The Office of the Chief Accountant (OCA) within the Securities and Exchange Commission allows financial statement filers to seek guidance on complex or novel accounting treatments. The consultations give the OCA staff a window into the companies' struggles.
At the Financial Executives International’s Corporate Financial Reporting Conference on Monday, held virtually, OCA and the SEC division of corporate finance staff raised the themes they see heading into regulatory reporting season this year.
One is risk assessment. Anita Doutt, senior associate chief accountant at the OCA, said the OCA has heard troubling feedback about management being “too narrowly focused” on matters directly affecting financial reporting and missing or disregarding broader, entity-level issues that could indirectly impact financial reporting. A data breach or a regulatory finding would be an example.
“We've observed that sometimes preparers don't dedicate the same level of rigor and attention to the statement of cash flows as they do to the other statements."
Senior associate chief accountant, OCA
“Management may be inadvertently biased towards evaluating each incident in isolation or rationalizing away disconfirming evidence and basically can conclude that these matters don't individually or in the aggregate rise to the level of a disclosure,” Doutt said.
When management has such a narrow focus, it can result in material risks to the business, Doutt added. The company may not have appropriate controls around the identified risks or they’re undisclosed. “And when you have such a narrow focus, that's harmful to investors … as a whole it diminishes the quality of the financial information,” Doutt said.
Doutt brought up the statement of cash flows as an example. “We've observed that sometimes preparers don't dedicate the same level of rigor and attention to the statement of cash flows as they do to the other statements,” she said. “The risk assessment process, and then identifying the key risks related specifically to the statement of cash flows are critical to internal controls over financial reporting [ICFR] and [the company’s] financial reporting quality.”
“There are a lot of little “r” revisionary statements in the statement of cash flows,” said Doutt. “Issuers are routinely deciding that material errors in the statement of cash flows don’t require that big “R” restatement.
The second common theme is auditor independence. Doutt reminded attendees that auditor independence is a shared responsibility between auditor management and the audit committee.
“There are all these news articles about [audit] firms changing their operating structure and other types of transactions,” Doutt said. “[The changes are] introducing complexity to entities and increasing the number of entities that must be monitored for auditor independence of the accounting firm.” Doutt said these “indirect relationships” may give rise to the appearance of substantive issues related to auditor independence.
An effective approach to independence doesn’t just look at how relationships impact the accounting firm today but also how they could impact the firm in the future, especially for relationships that can’t be unwound, she said.
An example would be a business relationship between an auditor and a non-audit client with a lot of investing and acquisition activity. It might not impact existing audit relationships today, but the non-audit client’s acquisition and investing activity could impact future relationships, Doutt pointed out.
Non-GAAP: Still Problematic
The third theme, a frequent topic of SEC comment letters, is the financial measures outside of generally accepted accounting principles, or “non-GAAP.” Despite the SEC’s well-established guidelines on non-GAAP reporting, companies still have trouble with basic compliance, said Lindsay McCord, chief accountant of the division of corporate finance. That includes matters like the reconciliation of non-GAAP to GAAP, or “having a full-blown GAAP MD&A [management discussion & analysis] without having a regular GAAP MD&A,” she said.
Over time, companies that did not have many non-GAAP measures have increased their non-GAAP measures, which has led to issues with prominence — the relative way GAAP and non-GAAP numbers are presented. They include erroneously presenting non-GAAP numbers more prominently than GAAP numbers and failing to clearly label and describe non-GAAP measures.
The division of corporate finance released some new disclosure interpretations last December, said McCord, so it expected to see a decline in the comment letters on non-GAAP reporting. “It was our hope, to be honest, and we did not see that.”
For companies needing to consult the OCA on an accounting topic, Jonathan Wiggins, deputy chief accountant of the SEC, said a filer should reach out to the OCA far before an audit or filing financial statements.
“That allows the company to engage with us in a collaborative process where they can explain the transaction or the structure, the basis for its conclusions, and why it rejected any alternatives it considered,” he said. “The collaborative back and forth with plenty of time to work through those complex issues allows us to really understand the fact pattern in the analysis and then provide our views on whether or not we would object,” Wiggins said.