Analysis of FASB Project: Disclosure Improvements—Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative

ABSTRACT

The purpose of this article is to examine the Financial Accounting Standards Board’s (FASB’s) ongoing project to revise financial statement disclosure requirements for companies, in response to the Securities and Exchange Commission’s (SEC’s) disclosure update and simplification initiative. Note, these changes encompass a wide array of complex subjects, so only their essential components are addressed here. The framework for this discussion will be as follows: (1) First, the history of the project will be covered, including how it came to be referred to the FASB from the SEC. (2) Next, a description of the project’s current status is examined, including a review of the proposed changes. (3) Finally, an analysis of the implications of adopting these changes will be performed, including assessment of any costs imposed or burdens lifted. While the adoption of new requirements will invariably entail transactional costs, especially for non-public issuers of financial statements, the FASB’s project appears likely to alleviate many of the disclosure burdens for publicly-traded companies, meanwhile minimizing the risk that relevant and accurate information will not be conveyed to investors.

BACKGROUND

Both the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) have issued a myriad of requirements concerning the disclosure of relevant information in financial statements issued by publicly-traded companies. These disclosure requirements can lead to improved outcomes for investors and other stakeholders, who rely upon such information to better understand a company’s future performance and value, while reducing the risk of mispricing securities. (See Campbell, et al., 2021).

Nevertheless, the SEC and FASB must be mindful of the burden that such disclosure requirements place on financial statement issuers. Indeed, industry practitioners and even the FASB itself has acknowledged that “excessive disclosure” requirements, issued in an ad hoc manner, can create confusion, inefficiency, and nearly limitless risk for publicly-traded companies. (See Cheney, 2012; see also Whitehouse, 2011). Balancing investors’ need for relevant information against the costs incurred and compliance burdens borne by issuing companies, the FASB has adopted a formal framework for the consideration and issuance of new disclosure requirements. (See FASB – Standard-Setting Process, 2013). This framework applies to the project currently under consideration.

Specifically, on July 13, 2016, the SEC proposed amendments to certain financial statement disclosure requirements it considered to be substantially similar, redundant, duplicative, overlapping, outdated, or superseded by, or in consideration of, other requirements promulgated under U.S. GAAP, International Financial Reporting Standards (IFRS), or the Commission’s other standards, as well as “changes in the information environment.” (See p. 21 of SEC Release No. 33-10110, 2016; see also p. 1 of SEC Release No. 33-10532, 2018). It, thus, sought to eliminate or amend these disclosure requirements, in order to simplify public companies’ compliance efforts while providing substantially the same information to investors. (See id.). After an initial period of public comment, on August 17, 2018, the Commission adopted many of its recommendations, substantially as proposed. (See p. 9 of SEC Release No. 33-10532, 2018).

Yet, in recognition of the FASB’s role as the “designated private-sector accounting standard setter in the United States,”[1] and in consideration of comments shared by industry stakeholders, the SEC referred several proposed changes to the FASB for consideration of whether to incorporate those requirements into U.S. GAAP, pursuant to its standard-setting process. (See pp. 16-19 of SEC Release No. 33-10532, 2018; see also Ernst & Young – Comments, 2016). The changes referred to the FASB included disclosures relating to the following subjects:

·????????Accounting Changes and Error Corrections (ASC 250-10)

·????????Earnings per Share (ASC 260-10)

·????????Interim Reporting (ASC 270-10)

·????????Segment Reporting (ASC?280-10)

·????????Commitments (ASC 440-10)

·????????Debt (ASC 470-10)

·????????Equity (ASC 505-10)

·????????Business Combinations (ASC 805-50)

·????????Consolidation (ASC 810-10)

·????????Derivatives and Hedging (ASC 815-10)

·????????Foreign Currency Matters, including Currency Transactions and Translation of Financial Statements (ASC 830-10 through ASC 830-30)

·????????Related Party Disclosures (ASC 850-10)

·????????Transfers and Servicing—Secured Borrowing and Collateral (ASC 860-30)

·????????Extractive Activities—Oil and Gas (ASC 932-235)

·????????Financial Services—Investment Company Activities (ASC 946-20)

·????????Real Estate Investment Trusts (ASC 974-10)

(See pp. 5-7 of FASB Exposure Draft, 2019).[2]?The FASB has agreed to consider incorporation of these recommendations into U.S. GAAP rules under its standard-setting process. The development of this review, as well as the Board’s probable decisions relating to the above recommendations, is discussed, infra.

CURRENT STATUS

Upon referral from the SEC, the Board chose to add this project to its technical agenda, followed by deliberations at various public meetings, and the issuance of an Exposure Draft, seeking comment from industry stakeholders. (See FASB – Project Update, 2020; see also FASB – Standard-Setting Process, 2013). Sixteen (16) comment letters were received before the comment period ended on June 28, 2019. (See FASB – Comments, 2019). The FASB is currently contemplating the incorporation of these changes into its Accounting Standards Codification, the source for U.S. GAAP.

While it is difficult to predict the final outcome of each recommendation, as we do not know how much weight may be accorded to the comment letters by FASB staff, the Exposure Draft provides a useful starting point to understand what changes may be going into effect. (See FASB – Exposure Draft, 2019). A brief discussion of each of these proposed changes as set forth in the Exposure Draft is provided, followed by a discussion of the implications of adoption.

1.?????Accounting Changes and Error Corrections (ASC 250-10)

This recommendation amends paragraph 250-10-50-6, indicating that when there has been a change in the reporting entity, the financial statements in both the interim period and the annual period of the change shall describe the nature of the change, as well as the reason for it. (See id., at p. 10). Furthermore, the rule was updated to add that “[t]he cumulative effect of the change on retained earnings or other appropriate components of equity or net assets… also shall be disclosed.” (See id.).

According to the Board, this update clarifies that disclosure of changes in reporting entities should be made in interim periods and that the effect of those changes on retained earnings should be reported. (See id., at p. 31). The FASB’s stated intent was to improve upon the instructions under Topic 250, and to better align it with guidance for related changes in accounting principles. (See id.). The Board anticipated that, while this amendment would likely increase the number of entities providing disclosures of the impact upon retained earnings, these changes would “not be costly because the effect on retained earnings would be known when an entity recasts its financial statements.” (See id.).

2.?????Earnings per Share (ASC 260-10)

This change amends paragraph 260-10-50-1 of the Accounting Standards Codification, to clarify that the rules pertaining to disclosures for earnings per share also apply to interim periods, and that an entity shall disclose “[t]he methods used in the diluted earnings-per-share computation for each dilutive security.” (See id., at pp. 11-12). An example of such a disclosure is provided in the Exposure Draft. (See id., at p. 12).

The FASB observed that Regulation S-X, Rule 10-01(b)(2) requires that an entity provide a reconciliation of the numerator and denominator used in the computation of earnings per share “for each period for which an income statement is presented.” (See id., at p. 31). It noticed, however, that some entities could interpret its previous guidance under Title 260 to require only annual disclosures, and that the effects and methods used to calculate diluted earnings per share could vary from period to period, especially in interim periods. (See id.). Accordingly, this change explicitly requires disclosure of earnings per share calculations during interim periods, including the methods used in calculating diluted earnings per share. (See id.).

3.?????Interim Reporting (ASC 270-10)

The Board amended paragraphs 270-10-45-12 and 270-10-50-1(g), concerning interim reporting, to add that any changes in the reporting entity must be disclosed during interim reporting periods. (See id., at pp. 12-13).

4.?????Segment Reporting (ASC 280-10)

The FASB updated paragraph 280-10-50-40, to delete language suggesting that a public entity might choose to refrain from reporting the activities of segments contributing 10% or more of consolidated revenue, if “impracticable” to do so. (See id., at p. 14). The Board chose to eliminate the impracticability exception, since it conflicted with Regulation S-K Item 101(c)(1)(i). (See id., at p. 32).

5.?????Commitments (ASC 440-10)

The FASB amended paragraph 440-10-50-1(c) of the ASC to include disclosure requirements for “[a]ssets mortgaged, pledged, or otherwise subject to lien, and the approximate amounts of those assets, and the related obligations collateralized.” (See id., at p. 15). The intent behind this change was to align U.S. GAAP with Regulation S-X Rule 4-08(b), since GAAP apparently did not previously require disclosure of all assets subject to a lien. (See id., at p. 32).

6.?????Debt (ASC 470-10)

The Board added a new requirement, paragraph 470-10-50-6, indicating that an entity shall disclose “[t]he amount and terms… of unused commitments for long-term financing arrangements,” as well as “[t]he amount and terms… of unused lines of credit for short-term financing.” (See id., at p. 15). They also added new paragraph 470-10-50-7, indicating that an entity “shall disclose the weighted-average interest rate on short-term borrowings outstanding as of the date of each balance sheet presented.” (See id.).

The FASB confirmed that these changes would not only bring U.S. GAAP into alignment with SEC Regulation S-X Rule 5-02.19, but would also enhance debt disclosure requirements, since information about existing or potential obligations provides users of financial statements with important information about a company’s liquidity and leverage. (See id., at pp. 32-33). The Board considered adding a carve-out exception for non-public entities, but ultimately chose to have the disclosure rules apply to all entities. (See id., at p. 33).

7.?????Equity (ASC 505-10)

The Board updated paragraph 505-10-50-4, concerning liquidation preferences for preferred stock, to remove language referring to amounts “considerably in excess of the par or stated value,” and replacing it with the less subjective description, “other than par or stated value.” (See id., at pp. 16 and 33-34). The FASB concluded that this update would “simplify existing GAAP and improve the consistency of disclosures related to preferences on involuntary liquidation.” (See id., at p. 34).

8.?????Business Combinations (ASC 805-10)

This change amends paragraph 805-50-50-3 of the ASC, concerning transactions between entities under common control, to explicitly require disclosures during interim periods, as well as “[t]he separate results of each combined entity before combination for comparative periods presented.” (See id., at p. 16). The Board deemed this modification to be appropriate, as GAAP did not previously “address disclosure requirements for a combination of entities under common control in an interim period.” (See id., at p. 34). It also determined that this disclosure would improve GAAP, as users of financial statements would have access to supplemental information regarding the entities prior to consolidation, leading to better assessment of financial performance after the businesses were combined. (See id.).

9.?????Consolidation (ASC 810-10)

The Board added a new requirement to the ASC, paragraph 810-10-50-1C, concerning changes in consolidated or combined entities, so that a reporting entity shall disclose “the names of those legal entities” when “there has been a change in the legal entities included in or excluded from the corresponding financial statements as compared with the preceding fiscal period.” (See id., at p. 17). The FASB determined that this requirement would be necessary, even though information concerning newly-consolidated entities is available under Topics 805 and 810, since there was no explicit disclosure requirement “on newly deconsolidated entities that are not variable interest entities.” (See id., at p. 34). It also found that requiring disclosure of the names of the consolidated and deconsolidated entities would provide necessary context. (See id.).

10.?Derivatives and Hedging (ASC 815-10)

The Board added another new requirement, paragraph 815-10-50-8B, concerning classification requirements for the Statement of Cash Flows, whereby “[a]n entity shall disclose where in the statement of cash flows derivative instruments and their related gains and losses are reported.” (See id., at p. 17). This requirement was added to align GAAP with Regulation S-X Rule 4-08(n)(7). (See id., at p. 35). The FASB also decided that requiring this disclosure would improve GAAP Topic 815, because it would provide information about “the effect of derivatives on all relevant measures of financial performance, not only the statement of financial position and results of operations.” (See id.).

11.?Foreign Currency Matters, including Currency Transactions and Translation of Financial Statements (ASC 830-10 through ASC 830-30)

The FASB deleted paragraph 830-10-15-7, as it was superseded by another Accounting Standards Update, and made incremental modifications to language in paragraphs 830-10-15-3, 830-10-15-4, 830-10-45-1, 830-10-45-2, 830-10-45-7, 830-10-45-11, 830-10-55-5, 830-20-25-2, 830-30-05-1, and 830-30-45-12 relating to foreign currency transactions, presentation, functional currency, changes in functional currency, functional currency in high inflationary economies, recognition, translation of financial statements, and reporting of translation adjustments. (See id., at pp. 18-21). According to the FASB, these changes were made to clarify that Topic 830 not only applies to foreign subsidiaries of the reporting entity, but also to the functional currency of the reporting entity, itself, since some issuers may, e.g., choose to present their financial statements in USD, even though their functional currency is actually something other than USD. (See id., at p. 35). These changes clarify the functional currency determination of the reporting entity, and enhance the convergence goals of U.S. GAAP and IFRS Standards. (See id.).

12.?Related Party Disclosures (ASC 850-10)

This update adds a new requirement, paragraph 850-10-50-4A, which mandates the disclosure in separate financial statements of intra-entity profits or losses resulting from transactions with related parties. (See id., at p. 22). The Board decided that this update would not result in significant incremental cost or effort for public entities, and would enhance the usefulness of separate financial statements by providing context about the economics of related party transactions. (See id., at p. 36). However, the FASB ultimately chose to exempt non-public entities from making such disclosures, as it anticipated that the costs of preparing the information would outweigh the benefits for private company financial statement users. (See id.).

13.?Transfers and Servicing—Secured Borrowing and Collateral (ASC 860-30)

These updates involve three new ASC requirements, set forth under paragraphs 860-30-45-2A, 860-30-50-9, and 860-30-50-10, while making other minor modifications to language in paragraphs 860-30-45-1, 860-30-45-1, 860-30-50-1A, and 860-30-50-7. (See id., at pp. 22-25). Specifically, new paragraph 860-30-45-2A notes that if, as of the date of the most recent financial statement, the “the aggregate carrying amount of reverse repurchase agreements… exceeds 10 percent of total assets, the assets shall be classified separately.” (See id., at p. 22). New paragraph 860-30-50-9, concerning counterparty risk, further adds that if the amount at risk under (reverse) repurchase agreements exceeds 10 percent of stockholders’ equity, the entity shall disclose the names of the counterparties, the amount of risk, and the weighted average maturity of the (reverse) repurchase agreements with each. (See id., at p. 24). Finally, new paragraph 860-30-50-10, also concerning counterparty risk, indicates that if the amount at risk under (reverse) repurchase agreements exceeds 10 percent of total assets, the entity shall disclose whether any provisions are in place to ensure that the market value of the underlying assets remains sufficient to protect against default and, if so, the nature of those provisions. (See id.).

The Board chose to add these provisions in order to align GAAP with SEC Regulation S-X Rule 4-08(m), which includes presentation and disclosure rules pertaining to complex repurchase and reverse repurchase agreements “incremental to the requirements in Topic 860.” (See id., at p. 36).

14.?Extractive Activities—Oil and Gas (ASC 932-235)

The FASB added new requirements pertaining to oil and gas extraction under paragraph 932-235-50-2A, noting that publicly-traded companies engaged in such activities should disclose information for all periods presented in the applicable financial statements. (See id., at pp. 25-26 and 37). This update was intended to remove any ambiguity that the supplemental information covered under this topic would be required for all periods presented, thereby improving GAAP. (See id., at p. 37).

15.?Financial Services—Investment Company Activities (ASC 946-20)

This update involves a minor technical correction to ASC paragraph 946-20-50-11, concerning disclosure requirements for financial services companies’ capital and distributable earnings, removing the word “only” from the paragraph, to improve clarity of this guidance and to “remove any perceived inconsistency in the Codification.” (See id., at pp. 26 and 38).

16.?Real Estate Investment Trusts (ASC 974-10)

Finally, the FASB updated disclosure requirements pertaining to real estate investment trusts (REITs) by adding a new requirement under ASC paragraph 974-10-50-1, reading as follows: “[a]n entity shall disclose the tax status of distributions per unit (for example, ordinary income, capital gain, and return of capital).” (See id., at p. 27). The Board elected to add this requirement, pursuant to Regulation S-X Rule 3-15(c), since “potential investors would benefit from information about the tax status of distributions [per unit for REITs] before they decide to invest.” (See id., at p. 38).

ADOPTION IMPLICATIONS

The above-described changes will undoubtedly have wide-ranging implications for the disclosure and compliance practices of both public and nonpublic issuers of financial statements.

The SEC issued its recommendations with the intent of facilitating disclosure of information to investors and simplifying compliance, without significantly altering the kind of information provided to investors. (See p. 1 of SEC Release No. 33-10532, 2018). However, the Commission anticipated that adoption of its amendments would affect approximately 7,570 issuers of financial statements who file using domestic forms, in addition to 745 foreign private issuers. (See id., at p. 132). They, further, anticipated that the changes would impact “4,100 investment companies, including approximately 100 business development companies,… the portion of the approximately 12,600 investment advisers to which Regulation S-X and Regulation S-K apply” and “3,883 registered broker-dealers,” among other stakeholders. (See id., at p. 133). Nevertheless, they opined that the elimination of redundant or duplicative requirements would simplify issuer compliance efforts, by reducing the number of rules to consider, leading to increased allocative efficiency of the market and facilitating capital formation. (See id., at p. 135).

The Commission noted that potential costs to investors could arise if U.S. GAAP were to change in such a way that information previously mandated by disclosure requirements were no longer provided for under U.S. GAAP. (See id., at pp. 135 and 144-145). However, they added that the potential for such changes could be mitigated by the FASB’s transparent, public standard-setting process, as well as the Commission’s oversight. (See id.). Additionally, issuers would remain liable for non-compliant disclosures, including the omission of information necessary to make the disclosures not misleading. (See id., at p. 135).

Meanwhile, the FASB anticipated that the proposed disclosure requirements would be “cost neutral for public business entities because those entities must comply with the SEC’s guidance regardless of the Codification’s disclosure requirements.” (See p. 29, FASB – Exposure Draft, 2019). The Board concluded that the proposed amendments would merely cause items to move from the nonfinancial statement portions of SEC filings to the financial statement notes, and that the “preparation costs associated with doing so would be minimal given the nature of those disclosures.” (See id., at p. 30). Furthermore, the proposed amendments would align GAAP closer with the SEC’s disclosure requirements, making it easier to comply with both. (See id.).

Notably, FASB also predicted that the proposed disclosure requirements would result in increased compliance costs for entities other than public business entities. (See id.). Still, upon consultation with the Private Company Council and FASB’s Small Business Advisory Committee, the Board determined that these costs would not be significant, in light of exceptions to certain disclosures, as warranted, and since the proposed amendments did not create new requirements for which information is not already readily available. (See id.). Finally, it noted that aligning disclosure requirements would improve consistency between public and non-public businesses, “which would benefit users of other-than-public business entity financial statements,” and could also potentially reduce costs if a nonpublic entity ever decided to become a public entity. (See id.; see also FASB – SBAC, 2019).

CONCLUSION

Accordingly, while the adoption of the proposed disclosure requirements will inevitably entail a period of transition and associated costs, especially for non-public entities during the initial implementation period, the FASB’s project appears likely to alleviate many of the disclosure burdens for companies, meanwhile minimizing the risk that relevant and accurate information will not be conveyed to investors. Furthermore, the de minimis increase in compliance costs for nonpublic entities may be offset through the alignment of U.S. GAAP with Commission rules, leading to greater efficiency and capital formation within the market, while also potentially easing the transition for private companies who choose to go public.

END NOTES

[1] Note, this role has been delegated to the FASB by the SEC under the Sarbanes-Oxley Act of 2002. Specifically, the Act established criteria by which pronouncements of an accounting standard-setting organization can be recognized as “generally accepted” for purposes of federal securities laws. Under these criteria, the SEC designated FASB as the private-sector accounting standard setter for U.S. financial reporting purposes, subject to the SEC’s ongoing monitoring for compliance. (See pp. 16-17 of SEC Release No. 33-10532, 2018).

[2] Other disclosure requirements were also referred to FASB for incorporation into U.S. GAAP, but as FASB chose not to incorporate them, these will not be discussed herein. (See pp. 38-41 of FASB Exposure Draft, 2019).

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