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At the PLI Securities Regulation Institute last week, the accounting and auditing update panel provided some useful insights—especially for non-accountants. The panel covered the new requirements for segment reporting, the intensified focus on controls, PCAOB activities (including NOCLAR) and errors and materiality.  Below are some takeaways. 

[Based on my notes, so standards caveats apply.]

Segment reporting.  Back in December last year, the FASB announced a final Accounting Standards Update designed to improve disclosures about public companies’ reportable segments, particularly disclosures about significant segment expenses—information that the FASB says investors frequently request. (See this PubCo post.)  The ASU requires that “a public entity disclose, on an annual and interim basis, significant segment expenses that are regularly provided to the chief operating decision maker (CODM) and included within each reported measure of segment profit or loss.” The panelists pointed out:

  • Significant segment expenses should reflect whatever the CODM uses.  Companies should consider adding discussion on this topic to the MD&A.
  • Even if there is ultimately only one segment, there are still reporting requirements; the ASU requires that a company “that has a single reportable segment provide all the disclosures required by the amendments in the ASU and all existing segment disclosures in Topic 280.”
  • The ASU requires companies to identify the CODM; the ASU requires disclosure of “the title and position of the CODM and an explanation of how the CODM uses the reported measure(s) of segment profit or loss in assessing segment performance and deciding how to allocate resources.”
  • Companies should focus on prior period comparisons.
  • Companies are permitted to report more than one measure of profit or loss; the ASU provides that, “if the CODM uses more than one measure of a segment’s profit or loss in assessing segment performance and deciding how to allocate resources, a public entity may report one or more of those additional measures of segment profit. However, at least one of the reported segment profit or loss measures (or the single reported measure, if only one is disclosed) should be the measure that is most consistent with the measurement principles used in measuring the corresponding amounts in the public entity’s consolidated financial statements.” It can get complicated if one of those measures is a non-GAAP financial measure. While including a NGFM in the footnotes to the financials is uncommon, the panel said, it would require compliance with the NGFM rules, such as the rules relating to reconciliation, prominence, etc.  And if the measure is a NGFM, then it would not be audited, which would require an explanation. Cross reference to disclosures outside the financials would be prohibited. Panelists recommended reviewing some of the materials on this topic from the Big Four.  (Here’s one I found from Deloitte.)
  • A panelist described the exercise as like double-clicking on current expense line items for more detail.  But will there be disclosure overload?
  • There will be practical challenges to implementation—what do you do with expenses of the C-suite?—and will require new processes and controls.

Controls.  The panels noted that there have been a number of recent enforcement cases that related solely to problems with controls; some of the actions did not even identify other harms. While there were some dissents in those cases, controls are also a matter of good hygiene. In that regard, the panel was a bit of a paean to SOX, which led to the institution of many of these controls and, in the panel’s view, resulted in real improvement. 

  • There was several enforcement actions cited by the panel where the misconduct related to controls—in some cases, solely to controls:
  • The panel viewed controls as fundamental and advocated that they be reviewed and updated—time for a refresh as a matter of good corporate hygiene.  The panel advocated commencing the review process early, in November or December.  In particular:
    • While the view was that internal control over financial reporting, which is more within the purview of the accountants, was generally well-handled, disclosure controls and processes, which are more within the ambit of the attorneys, maybe not so much. For example, internal accounting controls tend to be written down.  The panel advocated that companies commit their disclosure controls and procedures to writing. These two set of controls are a bit like a Venn diagram as to some overlapping matters—companies need to determine who is responsible for what.  
    • Take another look at the charter of the Disclosure Committee—what are its responsibilities? Do they have responsibility for more than periodic reports?  What about Forms 8-K, proxy statements, voluntary documents? 
    • What is the composition of the Disclosure Committee? Do the members have appropriate experience and expertise? For example, the panel mentioned an EY study that showed that less than half of these committees had any members with any cyber expertise. Does the committee need more education on some topics? The panel advised scheduling an early meeting of the Disclosure Committee to review changes in regulations and perhaps have an education session.

PCAOB matters.  The PCAOB was a creature of SOX; there was no requirement for nonpartisanship, and the members can be replaced any time.  Recently, the panel said, both new chairs replaced the members.

  • Many of the current PCAOB standards are holdovers from the standards crafted by the American Institute of Certified Public Accountants and developed almost 30 years ago, prior to the accounting scandals of the 2000s and the creation of the PCAOB under SOX. SEC Chair Gary Gensler has been advocating that the PCAOB update these carryover auditing standards.  (See this PubCo post and this PubCo post.)

SideBar

In opening remarks made at an SEC open meeting held to approve new updated PCAOB proposals, Gensler put this initiative in the historic context of the adoption of SOX in 2002, which led to the establishment of the PCAOB as “an independent watchdog over the audits of public companies and registered broker-dealers and their auditors. The Enron crisis revealed a key problem: the quality of auditing standards. Candidly, the relationships between issuers and auditors, between standard-setters and auditing firms, were too clubby.”  Auditing standards were set by the AICPA, which meant that, in effect, the “profession was writing its own rules. That’s an inherent conflict. To correct course, the PCAOB was tasked with setting enhanced auditing standards. For practical purposes, Congress permitted the newly established PCAOB to carry over existing AICPA standards on an interim basis. The expectation was that the Board would produce a more appropriate set of standards going forward.” Although these standards “were already decades-old when the Board adopted them in 2003,” before that meeting in August, the PCAOB had at the time adopted only seven new standards—“42 of these 49 so-called ‘interim standards’ remained in public company audit practice.” 

  • Noncompliance with Laws and Regulations, or NOCLAR, is still on the PCAOB agenda for 2025, the election notwithstanding.  The proposal would require auditors to identify laws and regulations with which the company is not in compliance that could materially affect the financial statements. Many objected to the broad scope and potential cost of the proposed standard, for example, having to understand the laws of different countries in the case of a multinational company or the rules of numerous agencies regulating companies in different industries.

SideBar

As  described in this Thompson Reuters article, the NOCLAR proposal was issued by the PCAOB in June 2023, designed to “strengthen the auditor’s role on their clients’ NOCLAR by requiring auditors to more proactively identify, evaluate, and communicate instances of a company’s NOCLAR.” However, there was significant opposition: “Opponents say that it would likely put auditors in a legal compliance role outside their purview. Business organizations banded together to also write a joint comment letter saying that the proposal would drive new liability concerns among auditors that would drive audit costs even higher without commensurate benefits.” As reported in AccountingToday (hat tip to thecorporatecounsel.net), one PCAOB member said that she had “spoken to various stakeholders, including investors, audit committee chairs and members, and some preparers as well. The question I got asked repeatedly was, what problem is PCAOB trying to solve?…. While there’s always room for improvement, they noted that a balance is necessary between increased investor protection and increased auditor implementation costs that are ultimately passed on to issuers, and that the NOCLAR proposal lacks such a balance.” Despite strong opposition to the proposal, the PCAOB had planned to adopt the new standard by the end of 2024. But questions remained as to whether the SEC would approve the new standard prior to changes in its composition reflecting the election results.

AccountingToday has now reported that the PCAOB has “decided to delay action on the standard this year.” According to the article, last week, the “PCAOB issued staff guidance outlining the existing responsibilities of auditors to detect, evaluate and communicate about illegal acts. The PCAOB was slated to finalize the NOCLAR standard by the end of this year, but after the election it has put the standard on hold for now, anticipating the upcoming change in the administration in Washington, D.C. ‘Following the recent issuance of staff guidance, the PCAOB will not take additional action on NOCLAR this year,’ said a PCAOB spokesperson. ‘We will continue engaging with stakeholders, including the SEC, as we determine potential next steps. As our process has demonstrated, the PCAOB is committed to listening to all stakeholders and getting it right.’” One reason cited for the change of plans was the expectation that the new Administration will change the regulatory environment, especially the SEC, which must approve the new standard. Citing “a person familiar with the PCAOB process,” AccountingToday reported that “no further action is expected until further consultation with the SEC under the incoming administration can take place.”

BTW, the staff guidance, Auditor Responsibilities for Detecting, Evaluating, and Making Communications About Illegal Acts, provides that “[u]nder federal securities laws, auditors have a longstanding responsibility to (1) detect illegal acts; (2) evaluate information indicating that an illegal act has or may have occurred; (3) determine whether it is likely that an illegal act has occurred, and, if so, to consider the possible effect of the illegal act on the financial statements of the company; and (4) make appropriate communications about illegal acts, unless ‘clearly inconsequential,’ to management, the audit committee, and possibly the United States Securities and Exchange Commission (SEC). PCAOB standards include similar requirements.”

What’s more, according to Thompson Reuters, the U.S. Chamber of Commerce “will likely sue if it is adopted as proposed. In a recent interview, Tom Quaadman of the Chamber said he would prefer to see the PCAOB altogether drop the proposal. If not, the business organization wants to see a second proposal as auditors have called on the PCAOB to do.” 

Audit inspections. The panel observed that there may be around 50 inspections of individual audits every year for each of the Big Four audit firms. If the inspection finds that there is insufficient evidence to support the audit opinion, then it may show up on the Part 1A list.  Among the Big 4, the deficiency rate was 26%; other firms’ rates were worse.  But just because there was a deficiency in the audit doesn’t necessarily mean that there was a problem or error in the company’s financial statements.  Rather, the finding speaks to an issue with the audit evidence or process.

  • As a result of these deficiencies, audit firms have become more cautious, the panel observed.  In addition, under the most recent rules, documentation must be completed within 14 days, as opposed to the prior 45 days.  
  • If the company’s audit is selected for an inspection and the PCAOB identifies a deficiency, the audit firm will try to repair the  problem, but, according to the panel, it will be unwilling to sign off on a Form 10-Q until it completes the work on the past audit. The panel advised companies to find out the issues and to help if possible; because of the issue with Forms 10-Q, it becomes the company’s problem.

Assessing materiality. SAB 99 requires the application of substantial judgment; there are no bright lines.  The approach is holistic, both quantitative and qualitative.

Posted by Cydney Posner

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