SEC Calls for Companies to Disclose Europe Debt Exposure

Staff members at the Securities and Exchange Commission have compiled a list of tips for preparers based on issues they commonly flag in their routine filing reviews, many of them driven by the poor economy and the debt crisis in Europe.

The SEC is looking carefully at how troubles abroad might affect companies and how they are explaining it to investors, said staff members speaking at a conference sponsored by the American Institute of Certified Public Accountants. Exposure to foreign debt and foreign currency exchanges, for example, are high on reviewers' checklists. Exposures in five specific countries deserve special attention—Greece, Ireland, Portugal, Italy, and Spain, said Kyle Moffatt, associate chief accountant at the SEC.

Where companies have exposure to debt in those countries, even if it doesn't exceed the usual threshold of 1 percent of total assets, investors deserve to hear all the ugly details, he said. Companies should assure their next 10-K provides transparent disclosure by country about gross and net exposures, directly or indirectly, to sovereign debt. “To merely provide disclosures on a net basis, even if offset by credit protection, is not sufficient for investors to understand registrants' exposures,” said Moffatt.

Ryan Milne, associate chief accountant at the SEC, said companies should be careful to make disclosures that help investors understand the impact of foreign currency exchange rates, considering not just issues that affect profit and loss, but other key measures that are important to the company as well.

Companies should address the nature of currency risk, said Milne, as well as any measures the company is taking to manage currency risks, any changes in exposures and how those exposures are managed, and any known trends in currency prices or anticipated exchange rates in future reporting periods. “We would also expect discussion of any positive impact and that it would have the same prominence as negative impacts,” he said.

Pensions and other post-employment benefits are also high on the SEC's checklist, said Milne. Such plans “have been on the receiving end of a double whammy, with interest rates being so low coupled with a decline in the value of plan assets in recent years,” he said. “Both result in increasing pension and other post-employment benefit obligations on the balance sheet.” Milne said the staff is concerned minimum statutory funding requirements will spike for companies carrying pension and OPEB liabilities, and they expect companies to give their investors some forewarning.

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Nili Shah, deputy chief accountant at the SEC, said companies need to think hard about their liquidity and capital disclosures in management discussion and analysis as it relates to their pension and OPEB obligations. The staff will be looking for companies to disclose any funding obligations they expect to face, even if they aren't sure what those obligations will be ultimately. “We understand there may be some uncertainty … but it may be possible to develop estimates based on assumptions used to measure pension and other post-employment benefit obligations at the balance sheet date,” she said.

“To merely provide disclosures on a net basis, even if offset by credit protection, is not sufficient for investors to understand registrants' exposures.”

—Kyle Moffatt,

Associate Chief Accountant,

Securities and Exchange Commission

The SEC is also taking note of companies that change their pension accounting policy to accelerate the recognition of changes in pension obligations, most recently to flush through pent-up losses so they won't create a drag on future earnings. A handful of major companies like Honeywell, AT&T, and others began testing the waters with such a change in accounting policy late last year. If other companies are thinking of following suit, Shah reminds them to get a letter from their auditors agreeing that the change in accounting policy is preferable to the existing policy and to provide plenty of disclosure.

For example, she said, companies need to be explicit about whether they are moving to recognize all gains and losses through earnings or only some. They also may face a significant fourth-quarter adjustment to elect such a change, she said, and that needs to be explained to investors as well. Finally, she said, some companies capitalize some of their employee costs through inventory or plant, property, and equipment. “There needs to be a consideration of how those gains or losses will be recognized, and disclose it,” she said.

Goodwill Watching

ECONOMIC CONSIDERATIONS

Below are “Considerations in the Current Economic Environment” from the AICPA's National Conference on Current SEC and PCAOB Developments:

Liquidity

Companies should consider the guidance in:

FR-83 – MD&A Release focused on Liquidity and

Capital Resources (companion release to Short-

Term Borrowings Proposal)

2003 Interpretive Release on MD&A (Release No.

33-8350)

Section 501.3 of the FRC

Income Taxes — DTAs/DTLs

“Forming a conclusion that a valuation allowance

is not needed is difficult when there is negative

evidence such as cumulative losses in recent

years.”

ASC 740-10-30-21

Testing Goodwill for Impairment – ASU 2011-08

Changes to Goodwill Impairment Test

Qualitative assessment was added

Assess qualitative factors to determine likelihood

(more than 50%) that FV of a reporting unit is less than

its CV, including goodwill.

Option to proceed directly to Step 1 without

performing qualitative assessment.

Corp Fin staff does not expect material changes

in the outcome of impairment testing/charges.

Goodwill Disclosures

MD&A Release 33-8350 for critical accounting

estimates.

FRM 9510 - “at risk” reporting units disclosures:

-The percentage by which fair value exceeded carrying

value as of the date of the most recent test;

-The amount of goodwill allocated to the reporting unit;

-A description of the methods and key assumptions used

and how the key assumptions were determined;

-A discussion of the degree of uncertainty associated

with the key assumptions; and

-A description of potential events and/or changes in

circumstances that could reasonably be expected to

negatively affect the key assumptions.

Pension and OPEB Plans

Double whammy

-Low interest rates

-Low asset returns

Impact on minimum statutory funding

requirements

Pension plan asset investment strategies

Changing accounting policy to accelerate

recognition of actuarial gains and losses

Other areas of staff comment

Source: AICPA.

In the area of goodwill, SEC staff will watch closely how companies test goodwill for impairment in light of new guidance from the Financial Accounting Standards Board that creates a simplified preliminary step. The new preliminary step allows companies to do a simplified, qualitative assessment of whether goodwill is likely to be impaired, and then take a pass on the full-blown, two-step impairment test prescribed by accounting rules if the results are favorable. Moffatt said it's a practical accommodation that shouldn't have a material effect on any company's actual impairment. “And we may have a comment if a registrant concluded it does have a material impact,” he said.

The idea is for the preliminary step, affectionately called the “step zero” test by many auditors, to create a filter for reporting units that will clearly pass the impairment test so they aren't subjected to the full test unnecessarily, said Moffatt. “We may have a comment if the step zero screen is used to avoid impairment testing on reporting units that are identified as at risk for failing step one,” he warned.

Additional advice offered by the staff includes:

Check the Financial Reporting Manual for changes in how to assess whether a subsidiary is subject to separate reporting based on terms of high-yield debt offerings.

Take care to study the criteria for when pro forma reporting would be required under Regulation S-X.

In the current economy, pay some special attention to disclosures about liquidity and capital resources, and button down the accounting around deferred tax assets and deferred tax liabilities.

Keep working on segment reporting and reporting of loss contingencies.

SEC staff also reminded accountants about the difference between a reclassification that can be corrected through an amendment and an error that must be corrected through a restatement. Todd Hardiman, an associate chief accountant, said a reclassification represents a change from one presentation that complies with Generally Accepted Accounting Principles to another that also complies, which is different from a flat-out mistake in the accounting.

He said the staff recently saw a case where a company had to correct its revenue recognition because it booked revenue as if it were the principal provider in a contract with a customer when it should have reflected the revenue as if it were an agent. Hardiman didn't name Groupon and its recent restatement of registration statements in its bid to become a public company, but the resemblance was uncanny. “If it needs to change the way it recognized revenue, from principal to agent, that's an error, not a reclassification, and it needs a restatement,” he said.