According to a review of SEC staff comments by Bloomberg, Corp Fin staff have been weighing in to remind companies about the need to discuss, in SEC filings, the material impact of inflation—and don’t forget the details. No doubt you remember that Item 303 of Reg S-K used to include an express requirement to discuss the impact of inflation and changing prices on net sales, revenues and income from continuing operations, but that provision was eliminated as part of the MD&A modernization project in 2020. (See this PubCo post.) Of course, at that point we hadn’t had any real inflation for years. Then the SEC removed the explicit requirement and what do we have? Inflation, of course—up to 9% in June 2022.
Although the express requirement to discuss inflation in MD&A has been eliminated, companies are still expected to discuss inflation and changing prices “if they are part of a known trend or uncertainty that has had, or the registrant reasonably expects to have, a material favorable or unfavorable impact on net sales, or revenue, or income from continuing operations.” In addition, the rules provide that, to the extent there are material changes in net sales or revenues, a narrative discussion is required of the extent to which the changes are attributable to changes in prices, the amount of goods or services being sold or to the introduction of new products or services. The narrative must include a discussion of the “underlying reasons” for these material changes in quantitative and qualitative terms, and accordingly, may also implicate a discussion of inflation.
Recently, Bloomberg reports, the SEC has been reminding companies of the need to talk about the impact of inflation as they prepare their SEC filings. (That’s still the case, even though, by July, inflation had cooled significantly to about 3.2%.) According to Bloomberg, “inflation” was mentioned by S&P 500 companies on earnings calls more than a thousand times over the past 30 days, compared to just over 100 times during the same period in 2020. That gives rise to the question, an accountant commentator told Bloomberg, “If companies deem inflation important enough to flag in an earnings call or an investor presentation, they had better mention it in their financial statement risk factors” or in MD&A: “‘Are they absorbing the costs? Are they passing them through in the form of price changes? How is this affecting the longer-term trends? If they’re addressing it in the calls but not in the filings, that’s an area that’s likely to trigger a comment,’” the commentator noted, “‘It just so happens right now that inflation is the topic du jour.’” (And the staff do consider disclosures on earnings call in the course of the comment process. See this post from thecorporatecounsel.net blog.)
But the SEC isn’t just asking companies to “mention” inflation. In regular comments on SEC filings to a diverse mix of companies, Corp Fin has asked companies to discuss in more detail the impact of inflationary pressures, including at times, with quantification. From a quick EDGAR search, I found, for example, a comment from Corp Fin related to a risk factor that discussed inflation, asking the company to “update this risk factor in future filings if recent inflationary pressures have materially impacted your operations. In this regard, identify the types of inflationary pressures you are facing and how your business has been affected.” In another case, where a company disclosed that its costs of necessary commodities, labor, energy and other inputs had significantly increased and were expected to continue to affect the business, the staff asked for more detail, requesting that the company revise its disclosure to quantify the impact of inflation, including providing year-over-year comparisons of the impact, and provide more detail regarding the company’s efforts to offset cost pressures through price increases, including the success of those efforts. In another instance, commenting on MD&A disclosure that inflation had negatively affected results of operations as a consequence of increased cost of sales and operating expenses, Corp Fin asked the company to “quantify and disclose the impact of the inflationary pressures you are experiencing on cost of sales, gross margins and operating expenses,” quantifying increases in transportation and fuel costs, materials, commodities and packaging costs, as well as production inefficiencies and geographical sales mix. Another comment asked a different company to expand on how the impact of higher rates of regional inflation and raw material supply in certain regions affected the company’s operations, potentially affecting its operating segment analysis. In yet another example, the staff observed that when the financials reflect material changes from period-to-period in one or more line items, or where material changes within a line item offset one another, the company is still required to describe the underlying reasons in quantitative and qualitative terms. The staff then asked the company to “quantify the impact of each factor or component associated with material changes, including the impact of inflation associated with any material changes.”
As an accounting academic (and former SEC academic fellow) remarked to Bloomberg, companies need to be specific: “‘You say inflation matters; tell us exactly what it matters for….Is it the price of all your products? Is it a cost of a key commodity? If so, which commodity? What’s the percentage increase? How much do you think that will impact your bottom line, or how much has it impacted your bottom line?’” Even if a company is protected from inflation by preset contract prices, the commentator advised that the company should still address what it “expect[s] to happen when the contracts expire.” In addition, companies should consider the need to discuss “the ripple effect of inflation: increases in prices they charge their customers. Those price increases could be a temporary boost to earnings if corresponding costs don’t rise as swiftly—and the SEC will be paying attention. ‘There’s just a zinger waiting for some companies there,’” she advised.