10-K Checklist:Dig Into the Numbers

SEC

Proposed - Special Purpose Acquisition Companies (SPACs, continued)

Proposed

Special Purpose Acquisition Companies, Shell Companies, and Projections

March 30, 2022

N/A

What’s Changin’: A bunch of new SPAC info on a variety of topics, including:

•Fairness/conflicts of interest: disclosures around whether the SPAC believes the de-SPAC transaction is fair to investors (e.g., SPAC didn’t overpay for acquisition) and conflicts of interest between the SPAC sponsor and public investors (e.g., SPAC sponsor has financial interest in target company)

•Extended liability: the private company acquired by SPACs are now considered “co-registrant” and underwriters of the original SPAC that also helped with de-SPAC transaction are considered underwriters for that transaction as well.

•Projections: new information on who prepared the financial projections, whether the projections are based on historical information and appropriate GAAP to non-GAAP reconciliations for non-GAAP projections.

Impact: With increased liability, the management team (of both the SPAC and acquired company) and underwriters will hopefully be more diligent with the de-SPAC transaction (…or potentially face investor lawsuits). We’re also all for reigning in sky-high projections with no basis and warning investors about potential conflicts of interest.

SEC

Cryptocurrency Accounting

Staff Accounting Bulletin No. 121

March 24, 2022

June 15, 2022

What’s Changin’: Various changes to the accounting and disclosures for companies that hold crypto-assets for others or provide a cryptocurrency exchange platform:

•Financial statements: recognition of a liability and corresponding asset related to the safeguarding of crypto-assets, both of which are measured at fair value.

•Disclosures: information on the nature and amount of crypto-assets held for its users, risks related to any concentration in crypto-assets (e.g., hold 10% of BTC), who holds the crypto-asset keys and safeguards the assets, as well as fair value disclosures (e.g., impairment testing, determining the right market comp, etc.)

Impact: For custodians and cryptocurrency exchange providers, the capitalization of the safeguarded crypto-assets (on the balance sheet) and accompanying disclosures should help investors better understand the various risks the companies are exposed to. Additionally, expect some P&L volatility from fair value accounting, as well as potential impact to ratios such as leverage and capital requirements.

• Financials

• Crazy for Cryptocurrencies: A ZRG Perspective

SEC

Proposed – Climate-Related Disclosures

Proposed

The Enhancement and Standardization of Climate-Related Disclosures for Investors

March 21, 2022

Proposed

FY 2023 10-K’s¹⁰

What’s Changin’: New climate-related disclosures which include (but not limited to):

•Greenhouse gas (GHG) emissions: information on emissions from directly owned operations (Scope 1), indirect emissions from purchased energy (Scope 2) and all others (Scope 3); Scope 3 emissions are only disclosed if material and/or tied to an emission goal.

•Financial disclosures: the quantified impact of climate-related events (e.g., estimated damage to facilities from a hurricane) and transition activities (e.g., capex on windfarm to reduce emissions) on line items within the financials, as well as the accompanying assumptions/estimates.

•Climate-related risks and impact: how climate-related risks will impact the company from the short-, medium- and long-term, impact operations/strategy, as well as how the company identifies climate-related risks and manages them.

Companies will be required to provide additional information on any climate-related goals, such as the time horizon for the goals, how the company intends to meet the goals and data used to measure progress. Auditors will eventually provide assurance on the emissions metrics and disclosures (see footnotes).

Impact: The proposal should help satisfy investors’ demand for more climate-related information and increase comparability, as well as provide it all in one-place (the 10-K vs. various investor presentations and voluntary reports). Additionally, auditor assurance ideally should increase the reliability of the information (…as well as the Big Four’s profits). Given the magnitude of this proposal and changes, we expect pushback and possibly a delay in the effective date.

• 10-K Checklist:Dig Into the Numbers

SEC

Proposed – Share Buybacks

Proposed

Share Repurchase Disclosure Modernization

December 15, 2021

N/A

What’s Changin': The proposed rule would provide more timely and granular information about share buybacks through two key changes:

•Form SR: a new form filed with the SEC the day after share buybacks which would include info such as class of securities repurchased (e.g., preferred stock, class A, class B, etc.), number of shares repurchased, and average price paid.

•Improved 10-K/Q Disclosures: the objective of share repurchases and how management determines the amount to repurchase, as well as any policies related to insiders selling during a repurchase program.

Impact: The increased granularity and timeliness (daily vs. existing monthly data on repurchases) could be valuable, such as identifying questionable management behavior (e.g., announce repurchase to boost share price prior to an insider sale), assuming the company doesn’t already publicly announce buybacks. The additional data could also help in measuring whether buybacks are value-added or not, which we have a few thoughts on (see research link). We’ll wait and see on the share repurchase objective info, which sounds good in theory, but we fear reality will be boilerplate (“return capital to shareholders”).

• Buybacks, Who’s Bad (or Good)?