Auditing Standards and Regulatory Matters Update

Transcription

1 Auditing Standards and Regulatory Matters Update

2 Today s agenda Auditing Standards Update Cyber Security Attestation Reporting Internal Control over Financial Reporting SEC Comments and Trends SEC Initiatives Page 2

3 Auditing Standards Update Page 3

4 PCAOB Transparency rules (Form AP) Transparency rules issued in 2016 require audit firms to file a new PCAOB Form AP that comprises the following key disclosures: The name of the signing partner for auditor s reports included for the first time in an SEC filing on or after 31 January 2017 The names, locations and extent of participation of other accounting firms for auditor s reports included for the first time in an SEC filing on or after 30 June 2017 Disclosures about other accounting firm(s) could prompt additional discussions about firm network s system of quality control, including oversight of network firms and communication protocols Page 4

5 PCAOB Auditor s reporting model Overview Final standard adopted in 2017 requires auditors to include significantly more information in the auditor s report, such as: Discussion of critical audit matters (CAMs) Disclosure of auditor s tenure Clarification of existing auditor s responsibilities The standard builds on more than six years of Board outreach The standard is subject to SEC approval Changes other than CAMs CAMs Large accelerated filers Effective for annual periods ending on or after: CAMs All other filers 15 December June December 2020 Page 5

6 PCAOB Auditor s reporting model Critical audit matters CAMs will include matters: Communicated or required to be communicated to the audit committee That relate to material accounts or disclosures That involve especially challenging, subjective or complex auditor judgment In determining CAMs, auditors will consider factors specific to the audit, including: Assessment of risks of material misstatement, including significant risks Degree of auditor judgment and subjectivity in auditing the matter Significant unusual transactions Nature and extent of audit effort Nature of audit evidence obtained The discussion of matters identified as CAMs will include: An explanation of the principal considerations that led the auditor to determine that the matter is a CAM An explanation of how the CAM was addressed in the audit Reference to the relevant financial statement accounts or disclosures Page 6

7 PCAOB Auditor s reporting model Other changes to the auditor s report Information on auditor tenure The auditor s report will include the year the auditor began serving consecutively as the company s auditor Standardization of certain elements of the auditor s report The auditor s opinion will be presented first Section titles will be required to guide the reader Clarification of existing auditor s responsibilities The auditor s report will include a statement that the auditor is required to be independent The phrase whether due to error or fraud will be added to the description of the auditor s responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement Page 7

8 PCAOB Auditing estimates Proposed auditing standard Would replace three auditing standards with a single standard for auditing estimates, including fair value measurements Additional focus on addressing management bias and maintaining professional skepticism Three approaches for auditing estimates would be retained: Testing the company s process Developing an independent expectation Evaluating subsequent events Includes an appendix addressing the use of pricing information from pricing services and brokers or dealers New guidance would address the valuation of investments based on investee financial statements Comments due by 30 August 2017 Page 8

9 PCAOB Using the work of specialists Proposed auditing standard Would address the following topics: Using the work of a company s specialist Supervising the work of auditor-employed specialists Using the work of an auditor-engaged specialist Would retain current definition of a specialist Income taxes and information technology would be outside the scope of the proposed guidance Would expand requirements for testing and evaluating the work of a company specialist Would largely align requirements for the auditor to supervise specialists, whether employed or engaged Comments due by 30 August 2017 Page 9

10 PCAOB Supervision of other auditors Proposed auditing standard Would strengthen the requirements for lead auditors to plan, supervise and evaluate the work of other auditors Introduces new terms: Lead auditor Other auditors Referred-to auditors Supplemental request for comment expected Q Page 10

11 Going concern PCAOB is evaluating potential revisions to its standard on the auditor s going concern evaluation Staff Audit Practice Alert No. 13 notes that in addition to considering the applicable financial reporting framework, auditors should continue to follow existing PCAOB auditing standards AICPA issued SAS No. 132 that is effective for audits of financial statements for periods ending on or after 15 December 2017 Changes to the auditor s responsibilities Requires an evaluation of management s assessment of going concern Clarifies the responsibility to separately conclude on the appropriateness of the use of the going concern basis of accounting Requires audit evidence about the intent and ability of a third party or ownermanager to provide financial support Broadens communication requirements to those charged with governance Page 11

12 PCAOB inspections PCAOB inspection staff said it continues to see improvement and inspection findings are trending downward 2017 inspections to focus on: Areas of recurring deficiencies (e.g., ICFR, assessing and responding to risks of material misstatement, auditing accounting estimates) Going concern evaluations Audit areas affected by economic risks and higher financial reporting risks (e.g., areas affected by fluctuations in oil and gas prices) Auditor transparency standard Implementation efforts for new accounting standards Inspections to inform standard-setting agenda Gathering information on auditor s consideration of company s use of non- GAAP measures Gathering information on firm s use of technology in performance of audits, including data analytics Page 12

13 Cyber security attestation reporting Page 13

14 Cybersecurity s expanding effects on our world today and other marketplace dynamics Expanding dependence on IT and interconnectivity Expanding use of third parties Limited number of qualified cybersecurity resources to address cybersecurity risks Issue: expanding/evolving cybersecurity risks to an entity Limited insight into cybersecurity risk management programs by stakeholders Growing sectorspecific regulatory focus on cybersecurity Evolving federal legislative focus on cybersecurity Issue: limited insight, coupled with risk of expanding regulatory and legislative requirements leave, stakeholders in a quandary Page 14

15 Under development Issuance date Q Being updated Issuance date Q Issuance date March 2017 Cybersecurity attestation Reporting options Based on the anticipated range of third-party assurance needs (i.e., range of potential users), the following three levels of potential cyber attestation reporting have been identified: Reporting level Purpose Scope and examples Entity level To address the needs of interested parties who desire greater transparency into an entity s overall cyber risk management program The enterprise-wide operations of the entity Examples: Public entity (e.g., a retail organization) Service provider level To address the vendor risk management needs of companies who obtain key services from third parties The operations supporting the services being outsourced Examples: Entities that provide key services to third parties (e.g., cloud service, telecommunications, claims processors) Supply chain level To address the supply chain risk management needs of companies who obtain key manufactured goods from third parties The operations supporting the manufacturing and distribution of key supply chain goods to others Examples: Entities that serve as a key supply chain vendor (e.g., medical device manufacturer to the health care sector) Page 15

16 Internal Control over Financial Reporting Page 16

17 Internal control over financial reporting Regulatory focus Over the next several years, updating and maintaining internal controls will be particularly important as companies work through the implementation of the significant new accounting standards. SEC Chief Accountant Wesley Bricker The ICFR audit, performed by an independent, objective auditor, is an important driver of trust in the integrity of financial reporting and helps facilitate capital formation in U.S. markets. Letter from the Council of Institutional Investors, Center for Audit Quality and CFA Institute to the House Financial Services Committee regarding the Financial CHOICE Act 2017 The transition to a new GAAP standard necessitates the need for management to carefully consider whether the transition (or consistent application of the standard once implemented) results in new risks or changes to previously identified risks, including fraud risks It is important for management to consider whether new or changes in internal controls are warranted to reduce the risk associated with management bias.management may want to establish a framework that defines how management will execute the judgments required in the new GAAP standards. SEC Professional Accounting Fellow in the Office of the Chief Accountant Page 17

18 Internal control over financial reporting Regulatory focus (continued) Restatement trends Restatements from accelerated filers from prior Form 8-K, Item 4.02 disclosure (prior financials could no longer be relied upon) Reissuance restatements Restatements with Form 8-K, Item Source: Audit Analytics (2016 Financial Restatements: A Sixteen Year Comparison) Largest negative restatements $4,513 $3,465 $6,335 $5,193 $2,377 (US$ in millions) $341 $671 $357 $717 $1,557 $459 $420 $286 $711 $1, Source: Audit Analytics (2016 Financial Restatements: A Sixteen Year Comparison) Page 18

19 Internal control over financial reporting Regulatory focus (continued) It is hard to think of an area more important than ICFR and the related assessment frameworks to our shared objective of providing high-quality financial information that investors can rely on. SEC Chief Accountant Wesley Bricker PCAOB inspections continue to focus on the audit of ICFR, with particular attention on review controls ICFR audit deficiencies continue to be the most frequent inspection finding Review controls over accounting estimates is a common area of deficiency SEC compliance and enforcement activities continue to focus on internal controls Page 19

20 Internal control over financial reporting Review controls related to new accounting standards New management review controls over key implementation processes related to: New revenue standard Revenue stream scoping Contract analysis Development of accounting polices Estimating variable consideration Computing transition adjustments Other new accounting standards, such as those on leases and credit losses Internal controls over Staff Accounting Bulletin 74 transition disclosures Page 20

21 Internal control over financial reporting Information produced by the entity Identify IPE used to perform the review control IPE is data and reports from: The entity s IT applications (financial or operational) Service organizations used by the entity If IPE information is produced by the entity and provided to the external specialist for use in developing its report, the information provided is IPE Consider how the IPE was created Is the IPE in an end user computing tool (e.g., Excel or PowerPoint)? If it is in Excel, was all information entered manually or was the original information exported from an IT application (subject to IT general controls)? If all information was entered manually, what were the sources of that information? For information exported from an IT application (subject to IT general controls), what user actions were required to produce the output? Document activities that address the risk of inappropriate or inaccurate user actions Document reviewer verification of information from an IT application, including: Accuracy of information entered by the user to produce the report Completeness of information transferred from an IT application to end user computing tool Accuracy of changes to the output information Page 21

22 SEC comments and trends Page 22

23 The SEC s filing review process Reviews by the Division of Corporation Finance Periodic reports, at a minimum every three years Mandated by the Sarbanes-Oxley Act Many registrants reviewed more frequently IPOs, Forms 8-K (Items 2.02, 4.01 and 4.02), merger proxies 60% 50% 44% Percentage of SEC issuers reviewed 52% 52% 48% 48% 51% 56% 40% 30% 20% 10% 0% FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 Source: SEC 2016 Annual Performance Report. Page 23

24 The SEC s filing review process (continued) Companies receiving comment letters by size Public float: Number of SEC staff comment letters per year 7,610 5,916 5,352 < $75m 11% 4,683 3,741 2,905 2,761 > $700m 68% $75m to $700m 21% * Forms 10-K and 10-Q Source: Audit Analytics SEC UPLOAD comment letters issued related to Forms 10-K and 10-Q for the 12-month periods ended 30 June 2011 through * The SEC staff publicly releases comment letters no earlier than 20 business days after completion of its review. Therefore, some letters for the 12-month period ended 30 June 2017 may not yet be publicly available. Page 24

25 The SEC s filing review process (continued) 80% 70% Number of comment letters issued to complete review 75% 60% 50% 40% 30% 20% 10% 0% 20% 4% 1% 1 letter 2 letters 3 letters 4 letters or more Source: Audit Analytics Comment letters related to Forms 10-K posted to EDGAR during the 12-month period ended 30 June Page 25

26 Areas of frequent SEC staff comment Ranking Comment letter topic Non-GAAP financial measures 1 2 Management s discussion and analysis (MD&A) 2 1 Fair value measurements 3 3 Segment reporting 4 5 Revenue recognition 5 4 Intangible assets and goodwill 6 7 Income taxes 7 6 State sponsors of terrorism 8 17 Acquisitions and business combinations 9 8 Executive compensation Source: Audit Analytics Comment letter taxonomy for SEC staff comment letters issued to registrants related to Forms 10-K from 1 July 2015 to 30 June Page 26

27 Areas of frequent SEC staff comment (continued) Non-GAAP financial measures SEC staff views on: Non-GAAP measures that are misleading Tailoring recognition and measurement principles Prominence of non-gaap measures Presenting measures per share that appear to be liquidity measures Determining the income tax effects of adjustments to non-gaap measures Examples Excluding normal, recurring cash operating expenses Presenting measures inconsistently between periods Excluding nonrecurring charges but not gains Accelerating the recognition of deferred revenue that must be recognized ratably under GAAP Modification of consolidation principles (e.g., use of proportionate consolidation) Omitting comparable GAAP measures Using bold or larger font for non-gaap measures Volume and order of discussion Excluding quantitative reconciliations for forward-looking, non- GAAP measures Full non-gaap income statements EBIT and EBITDA per share Adjusted EBITDA or adjusted funds from operations per share that appear to function as liquidity measures Non-GAAP income tax effects are not appropriately based on the non-gaap profit level Inappropriate use of cash tax as a performance measure Page 27

28 Areas of frequent SEC staff comment (continued) Non-GAAP financial measures examples of SEC staff comments We note that you disclose the non-gaap measure Adjusted earnings, which excludes pension settlement charges, merger and restructuring charges and abandonment and impairment charges. Considering you have not provided any adjustments to exclude net gains on asset sales, please advise us how you have considered Question of the updated C&DIs issued on May 17, We note that your adjusted EBITDA calculation adjusts for your proportionate share from equity accounted investments. Your proportionate presentation may be inconsistent with Question of the updated C&DIs issued on May 17, Please review this guidance when preparing future filings. We note that you present non-gaap earnings and non-gaap margin before the most directly comparable GAAP measures. Your presentation appears to give greater prominence to the non-gaap measures than to the comparable GAAP measures, which is inconsistent with the updated C&DIs issued on May 17, We note that non-gaap net income per share provides meaningful information regarding your operating performance and cash flows, including your ability to meet future debt service, capital expenditures and working capital requirements. As such, it appears that you are presenting non-gaap net income per share as a liquidity measure. Non-GAAP liquidity measures should not be presented on a per-share basis. Page 28

29 Areas of frequent SEC staff comment (continued) Management s discussion and analysis Results of operations Disclose what and why significant changes occurred Identify and quantify specific business drivers of results Discuss key metrics clearly and completely Critical accounting estimates Provide more analysis of how changes in assumptions could affect financial statements Known trends and uncertainties Type of exposure: Foreign exchange fluctuations Economic conditions low GDP growth Changes in interest rates Natural disasters (e.g., hurricanes) Describe effect of: Foreign currency losses Impairments, revenue reduction Changes to liquidity and financing costs Impairments, business disruption losses Page 29

30 Areas of frequent SEC staff comment (continued) Segment reporting Identification of chief operating decision maker (CODM) Registrants shouldn t default to the CEO as the CODM CODM does not need to have ultimate decision-making authority Identification of operating segments Neither organizational structure nor reports provided to CODM are determinative Emphasis should be on how the business is managed Aggregation of operating segments into reporting segments Consider similar economic characteristics and all qualitative criteria Similarity viewed from the perspective of a reasonable investor No bright lines on similar economic characteristics; future doesn t overcome past Providing appropriate disclosures Non-GAAP measures Entity-wide disclosures Page 30

31 Areas of frequent SEC staff comment (continued) Income taxes Realizability of deferred tax assets Support for realizability when there are consecutive annual losses or a significant loss in current year Additional information when disclosures are omitted or inadequate Foreign earnings Support for indefinite reinvestment assertions Domestic and foreign portions of taxable income Effect of foreign earnings on effective tax rate (ETR) Disproportionate income generated in low-tax jurisdictions Other income tax-related disclosures in MD&A Insight into the extent to which the past is indicative of the future and reasons for changes in the ETR Explain changes in line items in the reconciliation of the statutory tax rate to the ETR Page 31

32 Areas of frequent SEC staff comment (continued) Looking ahead Staff Accounting Bulletin (SAB) Topic 11.M (SAB 74) disclosures on new standards Disclose expected quantitative effect on the financial statements If quantitative effects are unknown, disclose: When the assessment is expected to be completed and status of project Qualitative information to help the reader assess the potential significance of the effect on the registrant s financial statements Disclosures should evolve as the effective date of a new standard nears SEC staff is monitoring implementation of the new revenue standard Consistent application is an area of focus Staff has said similar facts should result in consistent outcomes SEC staff expects companies to follow items of general agreement of the Transition Resource Group SEC staff rescinded its interpretive accounting guidance related to revenue recognition (e.g., SAB Topics 8 and 13) effective upon adoption of the new revenue standard Page 32

33 SEC Initiatives Page 33

34 Overview of key SEC initiatives Strategic priorities of new Commission leadership SEC s current composition Jay Clayton, SEC Chairman (Independent); Michael Piwowar, Commissioner (Republican); Kara Stein, Commissioner (Democrat) Two open Commission seats Strategic priorities Capital formation facilitate capital-raising opportunities for all companies, including small- and medium-sized businesses Rulemaking retrospective reviews of rules to assess relevance and effectiveness; consider both additional and cumulative costs; consider costs of compliance and demonstrating compliance Enforcement focus on individual accountability SEC mission protect long-term interests of Main Street investors Page 34

35 Overview of key SEC initiatives Disclosure effectiveness SEC and its staff issued a number of concept releases, requests for comment, reports and proposed rules related to the disclosure effectiveness initiative April JOBS Act Section 108 Required the SEC to review Regulation S-K's registration requirements and determine how they can be modernized and simplified October Chair White speech The Path Forward on Disclosure December Staff report Public company disclosures September Request for comment Regulation S-X Other entity financial statements December FAST Act Section requires SEC rulemaking to improve Regulation S-K (remove duplicate and outdated requirements) FAST Act Section requires SEC to study and report on Regulation S-K simplification, as well as make improvements to disclosure delivery and focus, and then undertake related rulemaking April Concept release Disclosure Requirements in Regulation S-K July Proposed rule Disclosure Update and Simplification August Request for comment Subpart 400 of Regulation S-K Proposed rule Exhibit Hyperlinks November Staff report Modernization and Simplification of Regulation S-K March Final rule Exhibit Hyperlinks Proposed rule Inline XBRL Request for comment Guide 3, Statistical Disclosure by Bank Holding Companies Page 35

36 Overview of key SEC initiatives New revenue recognition standard SEC five-year table Prior periods presented Effective New revenue standard Staff Accounting Bulletin Topic 11.M disclosures to evolve Full retrospective application date Potential reporting issues for full retrospective adoption: Modified retrospective application date 2019 Modified retrospective application date (emerging growth companies (EGCs) opting private company transition) New or initial registration statements filed in 2018 after adoption presented in Q Form 10-Q Selected financial data and earnings to fixed charges tables no requirement to recast earliest two years Investee significance for S-X Rules 3-09 and 4-08(g) when filing 2018 Form 10-K SEC staff will not require reassessing significance for prior periods Pro forma financial information prepared in accordance with Article 11 of Regulation S-X registrant must conform the acquired entity s transition date and method to its own Companies that are public business entities (PBEs) solely because their financial statements or financial information are included in SEC filings of other SEC registrants (e.g., reporting under Rules 3-05, 3-09, 4-08(g)) may adopt ASC 606 and ASC 842 using the private company adoption timeline Adoption likely is not a fundamental change that would trigger a post-effective amendment to registration statements Page 36

37 Overview of key SEC initiatives Non-GAAP financial measures a continued focus Revisit use of non-gaap measures in filings and earnings releases Consider alternative ways of presenting similar information Challenge usefulness and appropriateness of non-gaap measures Present GAAP measure with equal or greater prominence Place GAAP measure first; avoid discussion of non-gaap measures without corresponding GAAP ones Consider revising disclosure describing how management uses the non-gaap measure and how investors could use it Consider disclosure controls over: Non-GAAP measures Key operating metrics Other non-gaap measures in proxy statements Audit committees are well positioned to exercise healthy oversight by understanding management s controls to calculate non-gaap and other key operational measures. (April 2017) SEC Chief Accountant Wesley Bricker Page 37

38 SEC nonpublic review program Expansion of scope beyond EGCs Scope (regardless of filer category or status): All initial public offering (IPO) registration statements and other Securities Act registration statements filed before an IPO All registration statements within one year as a new SEC reporting company All initial registration statements under Section 12(b) of the Exchange Act Registrant may omit interim and annual financial information from the draft registration statement if it reasonably believes it will not be required to present this financial information separately when the registration statement is publicly filed Different from rule for EGCs, which is based upon expected effective date Public filing must be at least 15 days before road show (or if none, effective date) Registration statements submitted otherwise should be substantially complete This is an important step in our efforts to foster capital formation, provide investment opportunities, and protect investors. Director of the Division of Corporation Finance Bill Hinman Page 38

39 Pay ratio disclosure SEC final rule Pay ratio Annual total compensation of principal executive officer (PEO) Median annual total compensation of all other employees except PEO Allows some flexibility in determining median employee Disclose the methods and material assumptions used in determining components of the pay ratio Recent developments: Commissioner Michael Piwowar requested SEC staff to reconsider rule implementation guidance US House s CHOICE Act seeks to repeal the pay ratio disclosure rule Calendar year-end entities provide 2017 ratio in 2018 proxy Page 39

40 XBRL update Proposed rules would require Inline XBRL tagged financial statements Tags would be directly embedded in the HTML filing Today, companies submit XBRL-tagged financial statements as an exhibit to their SEC filings or use Inline XBRL under a voluntary program Proposal would not change: Scope of XBRL tagging Officer certification scoped out Auditor involvement not required Four-year phase-in after rule is effective Page 40

41 Other SEC reporting reminders Recent observations on voluntary disclosure improvements by registrants in SEC filings Using charts, tables and infographics to summarize information Using bullet points to replace lengthy text discussion Eliminating redundancies by using cross-referencing Avoiding boilerplate language and using plain English Certain reminders for financial reporting requirements for equity method investees Consideration for nonrecurring gains/losses in significance tests Reporting obligations when significance tests fall below the reporting thresholds during the current year Page 41

42 Enforcement activities Record number of cases in 2016 led to over $4 billion in recoveries SEC filed a total of 868 cases in financial reporting cases in 2016 versus 135 in Issuer reporting and disclosure actions Total enforcement actions '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Source: Select SEC and Market Data reports by fiscal year The SEC has strong and active enforcement and examination programs. I fully intend to continue deploying significant resources to root out fraud and shady practices in the markets, particularly in areas where Main Street investors are most exposed. SEC Chairman Jay Clayton Page 42

43 Enforcement activities (continued) Emphasis on holding gatekeepers accountable Accountants, lawyers, audit committee chairs, broker dealers Financial Reporting and Auditing (FRAud) Group Revenue recognition Inadequate controls over the accounting for rebates Earnings management and misleading non-gaap measures Non-GAAP measures that contain misleading adjustments Non-GAAP measures that are developed inconsistently from period to period Loss contingencies Undisclosed exposure from known defects in a sold product Failure to accrue and disclose a liability related to an ongoing government investigation Income tax accounting Overstating net income by posting top-side entries in the tax provision Whistleblower program protects and rewards whistleblowers More than 4,200 tips in SEC fiscal 2016 Page 43

44 Restatement themes Overview Top three topics 2016 % Top three topics 2015 % Income taxes 16 Income taxes 14 Revenue recognition 9 Revenue recognition 8 Reclassifications (balance sheet and income statement) 6 each Liabilities, depreciable assets, expense recognition 6 each Practices that may lessen the likelihood of errors/restatements include: Identifying and accounting for key contractual terms Focusing on changes in business and effects on estimates on a timely basis Entities should correct identified errors as soon as practicable to avoid restatement due to an accumulation of individually immaterial errors Page 44

45 Restatement themes Internal control considerations A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the company s annual or interim financial statements will not be prevented or detected on a timely basis As defined, a material weakness does not require that an error exist in a company s financial statements, but rather that there be a reasonable possibility that a material misstatement could occur Page 45