In the “Quarterly Perspectives: Financial Reporting & Beyond / Q2 2024” webinar from Forvis Mazars, we looked at a range of developments in the world of financial reporting—and the relevant standard setters, including FASB, the American Institute of CPAs (AICPA), the SEC, and PCAOB—and what they could mean for your organization. Read our webinar recap below and sign up for our remaining 2024 webinars for more timely insights.
Looking Back
Disclosures
During the past quarter, we observed a heavy volume of disclosure-related issues reported from peer reviews, such as financial statements not having all the revenue disclosures required by Accounting Standards Codification (ASC) 606. Considering that disclosure checklists can run hundreds of pages, accounting professionals may find it helpful to have a subscription service to a good checklist. We also recommend concentrating on disclosure items that are new or have changed.
Supreme Court Rulings
Although it remains to be seen, recent U.S. Supreme Court decisions in three cases will likely affect how the SEC operates. Two of the cases—Relentless, Inc. v. U.S. Department of Commerce and Loper Bright Enterprises v. Raimondo—concerned enterprises arguing that regulating agencies went too far, prompting the court to overturn 40 years of established law known as the Chevron doctrine, which historically held that the judiciary could defer heavily to a regulatory body. As a result, the judiciary will have more authority to interpret laws and companies may have more opportunities to challenge regulations, including those issued by the SEC.
In the third case, SEC v. Jarkesy, the court found the use of administrative law judges in seeking civil penalties in fraud cases violated the constitutional right to due process. Cases will now have to go to trial in the court system as opposed to SEC’s administrative law process.
Noncompete Agreements
The Federal Trade Commission (FTC) issued a final rule banning noncompete agreements. While there are some very narrow exceptions, such as grandfathered noncompete agreements with senior executives and in certain sales transactions, the ban could affect business practices and the accounting for intangible assets related to noncompete agreements. Absent any other court actions, the rule is effective in early September. (Note that a U.S federal court subsequently banned the enforcement of the rule. An appeal of that ban is expected.)
Here & Now
Cybersecurity
We’ve observed a lot of activity on disclosures stemming from the SEC’s new final rule regarding cyber incidents. Changes include new Regulation S-K Item 106, which covers processes to assess, identify, and manage material cybersecurity risks, as well as management’s role in assessing and managing those risks. There also is a new 8-K requirement in Item 1.05 to disclose material cybersecurity events and their related impact. In addition, SEC staff continues to provide additional guidance both formally (Compliance and Disclosure Interpretations) and informally (speeches and announcements).
We asked our audience, “Have you been involved (either directly or indirectly) in a cyber incident?”
| Yes | 46.8% |
| No | 38.1% |
| Not Sure | 10.9% |
| Not Applicable | 4.2% |
Due to the prevalence of data breaches, companies should recognize that it’s probably not a matter of if a cyber incident will occur, but when. A material cybersecurity event is viewed as one that would impact an investor’s decision making regarding an affected company. Private and public companies should assess both qualitative and quantitative factors when assessing materiality. Quantitative factors include a company’s financial condition or operational impacts while qualitative factors can be harder to quantify, such as an entity’s reputation.
Businesses also should watch their vendor relationships through third-party risk management. In one example, a company providing technology throughout the auto industry experienced a ransomware attack, which affected customers using their product. In another example, an attack on a company’s platform used in healthcare transactions may have impacted one-third of Americans.
Recent SEC actions highlight the agency’s focus on cybersecurity, such as filing a cease and desist order against a company for failing to design effective disclosure controls and procedures related to cybersecurity risk and incidents, among other claims. According to the SEC, the company had failed to execute a timely response for nearly a month in a breach that involved personal identification and financial information of some customers.
The effects of the SEC’s new cybersecurity rule on companies’ daily management include:
- Increased external audit procedures
- Enhanced cybersecurity and incident management policies and procedures
- Documented analysis on materiality evaluation and conclusion
- Adoption of tools supporting expedited response time for incidents to allow for timely detection, classification, and disclosure
- Increased training needs for management and control owners
- Additional third-party system vendor management practices
Documentation is key when making cybersecurity plans. Companies should have a strong incident response policy and make sure their employees have security awareness trainings.
FASB’s Private Company Council (PCC) Update
As the primary advisory board to FASB on private company accounting issues, the PCC has ongoing discussions with the board as it deliberates accounting standards. Following some recent changes to the composition of PCC because of term limits, it has four topics currently under consideration:
- Credit losses—short-term trade accounts receivable and contract assets
- Debt modifications and extinguishments
- Presentation of conditional retainage and overbillings as contract assets and liabilities
- Lease accounting simplifications such as practical expedients or accounting alternatives
We asked our audience, “Which of the PCC agenda items are of the most interest to you?”
| Credit losses—short-term trade accounts receivable & contract assets | 25.2% |
| Debt modifications & extinguishments | 19.6% |
| Presentation of conditional retainage & overbillings as contract assets & liabilities | 10.0% |
| Lease accounting simplifications such as practical expedients or accounting alternatives | 45.1% |
Leasehold Improvements
Before signing a lease or lease modification, it is important to understand the nature of leasehold improvements. Identifying the accounting owner of leasehold improvements could impact the determination of the commencement date, the calculation of the lease liability, or tenant improvement allowance. Consider the following questions and examples:
- Do the improvements have an alternative use to the lessor?
- Is the lessee consuming the majority of the economic life of the asset?
Example One
- Facts
- Five-year lease commencing May 1
- $800,000 of generic upgrades to be paid by the lessor
- $200,000 of generic upgrades to be paid by the lessee
- Generic upgrades of drywall and HVAC have a 20-year life
- Timing
- Lease signed January 1
- Construction starts January 1
- Property ready one month early on April 1
- Questions
- Who is the accounting owner of the leasehold improvements? The lessor.
- What do you do with the $200,000 payment? That’s merely prepaid rent.
- When does rent expense start getting recorded? You would start expensing it on April 1 when the property is turned over and you have control of it.
Example Two
- Facts
- 10-year lease commencing May 1
- $800,000 of custom upgrades to be paid by lessor
- $200,000 of custom upgrades to be paid by lessee
- Custom upgrades have 10-year life
- Timing
- Lease signed January 1
- Construction starts January 1
- Property ready one month early on April 1
- Questions
- Who is the accounting owner of the leasehold improvements? The lessee.
- What do you do with the $200,000 payment? This will become leasehold improvements that you will amortize over the shorter of the lease term or the life.
- What do you do with the $800,000 payment? It becomes a tenant improvement allowance and will start to impact the right of use asset.
- When does rent expense start getting recorded? On January 1, because that’s when construction is occurring.
Conversations You Should Be Having
As we approach the end of the year, there are new segment disclosures that are effective year-end for public companies that will take some time to understand and prepare, including for comparative historical periods.
Also worth noting is an SEC Statement from Erik Gerding, director of the SEC Division of Corporation Finance, that looks at some items the agency will be reviewing going forward. The statement provides information on financial reporting focus and SEC disclosure focus.
Forvis Mazars will continue to cover the latest in the accounting profession at our next Quarterly Perspectives webinar. Register now!
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.