As the clock ticks toward the effective date of sweeping new standards on revenue recognition, leases and credit losses, a potential “sleeper” issue has been put to bed by a Center for Audit Quality alert that says the SEC views financial statements as inclusive of related footnote disclosures for purposes of SAB 74 – disclosure of the expected impact of accounting standards that have been issued by the Financial Accounting Standards Board, but not yet adopted.
SEC staff have recently reminded registrants, through speeches and other outreach, that even if the impact of implementing a new accounting standard cannot yet be estimated, the company is still obligated under SAB 74 to provide certain disclosures, including with respect to changes to the footnotes, which are an integral part of the financial statements.
SAB 74 disclosures
“SAB 74 addresses disclosure requirements for both the footnotes to the financial statements and Management’s Discussion and Analysis (MD&A),” says the CAQ’s alert, adding, “the SEC staff, through guidance and recent comments, have suggested they expect registrants to include” the following in their SAB 74 disclosures:
- A comparison of accounting policies
- Status of implementation
- Consideration of the effect of new footnote disclosure requirements in addition to the effect on the balance sheet and income statement
- Disclosure of the quantitative impact of new accounting standard(s) if it can be reasonably estimated
- Disclosure [if] the expected financial statement impact of new accounting standard(s) cannot be reasonably estimated
- [On another potential sleeper issue, the alert adds: “Financial statement users may incorrectly assume there is no material financial statement impact if the registrant does not state otherwise.”]
- Qualitative disclosures
Each of the above areas is further detailed in the CAQ alert, which states, “While this CAQ Alert highlights certain areas for consideration, it should not be relied upon as definitive or all-inclusive, and should be read and considered in conjunction with the applicable rules, standards, and guidance in their entirety.”
The lead-up to the CAQ’s alert included discussion at the CAQ’s SEC Regs Committee meeting in March, at which leading experts from audit firms and companies were directed to a speech by SEC Chief Accountant Wes Bricker. In that speech, Bricker addressed SAB 74 disclosure requirements which apply – even if a company cannot yet estimate the impact of a new standard, or estimates the impact as immaterial:
“If a company does not know or cannot reasonably estimate the expected financial statement impact, that fact should be disclosed. But in these situations, the SEC staff expects a qualitative description of the effect of the new accounting policies, and a comparison to the company’s current accounting to aid investors’ understanding of the anticipated impact. It should also disclose the status of its implementation process and significant implementation matters yet to be addressed.
“(S)ome companies indicate that the impact of the new revenue standard is not expected to be material. The changes in the new standard will impact all companies. Even if the extent of change for a particular company is slight, the related disclosures to describe revenue streams may not be. The scope of the new standard addresses not only amounts and timing of revenue but also new, comprehensive disclosures about contracts with customers, including the significant judgments the registrant has made when applying the guidance. Accordingly, the basis of any statement that the impact of the new standard is immaterial should reflect consideration of the full scope of the new standard, which covers recognition, measurement, presentation, and disclosure for revenue transactions.”
Meanwhile, says SEC Professional Accounting Fellow Sylvia Alicea, “Some have suggested that when SAB 74 refers to the ‘financial statements,’ it is concerned only with effects on the primary financial statements and not how disclosures in the notes to the financial statements may also be affected. I believe that such a view misses the definition of ‘financial statements,’ which includes the accompanying notes.”
Alicea also detailed the views of the SEC staff on rev rec matters including identifying the contract, identifying performance obligations, and measuring progress.
The CAQ alert emphasizes the role of internal control over financial reporting (ICFR). and says, “As part of providing robust SAB 74 disclosures, registrants should consider whether appropriate internal controls are in place. Such controls are important to management’s ability to address the risks that SAB 74 disclosures are inaccurate or incomplete”
Additionally, “As part of the audit of ICFR, auditors are required to assess the design effectiveness and to test the operating effectiveness of these relevant controls, which may include controls over these SAB 74 disclosures.”
On the subject of internal control, SEC’s Alicea has stated, “(I)n designing such controls and considering their necessary level of precision, management should consider, among others, the nature of the transition disclosures in light of the status of the company’s implementation efforts and the objective of these disclosures.”
The CAQ alert also emphasizes the auditor’s responsibilities, saying, “Auditors should consider reviewing SAB 74 disclosures during reviews of interim financial information,” in addition to the year-end audit.
The alert also notes that Public Company Accounting Oversight Board (PCAOB) standards, “require the auditor to communicate to the audit committee if concerns are identified regarding management’s anticipated application of a new accounting standard.”