On November 13, 2024, during the Practising Law Institute's 56th Annual Institute on Securities Regulation, a panel discussed critical updates in accounting and auditing, emphasizing the evolving landscape shaped by the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB), including the below.
- Segment Reporting (ASU 2023-02). This update mandates new disclosures, including the identification of the Chief Operating Decision Maker (CODM) and significant segment expenses. The lack of a clear definition for "significant" presents challenges for companies in determining what to disclose, particularly for those with a single reportable segment. Legal professionals should ensure that significant segment items are included in the Management Discussion and Analysis (MD&A), that single-segment companies report new details, and that the CODM is clearly identified. Additionally, they should focus on prior period comparisons and ensure compliance with Securities and Exchange Commission (SEC) guidance for any non-GAAP measures presented, including necessary reconciliations and prominence of GAAP figures.
- Enhanced Income Tax Disclosures. Effective in 2025, public business entities must disclose detailed income tax information, including total taxes paid to federal, state and foreign authorities, along with reconciliations of reported tax expenses with statutory rates. This initiative aims to improve transparency relating to tax obligations, helping investors understand effective tax rates and their impact on cash flow. However, the complexity of these disclosures may lead to "disclosure overload," so companies should prepare in advance to ensure clarity and compliance while maintaining comparability with prior disclosures.
- Disaggregation of Expense Categories. Beginning in 2027, public companies must provide detailed disclosures of specific expense categories in their income statements, such as inventory purchases, employee compensation and depreciation. This requirement aims to enhance transparency and provide investors with clearer insights into financial performance. Legal professionals should help clients prepare to break down aggregate expenses in their MD&A to comply with these new standards effectively.
- Broadening Focus on Controls and Procedures. Recent SEC enforcement actions highlight the urgent need for robust internal control over financial reporting and disclosure controls and procedures (DCP), revealing issues such as inadequate controls over stock buybacks, failures in timely workplace misconduct disclosures, and deficiencies in managing non-GAAP financial measures. Additionally, the SEC's scrutiny of shortcomings in cybersecurity controls emphasizes the importance of strong procedures to protect sensitive information. Key takeaways include the need for companies to review regularly and enhance their DCP processes, assess the effectiveness of disclosure committees, foster collaboration between finance and legal teams, and ensure thorough documentation of DCPs to improve compliance and overall disclosure quality.
- PCAOB Oversight of Audit Profession. While the impact of a change in administration is unclear, the PCAOB may still be planning to finalize standards on Non-Compliance with Laws and Regulations (NOCLAR), which will require auditors to assess a company's compliance with laws and regulations in the jurisdictions in which it operates that could materially impact financial statements. This would broaden the scope of auditors' responsibilities significantly. Additionally, the PCAOB's inspection process emphasizes the need for thorough documentation and timely responses to identified deficiencies, as failure to obtain sufficient evidence can lead to significant audit deficiencies. Legal professionals should ensure close cooperation with auditors during inspections, as auditors may hesitate to sign off on their reviews or the company's Form 10-Qs until they have completed any necessary follow-up work on prior audits. This proactive approach is crucial for the timely filing of periodic reports.
In light of the upcoming reporting season and a new administration, companies should establish a dedicated disclosure committee for the Form 10-K to promote collaboration between accountants and lawyers, facilitating educational sessions on relevant changes.
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