In December 2010, the AICPA held its annual national conference on current SEC and PCAOB developments in Washington, DC. Over a three day period representatives from the SEC, FASB, IASB, AICPA and PCAOB addressed the audience on various accounting, reporting and regulatory matters. The major themes of the conference were restoring investor confidence and public trust, audit quality, convergence of U.S. GAAP and IFRS, and the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) on the profession. Other areas of focus included recent accounting standards and proposals (such as revenue recognition, goodwill impairment, and lease accounting), updates to the SEC Financial Reporting Manual and improvements to the “Management Discussion and Analysis” section of SEC filings.
In her SEC keynote address, SEC Chairman Mary Schapiro stressed the important role that the accounting profession plays in restoring investor trust and the need for international convergence of accounting standards. Ms. Schapiro highlighted various SEC initiatives and accomplishments over the past year to restore the public’s faith in our financial market, a market that had been damaged by “the scandals and crises of the last decade.” She stressed, though, that rulemaking and SEC reforms are not enough by itself. She challenged the accounting profession to “lead the fight” against investor skepticism by providing quality audits. She urged auditors to ask the tough questions when they sit down with the numbers, and have the courage to challenge those responses if they did not yield the answers needed. Accountants were also reminded of their code of conduct, their obligation to discharge their duties “with integrity, objectivity, due professional care and a genuine interest in service to the public.”
Continuing on a conference theme from last year, Ms. Schapiro spoke about the international convergence of Financial Reporting Standards or as she aptly describes it, “accounting without borders.” She emphasized the importance of having one set of rules by using an example of “a Tucson-based investor, trading on the New York Stock Exchange, may be trying to analyze a German chemical company with subsidiaries in Thailand and Chile, and a Paris-based auditor.” Ms. Schapiro reassured the audience that the “convergence of accounting standards is a top priority for the SEC,” but wanted to stress that the converged standards must be “high quality improvements over current standards.” During the question and answer session, Ms. Schapiro indicated that, though the SEC is still on track to make a final decision regarding the use of IFRS by US issuers by the June 2011 deadline, they will not sacrifice the objective of producing quality standards to meet an predetermined date.
A new topic discussed at the conference this year was the implementation of the Dodd-Frank Act. Brought on as a result of the global financial crisis that began in the fall of 2008, and signed into law by President Obama on July 21, 2010, the Act may be considered to have one of the largest changes to financial regulation since the Great Depression. In addition to the significant changes to corporate governance and disclosures expected as a result of the Act, including the PCAOB’s new comprehensive oversight authority over audits of broker-dealers, the Act provided permanent exemption from Section 404(b) of the Sarbanes-Oxley Act of 2002 for non-accelerated filers. Meredith Cross, director in the SEC’s Division of Corporation Finance (the “Division” or “Corp Fin”) talked about the significant rulemaking that the Commission is undertaking as result of the Dodd-Frank Act. Though the Division has “lots of rules to write” to implement components of the Dodd-Frank Act with “extremely demanding deadlines,” Ms. Cross emphasized that Corp Fin’s implementation of the Act’s provisions would not impact Corp Fin’s ability to carry out its responsibility to periodically review the filings of all registrants.
Among the accounting issues discussed at the national conference were consolidation of variable interest entities and debt and equity evaluation of convertible debt. The new consolidation standard on variable interest entities (“VIE”s) is effective for calendar year 2010. Instead of the former quantitative approach, the amended guidance requires a qualitative judgment based on the total mix of information. Paul Beswick, Deputy Chief Accountant at the SEC’s Office of the Chief Accountant, reminded registrants to focus on the qualitative approach of power and economics. The amended guidance requires companies to look at all sources of power when assessing who has the power to direct the most significant activities of the entity and the obligation to absorb significant losses or receive significant benefits from the VIE.
A common error the SEC staff continues to encounter by registrants is their failure to appropriately apply the guidance on distinguishing equity from liabilities, particularly when evaluating whether an instrument (or embedded feature) is considered indexed to an entity’s own stock. The guidance requires the Company to evaluate the contingent exercise provisions (if any) and then determine the settlement amount. Todd Hardiman, Associate Chief Accountant at the Corp Fin provided two examples of instruments for which the SEC has raised issues with the application of the indexation guidance – stock purchase warrants and debt instruments with embedded conversion options. These issues, he notes, are more often found on small and medium-sized registrants. One of the common problems the SEC staff has seen in these instruments relates to “down-round” protection that specifies that the strike price or conversion price will be adjusted downward if the company subsequently issues stock at a lower price than the strike price or conversion price of the instrument due to declining market price. Such a provision often will result in a conclusion that the instrument or feature should be presented as a derivative liability at fair value and any adjustments to such value would record through earnings. When valuing these liabilities, the SEC staff also observed inappropriate use of the Black-Scholes option valuation model. The Black-Scholes model was designed to value “fixed-for-fixed” options, in other words, when the option is exercisable at a fixed price, for a fixed number of shares. Since such liabilities classified equity derivatives, by definition, are not fixed-for-fixed, Black-Scholes is not sufficiently comprehensive to address the variable components of the instrument. In these circumstances a more complex valuation method, such as the Lattice model, is often necessary.
The annual national conference on current SEC and PCAOB developments provided everyone in attendance an update of what has occurred in the accounting profession, the goals the profession is working on and what the profession can expect over the next couple of years. For more information on the 2010 AICPA annual national conference, please visit www.sec.gov.
Phil Weiner contributed to this article.