Another seven key changes to annual reporting

Jim Brendel //February 14, 2012//

Another seven key changes to annual reporting

Jim Brendel //February 14, 2012//

(Editor’s note: This is the second of two parts. Read Part 1.)

There are seven more major changes being seriously considered on the financial reporting horizon. All of them are potential game changers in terms of the effort by the SEC and other rules makers to make financial reporting of public companies more transparent.

Changes to the auditor’s reporting model – The current auditor’s report has not changed significantly in more than 20 years, and is essentially a “pass/fail” model. Many investors would like to receive more information from the auditor than the standard three-paragraph report. The PCAOB is conducting a study of several different alternatives to improve and increase the amount of information supplied by the auditor. It seems a foregone conclusion that there will soon be significant changes in the auditor’s report, but the nature and direction of these changes is still up in the air. This is the first thing that will happen, probably within next year. In short, we don’t know what or when the new disclosures will be required, but regulators are saying we’d like to know more about what auditors have learned.

Presentation of Other Comprehensive Income – Starting in 2012, companies no longer have the option to present other comprehensive income (i.e., changes in stockholders equity other than capital contributions, distributions and net income) in the statement of stockholders equity. Other comprehensive income must be reported in the income statement, or in a separate statement that is consecutive with the income statement. One place you will see this is changes in fair value of held-to- maturity securities.

Going concern – This project was driven by concerns during the 2008 financial crisis that companies failed without adequate warning. The FASB is considering adding the requirements in Generally Accepted Accounting Principles (GAAP) for management to assess – in footnotes to the financial statement – whether it is their opinion the company will be able to continue as a going concern on a look-forward basis. Presently, the going concern guidance exists only in the auditing standards. This change would places a large responsibility on management.

Revenue recognition – The Financial Accounting Standards Board issued a new exposure draft of its revenue recognition guidance in November 2011. This pronouncement would replace all existing U.S. GAAP on revenue recognition. While a final rule is not expected until 2012, and may not be effective until 2015, companies would be wise to carefully monitor this development as revenue is an important financial metric, and adoption would be retroactive up to three years prior. The main effects will be on gross margins, specialized industries such as software, and revenues from contracts recognized over a period of time.

Leases – The FASB’s leasing project, which would put all lease obligations on the balance sheet, continues to move forward. A revised exposure draft is expected in the first half of 2012. The new lease accounting could significantly affect income statements and balance sheet strength.

International Accounting Standards – The SEC continues to study whether to require or allow U.S. public companies to report under IFRS rather than U.S. GAAP. Last year, the SEC staff floated the idea of “condorsement,” whereby IFRS standards would be adopted into U.S. GAAP over time. Many observers believe that this is the most likely outcome, but the SEC is not tipping their hand. Meanwhile, the FASB and IASB continue work on international convergence. The going has been slower than either board anticipated. Changes in leadership at both of the boards, along with some strong differences of position on at least one of the convergence projects, have many wondering whether convergence is a realistic goal.

Mandatory audit firm rotation – The Public Company Accounting Oversight Board, which was created by the Sarbanes-Oxley Act, is considering whether to require mandatory rotation of audit firms in an effort to maintain auditor independence. There are widely divergent opinions on this matter, with some believing that rotation would improve audit quality because auditors would be concerned about being second-guessed. Others believe that quality would diminish as a new firm would not have the same level of knowledge about the company as a firm that had been in place for several years, and that rotation would needlessly increase audit costs