current developments in the division of corporation finance
DESCRIPTION
CURRENT DEVELOPMENTS IN THE DIVISION OF CORPORATION FINANCE. National Conference on Current SEC & PCAOB Developments December 6, 2004. Disclaimer. - PowerPoint PPT PresentationTRANSCRIPT
CURRENT CURRENT DEVELOPMENTS DEVELOPMENTS
IN THE IN THE DIVISION OF DIVISION OF
CORPORATION CORPORATION FINANCEFINANCE
National Conference on Current SEC & PCAOB
DevelopmentsDecember 6, 2004
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The Securities and Exchange The Securities and Exchange Commission, as a matter of policy, Commission, as a matter of policy, disclaims responsibility for any disclaims responsibility for any private publication or statement by private publication or statement by any of its employees. Therefore, the any of its employees. Therefore, the views expressed today are our own, views expressed today are our own, and do not necessarily reflect the and do not necessarily reflect the views of the Commission or the other views of the Commission or the other members of the staff of the members of the staff of the Commission.Commission.
DisclaimerDisclaimer
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Corporation FinanceCorporation Finance
OverviewOverview
Financial Reporting and Financial Reporting and Disclosure IssuesDisclosure Issues
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Accounting Branch ChiefsAccounting Branch Chiefs
Health Care & Insurance Health Care & Insurance James AtkinsonJames AtkinsonConsumer Products Consumer Products
Michael MoranMichael Moran
George OhsiekGeorge OhsiekComputers & On Line ServicesComputers & On Line Services
Stephen KrikorianStephen Krikorian
Brad SkinnerBrad SkinnerNatural Resources & FoodNatural Resources & Food Jill DavisJill DavisStructured Finance, Transportation & LeisureStructured Finance, Transportation & Leisure
Linda CvrkelLinda Cvrkel
Michael FayMichael Fay
David HumphreyDavid Humphrey
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Accounting Branch ChiefsAccounting Branch Chiefs
Manufacturing & ConstructionManufacturing & ConstructionJohn CashJohn Cash
Rufus DeckerRufus Decker
Financial ServicesFinancial ServicesJohn NolanJohn Nolan
Kevin VaughnKevin Vaughn
Real Estate & Business ServicesReal Estate & Business ServicesKathleen CollinsKathleen Collins
Donna DiSilvioDonna DiSilvio
Emerging Growth CompaniesEmerging Growth Companies
Hugh WestHugh West
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Accounting Branch ChiefsAccounting Branch Chiefs
Electronics & Machinery Electronics & Machinery Brian CascioBrian Cascio
Daniel GordonDaniel Gordon
TelecommunicationsTelecommunicationsTerry FrenchTerry French
Robert LittlepageRobert Littlepage
Kyle MoffattKyle Moffatt
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Financial Reporting and Financial Reporting and DisclosureDisclosure
SOX Section 404 and 302SOX Section 404 and 302
Use of Other AuditorsUse of Other Auditors
Louise DorseyLouise Dorsey
Stephanie HunsakerStephanie Hunsaker
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SOX Section 404 and 302
Effective Date for 404404 vs. 302 RequirementsInteraction of 404 and 302Evaluating ICFRManagement’s ReportFAQs
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Effective Date of 404 for Accelerated Filers•10-K due March 16, 2005•11/17/04 – SEC postponed final phase-in period for one year Annual report deadline still 75 days
Quarterly report deadlines still 40 days
•Accelerated filing phase-in resumes for FYE ending on or after 12/15/05 Annual report- due in 60 days
Quarterly report- due in 35 days
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Effective Date of 404 for Accelerated Filers•11/30/04 – Exemptive Order
•45 Day Extension for cos. with
<$700 mil market cap at end of 2nd Qtr
•10-K still due March 16, 2005
All required items except 404 reports
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Effective Date of 404 for Effective Date of 404 for Accelerated FilersAccelerated Filers•10-K/A should include: Two 404 reports
302 certifications
307/308 disclosures, revised as needed
Consent, if necessary (i.e. shelf offerings, etc)
•Due 5/2/05 for calendar year filers•Co. not timely for S-3 until 10-K/A filed•No 12b-25 on the 10-K/A
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404 vs 302 Requirements
404 – ICFR•Annually assess ICFR•Review conducted as of year-end•Quarterly evaluation of any changes in ICFR•Documentation requirements for auditor to test•Internal control report
302 – DCP•Quarterly assess DCP•Review conducted as of quarter and year-end•Quarterly evaluation of any changes in DCP•N/A – no auditor testing requirements•Officers’ certification
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Interaction of 404 and 302
Substantial overlap DCP and ICFR DCP includes components of ICFR that provide
reasonable assurance that transactions are recorded as necessary to permit preparation of F/S in accordance with GAAP
Key differences DCP – apply to material financial and non-financial
information required in public reports
ICFR covers items that do not directly relate to disclosure
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Interaction of 404 and 302
•To the extent that ICFR impacts public disclosure, DCP are inclusive of such internal controls
•Disclosure controls apply to all material information to be included in financial reports, both within & outside f/ss
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Interaction of 404 and 302
Question
Could you have a situation where CFO/CEO reach a conclusion in their 302 certifications that DCP are effective at reasonable assurance level, even though there is a material weakness in ICFR?
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Interaction of 404 and 302
Answer
Generally officers will not be able to conclude DCP are effective when material weaknesses have been identified in IFCR
But……
There may be some limited circumstances
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Interaction of 404 and 302
Some elements of ICFR are not directly subsumed within the definition of DCP
Example in 404 adopting release– pure safeguarding of assets
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Interaction of 404 and 302
Likely impossible to conclude DCP are effective when material weaknesses exist in certain areas:
Example:
Material weakness in fraud prevention
Multiple material weaknesses
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Interaction of 404 and 302
QuestionWhat if a company has to restate its F/S because it or the auditor discovers a material weakness in ICFR that is also part of the company’s DCP?
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Interaction of 404 and 302
ANSWERNeed to consider whether the disclosures provided under Item 307 in original filing must be:
modified, supplemented or corrected
in order to explain relationship between failure of DCP and restated F/S
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Interaction of 404 and 302
•If officers conclude original conclusions are no longer correct:
Disclose this fact based on duty to correct a misstatement when it became known and Rule 12b-20
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Interaction of 404 and 302
Question
Can the officers conclude DCP were not effective as of end of reporting period covered by amended report, but conclude DCP are effective as of date the amendment filed?
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Interaction of 404 and 302
Answer
Yes – Company should expand disclosure to explain how mgmt determined DCP are now effective given the material weakness and other matters identified
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Interaction of 404 and 302
Other Areas for Disclosure?•MD&A Disclosure
Material weakness in ICFR may constitute a material trend or uncertainty that should be disclosed in MD&A
Detailed discussion of material weakness
quantification and analysis of associated uncertainties & trends
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Evaluating ICFR
•Will vary among companies•No specific method or procedures required •Must be based on procedures sufficient to evaluate both design & operating effectiveness•Documentation & evidential matter is key
Inquiry alone not adequate!
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Evaluating ICFR
Mgmt must attain the level of “reasonable assurance” when formulating conclusions regarding effectiveness of ICFR
Reasonable Assurance•Conforms to current auditing literature (AU 319)•Mgmt must use judgment •Implies consideration by mgmt of the cost of the control and its benefits in reducing risk
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Management’s Report
No standard formatCertain statements to be included:•Management’s responsibility for ICFR•Framework used•Mgmt’s assessment of the effectiveness of ICFR, as of end of most recent year•Auditor has issued report on ICFR•Disclosure of any material weaknesses
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Management’s Report, cont’d
Other Requirements:•Report should be located in “close proximity” to auditor’s attestation report•If management’s report contains additional information (i.e. plans, corrective actions to be taken, etc.)
Auditor to disclaim additional information
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Management’s Report
2 Possible Options•Effective
•Not Effective Prohibited from concluding effective
ICFR if one or more material weaknesses
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Management’s Report
What if management does not have the ability to assess certain aspects of ICFR?
Example:SAS 70 report not available at service organization and no other ability to assess controls in place at the service organization
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Management’s Report
NO scope limitation permitted in report Mgmt must conclude if ICFR
effective or not effective based on extent of scope limitation
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Management’s ReportManagement’s Report
EXCEPTIONS ( SEC FAQ 1, 2, 3)
•FAQ 1 – FIN 46 – entity in existence prior to 12/15/03•FAQ 2 – equity method investments•FAQ 3 – acquisitions – 1 yr max.
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Required Communications
•Mgmt must communicate all significant deficiencies & material weaknesses they detect to audit committee & external auditor Part of 302 certification
•Mgmt also must provide written representations to auditor
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SEC FAQs
•23 FAQ’s•Updated October 6, 2004•www.sec.gov/info/accountants/controlfaq1004.htm
•PCAOB also issued 3 separate sets of Staff Q&As (39) June 23, 2004
October 6, 2004
November 22, 2004
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SEC FAQs
Scope Limitations – Questions 1–3•FAQ 1 – consolidated VIEs, proportionate consolidations What is the meaning of “does not have the
right or authority to assess”? Neither legal rights nor ability of mgmt to
remediate deficiencies are necessarily tied to mgmt’s ability to assess ICFR
Facts and circumstances will dictate when mgmt has the ability
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SEC FAQs
•FAQ 2- Equity investee Not intended to prohibit registrants from
assessing ICFR of investees under the equity method
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SEC FAQs
•FAQ 3 – Recent business acquisition
Intent of issuing FAQ 3 is not to negatively impact mgmt’s business decisions
Will likely not object to anyone who decides to use this relief in the year of acquisition
“Business” as defined in EITF 98-3 or Article 11 of S-X
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SEC FAQs
FAQ 4 – Conclusion that ICFR is not effective Registrant will still be considered timely &
current re:
Rule 144, S-2/S-3/S-8 eligibility
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SEC FAQs
FAQ 9 – Disclosure of changes to ICFR made in preparation of 1st Mgmt report Giving relief for the 302 requirement to
disclose material changes in ICFR
HOWEVER…..
If change is driven from material weakness, notwithstanding the relief that is being given, registrants should carefully consider disclosing the material weakness and the resulting changes
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SEC FAQs
Other most frequent:
FAQ 8 – Transition reports
FAQ 14 – SAS 70 reports
FAQ 21 – Consents
FAQ 22 – Annual “glossy” reports
FAQ 23 – Supplementary information
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Other Questions
IPO -Initial 404 assessment
Due with first annual report once effective date passes
Discontinued operations not finalized as of end of year
No relief
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Other Questions
Registrants in Chapter 11 No automatic exemption from 404
If registrant qualifies for modified reporting under SLB 2 then registrant does not need to comply with 404
Must request relief in advance
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What we are seeing
Significant deficiencies & material weaknesses identified are being disclosed in Form 8-K and Form 10-QTypical areas where significant deficiencies/material weaknesses have been identified:
Personnel issues
Financial systems
Restatements due to lack of controls
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Final Remarks
We know there will be material weaknesses
Key is disclosure
What the problem is
What it impacts
How are you going to remediate
Timetable for remediation
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Use of Other Auditors
EXAMPLE:
•U.S. auditor relies on work of foreign audit firm to perform work on foreign subs of registrant
•U.S. firm chooses not to place reliance on work of other audit firm (i.e. no reference to other auditor)
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Use of Other Auditors
•Foreign firm must be registered with PCAOB if:
Performing a “substantial portion of the audit”
•Foreign firm must be “recognized” by SEC
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Use of Other Auditors
“Recognition” of Foreign Firm•Registration with PCAOB does not supercede existing means by which a firm demonstrates its qualifications to practice before the SEC US affiliation and Appendix K compliance
Demonstration to OCA of knowledge and experience of applying U.S. GAAP, PCAOB standards, SEC rules and SEC independence requirements
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Use of Other Auditors
Other Questions:
•What if U.S. firm uses local persons as independent contractors? i.e., Individuals, not firms
•Is the U.S. firm required to travel to the foreign location as part of the audit?
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Other Auditor Issues
Licensing Requirements•Have seen instances where auditor is not licensed in the state or country where principal audit procedures were conducted
Problematic in certain instances
Addressing on case-by-case basis
Contact DCF with questions on real life fact patterns
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Financial Reporting and Financial Reporting and DisclosureDisclosure
Tagged Data InitiativeTagged Data Initiative
Joel LevineJoel Levine
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Tagged Data InitiativeTagged Data Initiative
Concept releaseConcept release – –
Use of tagged data to Use of tagged data to facilitate timely and facilitate timely and accurate financial analysis.accurate financial analysis.
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Tagged Data InitiativeTagged Data Initiative
Possible benefits from tagged data:Possible benefits from tagged data: Information that is tagged can be Information that is tagged can be
searched, retrieved, and analyzed by searched, retrieved, and analyzed by automated means.automated means.
Reduces time, cost and errors Reduces time, cost and errors commonly associated with manual commonly associated with manual information collection and analysis.information collection and analysis.
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Tagged Data InitiativeTagged Data Initiative
Rule proposal –Rule proposal –
Voluntary program allowing Voluntary program allowing registrants to furnish registrants to furnish financial information in financial information in XBRL format.XBRL format.
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Concept ReleaseConcept Release
Concept release sought comment on:Concept release sought comment on:Adequacy of XBRL format and Adequacy of XBRL format and
technologies.technologies.
Types of information to be tagged.Types of information to be tagged.
Sufficiency of standard taxonomies.Sufficiency of standard taxonomies.
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Concept Release Concept Release
A taxonomy is a list of standard A taxonomy is a list of standard financial reporting elements (terms) financial reporting elements (terms) with their definitions and other with their definitions and other information. These elements may be information. These elements may be tagged with:tagged with: Monetary valuesMonetary values
Text – words or labelsText – words or labels
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Concept ReleaseConcept Release
Concept release also sought comment Concept release also sought comment on:on:
Commission’s role in development and Commission’s role in development and maintenance of standard taxonomies.maintenance of standard taxonomies.
Impact on investors, registrants, and Impact on investors, registrants, and accountants.accountants.
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Concept ReleaseConcept Release
Comment period ended Nov. 15th:Comment period ended Nov. 15th:XBRL standard is generally sufficient XBRL standard is generally sufficient
for tagging financial information.for tagging financial information.
Technical complexity of XBRL.Technical complexity of XBRL.
Eventually, a broader range of Eventually, a broader range of information in filings could be tagged information in filings could be tagged (e.g., MD&A, industry guide data, loan (e.g., MD&A, industry guide data, loan covenants, and officer compensation).covenants, and officer compensation).
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Concept ReleaseConcept Release
(Continued)(Continued)
Taxonomies should be developed and Taxonomies should be developed and maintained by the private sector, subject maintained by the private sector, subject to public review and comment and to public review and comment and Commission oversight.Commission oversight.
Impact on investors – quicker data Impact on investors – quicker data consumption allowing more time for consumption allowing more time for substantive financial analytics. substantive financial analytics.
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Concept ReleaseConcept Release
(Continued)(Continued)
Impact on registrants – need to learn data Impact on registrants – need to learn data tagging concepts and software tools; tagging concepts and software tools; consider taxonomy extensions; after consider taxonomy extensions; after startup, tagging effort should be nominal startup, tagging effort should be nominal and routine.and routine.
Impact on accountants – potential for Impact on accountants – potential for enhanced financial analysis, risk enhanced financial analysis, risk assessments, and internal control testing assessments, and internal control testing once XBRL is integrated into accounting once XBRL is integrated into accounting systems and audit tools are developed.systems and audit tools are developed.
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Concept ReleaseConcept Release
(Continued)(Continued)
Auditor attestation of tagged data:Auditor attestation of tagged data: Will build investor confidence in Will build investor confidence in
reliability of tagged data.reliability of tagged data. AICPA Interpretation No. 5 of SSAE AICPA Interpretation No. 5 of SSAE
No. 10 (AT Section 101): No. 10 (AT Section 101): “Attest Engagements on Financial “Attest Engagements on Financial Information Included in XBRL Information Included in XBRL Instance Documents”Instance Documents” currently currently provides sufficient guidance.provides sufficient guidance.
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Voluntary ProgramVoluntary Program
Registrants would tag their financial Registrants would tag their financial information in XBRL format using a information in XBRL format using a US GAAP standard taxonomyUS GAAP standard taxonomy::
Investment ManagementInvestment Management
InsuranceInsurance
Banking and Savings InstitutionsBanking and Savings Institutions
Commercial and IndustrialCommercial and Industrial
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Voluntary ProgramVoluntary Program
Regarding the XBRL documents:Regarding the XBRL documents:
Supplemental to official filing. Exhibit 100 Supplemental to official filing. Exhibit 100 to Exchange Act or Investment Company to Exchange Act or Investment Company Act filings.Act filings.
Furnished rather than “filed.”Furnished rather than “filed.”
Include in initial filing, an amendment, or Include in initial filing, an amendment, or an 8-K (6-K for foreign private issuers).an 8-K (6-K for foreign private issuers).
Information consistent with official filing.Information consistent with official filing.
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Voluntary ProgramVoluntary Program
(Continued)(Continued)
Excluded from Section 302 certifications.Excluded from Section 302 certifications.
No audit opinions or review reports.No audit opinions or review reports.
Label data unaudited (unreviewed).Label data unaudited (unreviewed).
Volunteers could start and end their Volunteers could start and end their participation at any time; may submit XBRL participation at any time; may submit XBRL data regularly or from time to time.data regularly or from time to time.
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Voluntary ProgramVoluntary Program
No stated end date. If adopted, after No stated end date. If adopted, after some period of time we may:some period of time we may:Leave voluntary program in place Leave voluntary program in place
indefinitely, change one or more indefinitely, change one or more features in the program, or terminate features in the program, or terminate the program.the program.
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Voluntary ProgramVoluntary Program
Rule proposal sought comment on:Rule proposal sought comment on: Is there a better way to test XBRL?Is there a better way to test XBRL? Should we permit tagging of less than a Should we permit tagging of less than a
complete set of financial statements?complete set of financial statements? Concerns about company extensions?Concerns about company extensions? Eliminate 8-K or 6-K filing options?Eliminate 8-K or 6-K filing options? Should mgmt. certify XBRL data?Should mgmt. certify XBRL data? Should auditors attest to XBRL data?Should auditors attest to XBRL data? How to assess usefulness of the data?How to assess usefulness of the data?
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Voluntary ProgramVoluntary Program
Comment period ended Nov. 1st:Comment period ended Nov. 1st:Generally supportive of voluntary Generally supportive of voluntary
program and proposed features.program and proposed features.
Standard taxonomies thought to be Standard taxonomies thought to be sufficiently developed for purposes of sufficiently developed for purposes of the program.the program.
Software tools may prove challenging Software tools may prove challenging to use in their current state.to use in their current state.
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Voluntary ProgramVoluntary Program
All comment letters we received are All comment letters we received are available on our website:available on our website:
www.sec.govwww.sec.gov
Under “Regulatory Actions.”Under “Regulatory Actions.”
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Tagged Data InitiativeTagged Data Initiative
What we’re doing:What we’re doing: Learning more about XBRL.Learning more about XBRL.
Evaluating comments received.Evaluating comments received.
Determining appropriate form of Determining appropriate form of adopting release.adopting release.
Developing internal capabilities to Developing internal capabilities to receive and analyze XBRL formatted receive and analyze XBRL formatted data.data.
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Financial Reporting and Financial Reporting and DisclosureDisclosure Statement of Cash Flows and Statement of Cash Flows and
Long-Term Customer ReceivablesLong-Term Customer Receivables
Private-equity valuationPrivate-equity valuation
Non-GAAP Managed Basis Non-GAAP Managed Basis MeasuresMeasures
Dividend Policy DisclosuresDividend Policy Disclosures
Todd E. HardimanTodd E. Hardiman
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Are the cash flow effects of Are the cash flow effects of customer receivables operating customer receivables operating
or investing cash flows?or investing cash flows?
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Paragraph 22a of Statement 95:Paragraph 22a of Statement 95:
22. Cash inflows from operating activities 22. Cash inflows from operating activities are:are:
a. Cash receipts from sales of goods or a. Cash receipts from sales of goods or services, including receipts from services, including receipts from collection or sale of accounts, and collection or sale of accounts, and both short- and long-term notes both short- and long-term notes receivable from customers arising receivable from customers arising from those sales.from those sales.
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Paragraph 16a of Statement 95:Paragraph 16a of Statement 95:
16. Cash inflows from investing activities are:16. Cash inflows from investing activities are:
a. Receipts from collections or sales of loans a. Receipts from collections or sales of loans made by the enterprise and of other entities’ made by the enterprise and of other entities’ debt instruments (other than cash debt instruments (other than cash equivalents, certain debt instruments that equivalents, certain debt instruments that are acquired specifically for resale as are acquired specifically for resale as discussed in Statement 102, and securities discussed in Statement 102, and securities classified as trading securities as discussed classified as trading securities as discussed in Statement 115) that were purchased by in Statement 115) that were purchased by the enterprise.the enterprise.
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Statement 95 deliberations:Statement 95 deliberations:
Explicit consideration of Installment Explicit consideration of Installment SalesSales
Exposure Draft - split presentationExposure Draft - split presentation
Final standard – ALL cash flows from Final standard – ALL cash flows from inventory sales are operating cash flowsinventory sales are operating cash flows
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Effect of Statement 102Effect of Statement 102 - - Statement of Statement of Cash Flows – Exemption of Certain Cash Flows – Exemption of Certain Enterprises and Classification of Enterprises and Classification of Cash Flows from Certain Securities Cash Flows from Certain Securities Acquired for ResaleAcquired for Resale Are cash flows of a financial institution’s Are cash flows of a financial institution’s
trading account and similar items, such trading account and similar items, such as loans acquired for resale, as loans acquired for resale, similar tosimilar to inventoryinventory??
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Example - Captive Finance Subsidiary Example - Captive Finance Subsidiary
Assumptions:Assumptions:
Registrant (Parent) sells Product A for $10Registrant (Parent) sells Product A for $10
Customer pays no cashCustomer pays no cash
Captive finance sub issues loan to Captive finance sub issues loan to customer for $10 and remits $10 to Parentcustomer for $10 and remits $10 to Parent
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Example - Captive Finance Sub., continuedExample - Captive Finance Sub., continued
Stand-alone Parent perspective:Stand-alone Parent perspective:•Operating cash inflow of $10Operating cash inflow of $10
Stand-alone Sub perspective:Stand-alone Sub perspective:•Investing cash outflow of $10Investing cash outflow of $10
Consolidated entity perspective:Consolidated entity perspective:•Non-cash transactionNon-cash transaction
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Statement of Cash FlowsStatement of Cash FlowsL/T Customer ReceivablesL/T Customer Receivables
Example - Captive Finance Sub., continuedExample - Captive Finance Sub., continued
•Conclusions:Conclusions: Consolidated entity perspectiveConsolidated entity perspective
Analogies to EITF 85-12 not persuasiveAnalogies to EITF 85-12 not persuasive
ALL Cash flows from sale of inventory are ALL Cash flows from sale of inventory are operating cash flows regardless ifoperating cash flows regardless if Collection from customer or sale to othersCollection from customer or sale to others On account or in form of a note or loanOn account or in form of a note or loan Short-term or long-termShort-term or long-term
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Financial Reporting and Financial Reporting and DisclosureDisclosure
Valuation of Privately-Held-Valuation of Privately-Held-Company Equity Securities Company Equity Securities
Issued as CompensationIssued as Compensation
(VPES or “Cheap Stock”)(VPES or “Cheap Stock”)
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VPES or “Cheap Stock”VPES or “Cheap Stock”
CircumstancesCircumstances•No Quoted Market PricesNo Quoted Market Prices•No Recent Sales of the Same or a Similar No Recent Sales of the Same or a Similar Company SecurityCompany Security
Valuation MethodologiesValuation Methodologies•Generally, Two Step ApproachGenerally, Two Step Approach Enterprise Value DeterminationEnterprise Value Determination
Enterprise Value Allocation (if Multiple Equity Enterprise Value Allocation (if Multiple Equity Classes)Classes)
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #1Theme #1: The Approach Used to : The Approach Used to DetermineDetermine Enterprise Value Must be Appropriate for the Enterprise Value Must be Appropriate for the Company’s Stage of DevelopmentCompany’s Stage of Development Stages of Development Stages of Development
No revenue/founder’s capitalNo revenue/founder’s capital Initiate product development/Outside financingInitiate product development/Outside financing Achieve product development milestonesAchieve product development milestones Saleable productSaleable product Operating profitabilityOperating profitability Sustained OperationsSustained Operations
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #1Theme #1: - continued: - continued
Three Broad Approaches to Determine Three Broad Approaches to Determine Enterprise ValueEnterprise Value
Market ApproachMarket Approach
Income ApproachIncome Approach
Asset-Based ApproachAsset-Based Approach
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #1Theme #1: : - continued- continued
ObservationObservation::
Asset-based approach likely not appropriate Asset-based approach likely not appropriate for IPO reporting periodsfor IPO reporting periods
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #2Theme #2: The Method Used to : The Method Used to Allocate Allocate Enterprise Value Enterprise Value Must be Appropriate for the Company’s Stage of Must be Appropriate for the Company’s Stage of DevelopmentDevelopment
Required if Multiple Classes of StockRequired if Multiple Classes of Stock
Three Broad MethodsThree Broad Methods
Probability-Weighted Expected Return MethodProbability-Weighted Expected Return Method
Possible Future Outcomes might include IPO, Possible Future Outcomes might include IPO, Remaining Private, Merger or Sale, DissolutionRemaining Private, Merger or Sale, Dissolution
Option-Pricing MethodOption-Pricing Method
Current-Value MethodCurrent-Value Method
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #2Theme #2: -continued: -continued Two Trends in IPO Filing ReviewsTwo Trends in IPO Filing Reviews
Use of Current Value Allocation Use of Current Value Allocation MethodMethod
Averaging Allocation MethodsAveraging Allocation Methods
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #2Theme #2 - continued - continued Use of Current Value Allocation Use of Current Value Allocation
MethodMethod
Observation:Observation:
Current-Value method likely not Current-Value method likely not appropriate for IPO reporting periodsappropriate for IPO reporting periods
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #2Theme #2 - continued - continued Averaging Allocation MethodsAveraging Allocation Methods
Observations:Observations:Select the allocation method that is most Select the allocation method that is most appropriate for the circumstancesappropriate for the circumstances
Averaging disparate results of different Averaging disparate results of different allocation methods may not be appropriateallocation methods may not be appropriate
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #3Theme #3: Discounts: Discounts•Objective and Reliable Support NeededObjective and Reliable Support Needed•Appropriateness of:Appropriateness of:
TypeType of Discount of Discount
Lack of Control DiscountLack of Control Discount
Disproportionate Returns?Disproportionate Returns?
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VPES or “Cheap Stock”VPES or “Cheap Stock”
Theme #3Theme #3: Discounts - continued: Discounts - continued•Appropriateness of:Appropriateness of:
MagnitudeMagnitude of Discount of Discount No Bright LinesNo Bright Lines
Burden on ManagementBurden on Management
Sufficient Objective SupportSufficient Objective Support
Facts and Circumstances of EntityFacts and Circumstances of Entity
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Financial Reporting and Financial Reporting and DisclosureDisclosure
Non-GAAP Managed-Basis Non-GAAP Managed-Basis MeasuresMeasures
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Non-GAAP Managed-Basis Non-GAAP Managed-Basis MeasuresMeasures
•Financial Institutions and Retailing Financial Institutions and Retailing CompaniesCompanies Remove sale treatment of loan and receivable Remove sale treatment of loan and receivable
securitizations accounted for as salessecuritizations accounted for as sales
•Non-Financial InstitutionsNon-Financial Institutions Include revenue of businesses managed on Include revenue of businesses managed on
behalf of othersbehalf of others
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Non-GAAP Managed-Basis Non-GAAP Managed-Basis MeasuresMeasures
Non-Financial InstitutionsNon-Financial Institutions
System Wide RevenuesSystem Wide Revenues Frequently calculated asFrequently calculated as
Registrant’s revenues +Registrant’s revenues +
Managed entities revenue – Managed entities revenue –
Registrant’s management feesRegistrant’s management fees
Appropriate or prohibited?Appropriate or prohibited?
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Non-GAAP Managed-Basis Non-GAAP Managed-Basis MeasuresMeasures
Financial Institutions and Retailing Financial Institutions and Retailing CompaniesCompanies•Managed Basis MeasuresManaged Basis Measures Remove Effects of Securitization Accounted for Remove Effects of Securitization Accounted for
as Sales = Non-GAAP Measureas Sales = Non-GAAP Measure
Consistency with Management’s Approach?Consistency with Management’s Approach?
Comparability vs. Normalize?Comparability vs. Normalize?
95
95
Non-GAAP Managed-Basis Non-GAAP Managed-Basis MeasuresMeasures
Financial Institutions and Retailing Financial Institutions and Retailing CompaniesCompanies
Disclosures required by Statement 140Disclosures required by Statement 140 Not a Non-GAAP MeasureNot a Non-GAAP Measure
Goal is to Highlight Sources of Risk and Goal is to Highlight Sources of Risk and Benefit Stemming from Retained InterestBenefit Stemming from Retained Interest
96
96
Financial Reporting and Financial Reporting and DisclosureDisclosure
Management’s Statement of Management’s Statement of Intent to Pay Future DividendsIntent to Pay Future Dividends
and the Need forand the Need for
Dividend Policy Disclosures Dividend Policy Disclosures
97
97
Dividend Policy DisclosuresDividend Policy Disclosures
•Income Deposit Security (IDS)Income Deposit Security (IDS)Yield =Yield =
Coupon on DebtCoupon on Debt
plusplus
Intended DividendIntended Dividend
Equal to Cash in Excess of Operating Equal to Cash in Excess of Operating NeedsNeeds
Paid quarterlyPaid quarterly
98
98
Dividend Policy DisclosuresDividend Policy Disclosures
•Why Focus on Disclosures about Intended Why Focus on Disclosures about Intended Dividends?Dividends?
SignificanceSignificance CompanyCompany
Assumes Best Use of Excess Cash is Payout to Assumes Best Use of Excess Cash is Payout to Shareholders, Not Reinvestment in BusinessShareholders, Not Reinvestment in Business
MarketingMarketing Contrast to equity IPO where return on Contrast to equity IPO where return on
investment stems primarily from stock investment stems primarily from stock appreciationappreciation
99
99
Dividend Policy DisclosuresDividend Policy Disclosures
•Why Focus on Disclosures about Intended Why Focus on Disclosures about Intended Dividends?Dividends?DiscretionaryDiscretionary
No Contractual Obligation to Pay No Contractual Obligation to Pay Different from REITs – Not Obligated by Tax Different from REITs – Not Obligated by Tax
Code to Pay Out Most of their CashCode to Pay Out Most of their Cash Board Discretion as to Timing and Amount (can Board Discretion as to Timing and Amount (can
be $0), regardless of policybe $0), regardless of policy Shareholder has No Contractual Demand Shareholder has No Contractual Demand
Right Right Lack of PrecedentLack of Precedent
100
100
Dividend Policy DisclosuresDividend Policy Disclosures
•Key Elements of DisclosureKey Elements of Disclosure:: Clear articulation of what the dividend policy Clear articulation of what the dividend policy
will be, how the company arrived at it, and how will be, how the company arrived at it, and how they expect to be able to pay itthey expect to be able to pay it
Identification of Risks and LimitationsIdentification of Risks and Limitations Inclusion of Forward-looking information to Inclusion of Forward-looking information to
support ability to pay intended dividends support ability to pay intended dividends Analysis - Liquidity and Capital ResourcesAnalysis - Liquidity and Capital Resources
Note: Note: NotNot a One-Size Fits All Model: address a One-Size Fits All Model: address specific facts and circumstancesspecific facts and circumstances
101
101
Dividend Policy DisclosuresDividend Policy Disclosures
•Risks and LimitationsRisks and Limitations – (clearly disclose them) – (clearly disclose them) DiscretionaryDiscretionary
Intended policy can be modified/revoked at any time Intended policy can be modified/revoked at any time Dividends may not be paid in accordance with policyDividends may not be paid in accordance with policy
Limitations imposed by debt covenants and state lawsLimitations imposed by debt covenants and state laws Consequences of no invest. in future growth Consequences of no invest. in future growth Assumes ability to refinance debt when due Assumes ability to refinance debt when due No provision for unexpected cash needsNo provision for unexpected cash needs Impact of adverse tax outcomes, if anyImpact of adverse tax outcomes, if any Impact of subordination clauses, if any, when multiple Impact of subordination clauses, if any, when multiple
classes of stockclasses of stock
102
102
Dividend Policy DisclosuresDividend Policy Disclosures
•Forward-looking infoForward-looking info - - (include in filing)(include in filing)
Must support the assertion registrant Must support the assertion registrant will have will have cashcash necessary to pay the necessary to pay the intended dividends intended dividends
Intended dividends policy should not be Intended dividends policy should not be stated for periods in excess of period stated for periods in excess of period supported by expected future cash flows supported by expected future cash flows (for example, next 12 months)(for example, next 12 months)
103
103
Dividend Policy DisclosuresDividend Policy Disclosures
•Forward-looking infoForward-looking info - - (include in filing)(include in filing) Balance Forward-Looking “estimated cash available” Balance Forward-Looking “estimated cash available”
with comparable Historical Amounts of “cash available”with comparable Historical Amounts of “cash available”
Identify Differences from Historical Amounts – perhapsIdentify Differences from Historical Amounts – perhaps
Increased costs due to being publicIncreased costs due to being public
Increased interest expense (Income Deposit Sec.)Increased interest expense (Income Deposit Sec.)
Changes in levels of capital expendituresChanges in levels of capital expenditures
Explain why mgt. believes they can pay intended Explain why mgt. believes they can pay intended dividend if historical amounts indicate otherwisedividend if historical amounts indicate otherwise
Identify need, if any, to borrow to pay dividendsIdentify need, if any, to borrow to pay dividends
104
104
Dividend Policy DisclosuresDividend Policy Disclosures
•Forward-looking infoForward-looking info - (include in filing) - (include in filing) Detailed Assumptions used in forward-looking Detailed Assumptions used in forward-looking
info.info. Bullet point list of assumptions and any Bullet point list of assumptions and any
changes from historical amounts is an changes from historical amounts is an acceptable presentationacceptable presentation
Discuss risks and possible outcomes if Discuss risks and possible outcomes if expected results are not achievedexpected results are not achieved
State whether mgt. expects company to be in State whether mgt. expects company to be in compliance with debt covenants based on compliance with debt covenants based on forward-looking operating results and expected forward-looking operating results and expected cash flowscash flows
105
105
Dividend Policy DisclosuresDividend Policy Disclosures
• MD&A -Liquidity and Capital ResourcesMD&A -Liquidity and Capital Resources Intended dividend policy for the next year, and how they Intended dividend policy for the next year, and how they
intend to fund it (e.g., cash from operations or intend to fund it (e.g., cash from operations or borrowings/credit facility)borrowings/credit facility)
Assumptions re: Cash available for dividends Assumptions re: Cash available for dividends
Effect of new securities and financing agreements, if anyEffect of new securities and financing agreements, if any
Increased interest expenseIncreased interest expense
Effect of paying out cash as dividends rather than Effect of paying out cash as dividends rather than retaining for expansion and reinvestment in the businessretaining for expansion and reinvestment in the business