This article contains practical guidance and support as to the appropriate disclosure of the expected effects of significant future accounting changes from new GAAP standards that have been enacted but are not yet effective or adopted. FASB’s Accounting Standards Update (ASU) 2017-03 added guidance (ASC 250-10-S99-6) in a paragraph designated with the letter “S,” signifying that it constitutes guidance solely applicable only to SEC issuers (i.e., public entities). Therefore, this added paragraph should not be interpreted as GAAP applicable to private reporting entities.
For most reporting entities, public and private, the guidance that follows is particularly relevant to the imminent adoption of the new revenue recognition standard [Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers”]; the new lease accounting standard (ASC Topic 842, “Leases”), particularly for lessees with many long-term operating leases that will be capitalized; and Topic 326, “Financial Instruments—Credit Losses,” primarily for financial services firms with expected credit losses resulting from holding financial instruments that are not accounted for through fair value adjustments charged or credited to income.
All Entities Reporting in Accordance with GAAP
There is not, nor has there ever been, any express GAAP requirement to disclose expected effects of pending accounting changes mandated by new, but not yet effective, accounting standards. Historically, however, as pointed out in SEC Staff Accounting Bulletin (SAB) 74, “Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant When Adopted in a Future Period” (alternatively referred to as SAB Topic 11M), the AICPA’s Auditing Standards Board (ASB) issued Auditing Interpretation 3 to AU section 410 (AU 9410.13-18), which addressed these reporting considerations.
It should be noted that SABs are technically nonauthoritative, interpretive views of the SEC staff on various accounting matters, and theoretically are neither GAAP nor legal requirements such as they would be under Regulation S-X. Accordingly, by their language (e.g., “should be considered” or “encouraged”), they may appear to be merely suggestions or recommendations. Nevertheless, they are often vigorously enforced upon issuers by SEC staff through its comment process and upon auditors by the PCAOB through its inspection process. Hence, their provisions are commonly referred to as “requirements.”
Unfortunately, as a consequence of purging its auditing standards of references to GAAP to accommodate alternative financial reporting frameworks in connection with its Clarity Project recodification, the ASB withdrew AU 410 and its related interpretations for private entities in 2009. And, effective December 31, 2016, the PCAOB rescinded the same provisions of its Interim Auditing Standards in connection with its reorganization project (PCAOB Release 2015-002).
Despite the guidance in AU 9410.13-18 no longer existing in current auditing standards or interpretations and never having been included into the ASC (i.e., GAAP), the underlying principle quoted above continues to be widely understood and observed: that is, that financial statement disclosure is adequate only when it includes all information that is essential for a user’s understanding of the financial statements. The principle was deeply rooted almost 50 years ago in the famous court case commonly referred to as Continental Vending (U.S. v. Simon, 38 U.S.L. Week 1077, 2d Cir. November 12, 1969), in which it was ruled that despite full, literal compliance with the express requirements of GAAP, disclosure is inadequate if it omits information crucial to a proper understanding by, or contributes to a materially misleading impression in the minds of, financial statement users. In 2011, the U.S. Supreme Court (Matrixx Initiatives, Inc., et al. v. Siracusano, et al., No. 09-1156, 563 U.S.) issued the oft-cited definition embraced by standards setters and regulators, which effectively held that financial information was material if it would make a difference to investors.
The more significant the expected effects of adopting the new GAAP and the closer the expected adoption of the change, the more important the disclosure and the more detailed the disclosures should be. Such disclosures generally should be considered also for inclusion in interim financial statements unless 1) they were included in previous annual financial statements that are available to the same users and 2) the extent of knowledge available about future effects of adoption has not materially changed.
Determining the nature, timing, and extent of disclosures that would be adequate to provide a suitable understanding requires the application of considerable judgment as to what would be significant from the viewpoint of probable financial statement users. For private entities, one may look to the guidance provided for public entities by the SEC staff (referred to below) for ideas, but this guidance should not substitute for good judgment in the clients’ particular circumstances. Even when the effect of a mandated change in a succeeding period is deemed likely to be significant, a financial statement note disclosure made by a private or public entity reporting under GAAP could be substantially briefer than that typically expected by the SEC staff in the management discussion and analysis (MD&A) of an SEC issuer (see Sidebar for practical examples).
Even though the enactment of a significant new GAAP requirement to be adopted in a future period will likely have occurred prior to the balance sheet, its expected future effect might well be viewed as a nonrecognizable (i.e., type 2) subsequent event and therefore discloseable under ASC Topic 855. Placement of this disclosure could be in a subsequent events note, among the accounting policies, or in a separate note.
Note disclosure of new accounting standards not expected to have a material retrospective or future effect is not recommended unless there is a perceived user expectation or concern about such matters.
Illustrative Notes for GAAP Financial Statements
Example 1. For entities likely to be affected significantly only by the new revenue recognition standard (ASC 606):
A new standard has been issued by FASB that will require significant changes in the method and timing of recognition of certain contract revenues and related incremental expenses (such as sales commissions) once it becomes effective for nonpublic entities. This standard will be adopted by the Company beginning in 2019 and will entail certain retrospective adjustments at that time. The effects of this change on the Company’s financial statements have not yet been determined.
Example 2. For entities likely to be affected significantly by both the new lease accounting and revenue recognition standards (ASC Topics 842 and 606, respectively):
Effective for its annual financial statements for 2019 and interim financial statements thereafter, the Company expects to adopt new accounting standards issued by FASB that will require significant changes in accounting for operating leases under which the Company is lessee, and in the method and timing of recognition of certain nonlease contract revenues and certain incremental expenses such as sales commissions. Upon adoption, among other effects, the Company will be required to record assets and liabilities for all operating lease obligations with terms of 12 months or greater. These changes will entail certain retrospective adjustments. The qualitative effects on the Company’s future financial statements of these changes and related retrospective adjustments have not yet been determined.
Note: Consider disclosing additional details, if and when known, such as the timing of any intended early adoption and the transition method (i.e., full or modified retrospective application) selected when judgmentally determined likely to be of significance to financial statement users. Such judgments should be documented. It is recommended, however, that other details typically expected of SEC issuers pursuant to SAB 11M and ASC 250-10-S99-6 be included only in an MD&A of a public entity and excluded from financial statement disclosures.
Public Entities Only
With respect to the provisions of SAB 11M, ASU 2017-03 added ASC subtopic 250-10-S99-6, incorporating an SEC staff announcement made at the September 22, 2016, Emerging Issues Task Force (EITF) meeting. This guidance interprets and effectively strengthens (without amending) the guidance in SAB 11M.
Public entities that report on a calendar year basis (as most do) have already adopted ASC 606 (and probably ASC 842) during the interim periods of the current year and, therefore, need no longer be concerned with the disclosures that are the subject of ASU 2017-03 with regard to these two matters; however, issuers with fiscal year-ends (and those subject to significant effects from ASC Topic 326 beginning in 2020 or other mandated accounting changes yet to come) may not yet have reported on their first interim period after adoption of one or more of these new standards.
According to SAB 11M, the SEC staff believes the subject disclosures should be made in the MD&A, and it suggests that they be considered also for inclusion in the notes to the financial statements, perhaps in addition to those made pursuant to ASC 855 or solely because they are judged necessary for an adequate understanding by users. More recently, however, the SEC has been publicly discouraging redundant disclosures in its filings. To reduce the potential for redundancies, ASC 250-10-S99-6 suggests that the MD&A may contain cross-references to related disclosures that appear within the financial statement notes. Cross-references in the opposite direction (i.e., from the notes to the MD&A) are to be avoided, however, because the notes must be audited and the MD&A is not. Auditing management representations about its expectations and intentions included in the notes would be challenging and would likely increase audit costs.
At the September 22, 2016, meeting of FASB’s EITF, SEC assistant deputy chief accountant Jenifer Minke-Girard specifically addressed SAB Topic 11M disclosures with respect to the revenue recognition and other emerging standards. (This is the SEC staff announcement that now constitutes ASC subtopic 250-10-S99-6 mentioned above.) In that presentation, Minke-Girard indicated that when an issuer is unable to estimate reasonably the impact of adopting a new standard, the SEC staff nevertheless would likely expect qualitative disclosures as early as practical, with relevant detail added in succeeding periods as they become known, about the significance of its expected impact on the issuer’s future financial statements. This would include a description of the effects, if significant, of any accounting policies that the issuer expects to select upon adoption and how they may differ from current accounting policies, the planned timing of adoption and status of the issuer’s implementation process, and the nature of any significant implementation matters not yet addressed. Once it has been decided, the expected transition option (i.e., full or modified retrospective application) also should be disclosed.
Although the language in SAB 11M does not call for any disclosure when the effect of adopting a new standard is not expected to be material, because of the pervasive significance of the new revenue recognition standards, Minke-Girard also indicated that the staff “encourages” management to consider more defensive and detailed SAB 11M disclosures than have been typical in the past, such as described above. One may find examples online in 2016 and 2017 10-K filings of SAB 11M disclosures that meet these staff expectations. Disclosure of new accounting standards in development but not yet finalized by FASB is not recommended by the staff, since such standards may change before they are finalized and thus the disclosures could be misleading.
Reference is made also to the AICPA’s Center for Audit Quality’s Alert 2017-03, SAB Topic 11.M – A Focus on Disclosures for New Accounting Standards (http://bit.ly/2yfMi3h). It contains a comprehensive analysis of this topic, including relevant excerpts from, and links to, SEC staff speeches and public comments, as well as other resources.