The SEC recently completed its review of Form 10-K annual reports filed in 2002 by all Fortune 500 companies, and issued comment letters to more than 350 of the Fortune 500 companies. The SEC posted on its website a summary of the most frequent areas of comment where the SEC believes that disclosure could be significantly enhanced.
This guidance from the SEC will be helpful for those companies that are in the midst of finalizing disclosures for this annual reporting season. Also, as a result of the mandate under Sarbanes-Oxley that the SEC review each issuer’s 1934 Act reports at least once every three years, many issuers can expect the SEC to subject their filings to some level of review this year. Compliance with the SEC’s guidance and related pronouncements under Sarbanes-Oxley will increase the likelihood that an issuer gets only a limited review by the SEC or is able to quickly respond to all SEC comments.
The primary areas of comment identified by the SEC are listed below.
Management’s Discussion & Analysis Generally
Not surprisingly, MD&A received more comments than any other topic. The SEC issued numerous comments generally seeking greater analysis of the issuer’s financial condition and results of operations, which is the primary purpose of MD&A. The SEC encourages issuers to avoid boilerplate analyses consisting only of recitations of financial statement items and percentage calculations, but rather focus on known trends, uncertainties or other factors that provide insight into the issuer’s past performance and business prospects. The SEC also believed that many issuers had provided insufficient disclosure of liquidity, cash flow and capital resources.
Critical Accounting Policy Disclosure
As the SEC indicated in its December 2001 guidance and May 2002 proposed rule, the SEC believes issuers should expand the discussion of its critical accounting policies in MD&A. Issuers should identify the few most difficult and judgmental estimates and most important policies and provide a sensitivity analysis to help investors understand how the estimates and policies affect the reported financial results. The SEC particularly noted the lack of any sensitivity analysis from most issuers’ disclosures.
Non-GAAP Financial Information
Another hot issue for the SEC, as evidenced by their recent issuance of final rules governing the use of non-GAAP financial information, is the use of financial measures that deviate from the GAAP measurement and may be misleading or susceptible to misinterpretation. To the extent issuers provide non-GAAP financial measures, the disclosure should display the most comparable GAAP measure with equal or greater prominence, provide a reconciliation and explain the uses of the non-GAAP measure.
Revenue Recognition
The SEC continues to request clarification on how issuers recognize revenue and whether their policies comply with SAB 101. The SEC noted the following industry-specific comment themes:
- Computers – expand accounting policy disclosure for software and multiple element arrangements
- Capital goods, semiconductor and electronic instruments – expand accounting policy disclosure for deferred revenue, revenue recognition for products with returns or price protection features, requirements for installation of equipment and other customer acceptance provisions
- Energy – disclose material terms of energy contracts
- Pharmaceutical and retail – expand accounting policy disclosure for product returns, discounts and rebates
Restructuring Charges
The SEC requested that several issuers explain more fully their accounting for restructuring charges. With respect to the financial statements, the SEC requested that issuers include a period-by-period analysis of the restructuring charges, describe the timing of cash payments to be made under the restructuring plan and describe the reason for adjustments or reversals of restructuring charges. The SEC requested that issuers expand their MD&A disclosure to describe the reasons for and likely effects of the restructuring and discuss each component of the total restructuring plan.
Impairment Charges
Comments on impairment charges focused on three distinct areas. First, the SEC requested expanded disclosure on the timing, measurement and disclosure of impairment charges for long-lived assets. Second, the SEC requested disclosure on how issuers determined whether unrealized losses on investment securities were temporary or other-than-temporary. Finally, the SEC questioned issuers about their impairment testing of goodwill and intangible assets with indefinite lives.
Pension Plans
The SEC asked several issuers to explain the assumptions used to determine the amount of pension income or expense to recognize, including trends in such assumptions and a sensitivity analysis of the assumptions.
Segment Reporting
The SEC reminded issuers about the requirement to provide segment information for any operating segment, which is defined as a segment that has separate financial information that management evaluates. The SEC commented that several issuers inappropriate aggregated information or failed to explain the basis for aggregating information.
Securitized Financial Assets and Off-Balance Sheet Arrangements
The SEC requested that issuers expand their MD&A disclosure to describe the structure, business purpose and accounting for securitized financial assets and other off-balance sheet arrangements. The SEC indicated that it would continue to review disclosure of these arrangements and issuers’ compliance with the new rules issued on this topic.
Environmental and Product Liability Disclosures
For a number of oil, gas and mining companies and several manufacturing companies, the SEC reminded issuers with environmental and product liabilities to disclose the nature of the loss contingency, the amount accrued, an estimate of the range of reasonably possible loss, significant assumptions underlying the accrual and the cost of litigation. The SEC also encouraged issuers to disclose in MD&A how the amounts charged in each period were determined and recorded.