Deciphering the Latest Financial Reporting Trends: Key Takeaways from the 2023 AICPA & CIMA SEC and PCAOB Conference

In December 2023, industry experts from top regulatory and standard-setting bodies convened at the AICPA and CIMA Conference to engage in a critical dialogue on the latest developments surrounding the SEC, PCAOB, FASB, and IASB. This conference provided a platform for discussions on various pivotal financial reporting topics. Among the key highlights were in-depth deliberations on the newly issued ASU 2023-07 concerning segment reporting, the intricacies of deferred offering costs in initial public offerings, the cruciality of the statement of cash flows, and the challenges of fair value measurements in today’s complex financial landscape. Here, we offer a summary of these crucial issues, exploring their implications for financial reporting and the rigorous compliance standards required by regulators.

Segment Reporting

Regulators spoke about the implications of the newly released ASU 2023-07 related to segment reporting. This included how public companies should weigh the ASU against the SEC’s rules and the staff guidance on non-GAAP financial measures.

ASU 2023-07 mandates that public companies provide more detailed segment information, including key expenses and other segment-related data, both annually and for interim periods. While the ASU permits but does not require entities, even those with just one reportable segment, to disclose multiple segment profit or loss metrics if the chief operating decision-maker (CODM) uses these metrics to manage resources and evaluate performance, all entities must clarify in their financial statement notes how the CODM utilizes each profit or loss metric reported for segment assessment and resource allocation.

According to ASC 280, if a CODM evaluates segment performance and resource distribution using multiple profit or loss measures, the required reported measure is the one that aligns most closely with the principles used in the consolidated financial statements, meaning it should be consistent with GAAP.

One of the speakers from the SEC stated that any additional segment profitability measures disclosed by a public entity not based on US GAAP are deemed non-GAAP financial measures. This is because the accounting standard neither mandates the disclosure of extra profit or loss measures nor explicitly allows their disclosure by outlining permissible measures. As such, these additional non-GAAP measures fall under the relevant SEC rules, which include a ban on presenting them within the financial statements or notes. Despite this restriction, if companies, post-ASU adoption, disclose additional non-GAAP segment profit or loss measures, they must not be misleading and should comply with SEC guidance. Additionally, disclosure in filings, such as management’s discussion and analysis (MD&A), must include the information required for non-GAAP measures.

Early adopters of ASU 2023-07 who plan to disclose extra segment profit or loss measures regarded as non-GAAP are encouraged to consult with the SEC’s Division of Corporate Finance’s (DCF) Office of the Chief Accountant (OCA) about their specific circumstances.

The SEC also noted that if a company has a single reportable segment managed on a consolidated basis (a single operating segment), the SEC staff expects the disclosed segment profit or loss measure to be the consolidated net income.

The SEC provided additional reminders for compliance with current segment reporting requirements:

• The SEC staff generally views segment operating results that the CODM reviews or receives quarterly as satisfying the “regularly reviewed” and “regularly provided” criteria in ASC 280. However, reviews that are less frequent than quarterly may still be considered regular.
• “Revenues from external customers” is an amount that must be disclosed for each reportable segment under ASC 280 if it is part of the segment profit or loss measure reviewed by the CODM or is routinely provided to the CODM, even if not included in the measure itself. The SEC staff requires that such revenue amounts align with the appropriate accounting guidance under ASC 606 and has raised objections to disclosures based on a different methodology.

Deferred Offering Costs

The SEC staff highlighted the accounting treatment for expenses incurred during initial public offerings (IPOs). They pointed out that only those additional costs directly linked to an offering can be deferred and offset against the offering’s proceeds (meaning they reduce equity instead of counting as an expense) to be consistent with the guidance under ASC 340-10. However, this does not cover general overhead like management salaries or other administrative costs. For instance, the SEC staff would challenge the decision of companies to defer expenses associated with the preparation of financial statements and external audits since these costs are not directly connected to the offering itself.

Statement of Cash Flows

The SEC highlighted the significance of the statement of cash flows (SOCF) for investors. Guidance for the SOCF is included within ASC 230. The SEC underscored the need for the same degree of professional care, strong internal controls, and thorough audit practices for the SOCF as for other financial statements, given its status as a primary financial statement.

They pointed out that there seems to be a disparity in the level of focus applied to the SOCF by preparers and auditors, as suggested by its frequent role in financial statement restatements. Such restatements might also signal significant deficiencies in internal control over financial reporting (ICFR). They reminded those responsible for preparing and auditing financial statements to maintain an impartial perspective, considering what a reasonable investor would deem material when assessing errors in the SOCF.

They also remarked that errors should not be automatically deemed insignificant just because they involve classification differences, given that proper classification is crucial to the SOCF. They advised preparers to thoughtfully determine the best way to represent cash and non-cash data and whether additional disclosures might enhance investors’ understanding of the SOCF.

Fair Value Measurements

The SEC staff stressed the considerable judgment involved in applying the standards of ASC 820, Fair Value Measurement, particularly for certain types of transactions such as those involving cryptocurrency assets. These assets are expected to be measured at their fair value in the near future, provided they meet certain criteria. They emphasized that identifying the principal or most advantageous market is crucial because it influences which market participants are identified and the information and assumptions they would use to determine fair value.

They pointed out that the crypto asset market is different, unlike traditional markets where transaction venues are limited, and most trading occurs in a few places. It’s rapidly evolving, and the criteria for determining the primary market can shift with time. The characteristics of the crypto market—including how pricing is set, its regulatory environment, and the reliability of available information—vary widely, depending on the specific asset and the entity’s involvement.

The application of fair value to loan measurements and related credit loss allowances was also addressed. Loans held for investment, which aren’t classified as debt securities under ASC 320, are measured at their amortized cost and must be examined for expected credit losses unless an entity opts for the fair value election.

Under ASC 326, there is a practical expedient for calculating credit loss allowances for collateralized loans based on the fair value of the collateral if the borrower is experiencing financial difficulty and the repayment is expected to come from selling or using the collateral. If foreclosure is likely, then the allowance should be measured based on the fair value of the collateral. Entities must make careful and appropriate judgments, especially during tough economic times or when dealing with illiquid collateral assets.

As a general reminder, there are three levels to the fair value hierarchy (Level 1 is the highest priority, and Level 3 is the lowest priority):

• Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
• Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly
• Level 3: Unobservable inputs (e.g., a reporting entity’s or other entity’s data)

The SEC staff stated that valuation methods should lean heavily on observable inputs (levels 1 and 2 under the fair value hierarchy) wherever possible. Moreover, according to ASC 820, when a valuation method includes inputs that are not observable, the valuation technique must be adjusted when the initial transaction price represents fair value.

Registrants should assess whether their fair value estimates are considered critical accounting estimates and, if so, should disclose them accordingly.

Critical Accounting Estimates

The SEC highlighted the ongoing emphasis on the disclosure of critical accounting estimates. They pointed out that such disclosures provide both qualitative and quantitative insights necessary for understanding the uncertainty associated with estimations and their potential or actual impact on a company’s financial health or operational results. They suggested several questions that registrants should consider to steer clear of generic disclosures regarding critical accounting estimates:

• Can the investor understand from disclosure why that particular estimate is critical?
• Does the disclosure include both quantitative and qualitative considerations?
• Is it likely that an investor would find it difficult to understand the estimation uncertainty in the absence of any quantification?
• Does the disclosure provide information beyond what is in the financial statements’ summary of significant accounting policies?
• Can an investor understand the past variability in the estimate?
• Does the disclosure include a discussion of the sensitivity of the reported amount to changes in assumptions and methods used from both a quantitative and qualitative perspective?

Non-GAAP Financial Measures

The SEC staff highlighted the ongoing attention non-GAAP financial measures receive in the SEC staff’s comment letters. Non-GAAP measures are governed by Regulation G and Item 10(e) of Regulation S-K. They warned against using non-GAAP figures that alter the recognition and measurement rules established by GAAP, leading to measures that might be “individually tailored” and could be misleading. Some particular points of focus include the following:

• Non-GAAP metrics that omit what seems to be standard, repetitive costs, like start-up expenses and losses on commitments to purchase. The staff previously conveyed that opening new retail locations, or eateries in the case of the hospitality sector, are considered usual activities for such businesses. This rationale should also apply to other industries, such as healthcare, where opening a new medical facility might incur one-time costs. Still, these pre-opening expenses are considered routine operational costs at the company level.
• Adjusting non-GAAP figures to deviate from GAAP’s recognition and measurement standards can lead to deceptive outcomes. This warning is not limited to revenue-related measures but also extends to others. Other examples include:
  • Companies presenting non-GAAP metrics that adjust inventory accounting from GAAP-compliant methods to internal methods not allowed by GAAP.
  • Reporting revenue-related non-GAAP metrics that omit transaction costs may inaccurately portray the company as an agent instead of a principal, as required by US GAAP.

The SEC staff also emphasized the necessity of properly naming non-GAAP financial measures and transparently detailing the adjustments in a way that clarifies their nature and usefulness to investors.

Non-GAAP financial measures are still a prominent subject in SEC staff comments. Companies must be able to justify the usefulness of their non-GAAP presentations to investors and ensure compliance with the SEC’s regulations and recommendations.

Conclusion

During the conference, the speakers from the SEC brought up some key points related to financial reporting. Broadly, some of the more significant points are as follows:

• Segment Reporting – there are some new requirements that companies will need to comply with soon, and they should pay particular attention to how the latest guidance interacts with the guidance for non-GAAP measures.
• Deferred Offering Costs – companies should avoid deferring costs directly related to preparing and auditing financial statements as part of deferred IPO costs.
• Statements of Cash Flows – this statement is very important and one of the primary financial statements, and it deserves as much focus and attention from companies as the other primary financial statements.
• Fair Value Measurements – The SEC underscored the complexities of applying ASC 820 to assets such as cryptocurrencies, highlighting the need for careful judgment in these rapidly evolving markets to determine fair value. With the diverse nature of the crypto market’s pricing, regulatory environment, and the reliability of information, identifying the primary market is key for fair value assessments. The staff also discussed fair value application in loan measurements and credit loss allowances, with specifics on collateralized loans under ASC 326 and the necessity for sound judgments during tough economic times or with illiquid collateral. They also emphasized the importance of disclosing critical accounting estimates related to fair value.
• Critical Accounting Estimates – this section should help investors understand the uncertainty associated with estimations and their potential or actual impact on a company’s financial health or operational results and should avoid reiterating what has already been disclosed in the financial statements (i.e., “F pages”).
• Non-GAAP Financial Measures – The SEC continues to scrutinize non-GAAP financial measures, stressing the importance of not presenting non-GAAP figures that misrepresent GAAP recognition and measurement standards. They also emphasized the need for accurate labeling and a clear explanation of non-GAAP adjustments.

In conclusion, the 2023 AICPA and CIMA Conference offered invaluable insights into the latest SEC and PCAOB developments shaping the financial reporting landscape. It underscored the imperative for clarity, accuracy, and adherence to regulatory standards, serving as a crucial touchstone for financial professionals committed to upholding the integrity of financial reporting in a changing regulatory environment.

The information provided herein is for general guidance and is not a substitute for professional advice. Please get in touch with a Marcum Financial Accounting and Advisory Services (FAAS) Advisor with any questions.