Statement in Connection with the 2017 AICPA Conference on Current SEC and PCAOB Developments

Wesley R. Bricker, Chief Accountant

Washington D.C.

Dec. 4, 2017

The Securities and Exchange Commission (“SEC” or “Commission”) disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This Statement expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

This Statement describes matters discussed among Wesley Bricker, Chief Accountant, and Julie Erhardt, Jenifer Minke-Girard, Marc Panucci, and Sagar Teotia during a Deputy Chief Accountant panel discussion at the 2017 AICPA Conference on Current SEC and PCAOB Developments held on December 4, 2017 in Washington, D.C.

Introduction

The federal securities laws establish the authority of the Securities and Exchange Commission (“SEC” or “the Commission”) to set accounting, audit, and independence standards to be followed in the preparation and the audit of the financial statements of public companies. The SEC’s Office of the Chief Accountant (“OCA”) is led by the Chief Accountant, who serves as the principal advisor to the Commission on accounting and auditing matters.[1] “We” and “our” are used in this Statement to refer to OCA or OCA staff.

The ongoing efforts of the fewer than 50 employees in OCA promote robust financial reporting and audits that are critical to safeguarding millions of investors, facilitating the ability of thousands of companies to raise capital, and instilling confidence in the integrity of our multi-trillion-dollar U.S. capital markets. Through our participation in a variety of financial reporting conferences and meetings with constituents,[2] we aim to improve the effectiveness of financial reporting by assisting professionals to make better decisions over time. These efforts promote high-quality financial reporting, which facilitates good decision making as investors evaluate how to allocate their capital to the companies that need it.

Each year, we assist the SEC in discharging its authority by working with the more than 1,000 professionals who collectively serve at the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) for accounting standard setting, and of the Public Company Accounting Oversight Board (“PCAOB”) for oversight of audits of public companies and brokers and dealers. We gather valuable input regarding financial reporting directly from the public through rulemaking initiatives and attending conferences and other meetings. We also gather valuable input by addressing several hundred consultations on accounting and professional practice matters each year. The dialogue resulting from these interactions informs our work on accounting and auditing.

We also want to acknowledge the hard work and dedication of accountants and auditors in practice who foster reliable financial reporting. We hold accountants and auditors in high regard and consider them to be key partners in our investor protection efforts. We work with the SEC’s Division of Enforcement to hold professionals accountable for reliable financial reporting, audit quality, auditor independence, governance, and other roles. It is a privilege to practice before the SEC and it is no place for bad actors.

Our Activities

Rulemaking and Standard Setting

We participate in SEC rulemaking initiatives that could have an impact on accounting and auditing and we issue staff guidance on complex and challenging accounting and disclosure questions.

As an official observer, OCA staff attended a total of 28 meetings at the FASB, IASB, and PCAOB during the SEC’s fiscal year ending September 30, 2017, as well as 20 meetings during fiscal 2016.

Private sector standard setting is also important to financial reporting, fundamentally addressing the question of: “What is the best way to do this?”

Practically since its inception, the SEC has looked to the private sector to play a leading role in setting accounting standards.[3] The SEC oversees standard setting activities by the FASB. The SEC also monitors the standard setting activities of the IASB. The FASB’s and IASB’s respective standards are used in preparing financial statements.

In addition, the PCAOB’s activities, including standard setting, are designed to promote audit quality. The PCAOB’s standards, after approval by the Commission, are intended to respond to the changing risks to audit quality.

Standard setters have a responsibility—with stakeholder input and coordination—to timely address issues with appropriate guidance. Standard setting is done best when it reflects input from all stakeholders in our capital markets, including preparers, auditors, and investors, as well as regulators, so that the basis for the standard setters’ decisions are inclusive of diverse thinking about “the best way” to address accounting or auditing issues.

Consultations

Communication and information provided through our consultations promote high-quality financial reporting by communicating expectations regarding financial reporting responsibilities.

We encourage colleagues, companies, audit committees, and auditors to consult with us on accounting and financial reporting concerns or questions, especially those involving unusual or complex transactions for which no clear authoritative guidance exists, as well as on issues regarding auditor independence.

Enforcement

We rely on the accounting profession more broadly as essential partners in fostering comprehensive, accurate, and reliable financial reporting, and they have our full support in this regard. Yet, we will continue to work with our colleagues in the Division of Enforcement and others to hold accountable those who fail to meet their responsibilities under the accounting, audit, and independence requirements.

Our Ongoing Priorities

OCA is responsible for covering much ground across financial reporting and auditing. As a result, we must constantly assess whether we are allocating our finite resources appropriately to address the most significant financial reporting risks and in the most effective manner, keeping front of mind the need for financial reporting to respond to the ever changing needs of investors. But, at the most basic level, OCA’s area of greatest focus—credible financial reporting—has not changed over time.

Today, this perspective is driving our resources to:

  • Support successful implementation of new GAAP standards including revenue recognition, leases, and current expected credit losses;
  • Conduct oversight of the FASB in its standard-setting role and involvement in other key accounting and disclosure topics;
  • Conduct oversight of the PCAOB across its broad role of promoting integrity in the audits of public companies and brokers and dealers, including assisting the Board with its post-implementation review of the updated auditor’s reporting model;
  • Consult on accounting issues and auditor independence rules;
  • Monitor internal control over financial reporting;
  • Advance the effectiveness of audit committees in financial reporting;
  • Contribute to international accounting, audit, and disclosure work; and
  • Identify innovations and emerging issues and evaluate their implications for financial reporting.

These issues will be priorities for OCA, and we will continue to advance efforts to protect investors, facilitate capital formation, and maintain market integrity.

The remainder of this Statement addresses a number of specific matters associated with OCA’s work.

New GAAP Standards

With regard to accounting standards, investors, businesses, and others requested that the FASB and IASB enhance the accounting and reporting of revenue, leases, and current expected credit losses (“CECL”).[4] As it relates to U.S. GAAP, the FASB has issued new standards in these areas, which we collectively refer to as “new GAAP standards.” Over the upcoming years, companies will be required to incorporate these new GAAP standards into their financial reporting as they become effective.

In September 2017, Deputy Chief Accountant Sagar Teotia outlined six general observations regarding implementation:[5]

Observations

Description

  1. Keep going / get going

The new GAAP standards are important for investors. Among other improvements, they provide incremental disclosures and we believe companies need to prioritize the new GAAP standards in order to achieve a high quality implementation.

  1. Internal control over financial reporting

Implementation may require changes to existing business processes and related internal control over financial reporting.

  1. Transition disclosures

The SAB 74[6] transition disclosures provide information to investors about the anticipated effect of the standards. We urge preparers to appropriately disclose the state of the company’s implementation efforts and, if a company is behind (which may be reflected in the SAB 74 disclosures), for audit committees to hold management accountable for developing an implementation plan for the new GAAP standards.

  1. Disclosures within the new GAAP standards

There are important disclosures required by the new GAAP standards that should be addressed within the implementation plan. Companies should anticipate the effort required to prepare the disclosures.

  1. Importance of reasonable judgment

Application of the new GAAP standards will require companies to develop and apply reasonable judgments in certain areas. OCA has accepted (and will continue to accept) reasonable judgments in consultations on the new GAAP standards.

  1. Role of the audit committee

Audit committees can contribute to an effective implementation by setting a tone at the top, establishing expectations for implementation dialogue, and understanding management’s response to any auditor concerns.

Revenue Recognition

The time until required application of the new revenue standard is limited for most public companies (except for those who have already early adopted). For those companies whose implementation efforts are still underway, we urge you to keep the momentum going. Companies cannot afford to get the accounting for revenue wrong for investors and other users of the financial statements.

Among the other related points, the first item to emphasize is the positive impact on implementation of an audit committee’s understanding of management’s implementation plans and understanding the status of progress, including any required updates to internal control over financial reporting (“ICFR”). The audit committee plays a very important role in overseeing a company’s financial reporting, including the implementation of new accounting standards.

Auditors have an important role as well. Auditors, among other things, communicate with the audit committee about concerns identified by the auditor regarding management's anticipated application of a new accounting standard that, while it is not yet effective, might have a significant effect on future financial reporting.[7]

Second, upon adoption, the disclosures required by the standard will provide investors with additional information about revenue from a company’s contracts with its customers. We encourage companies to dedicate the appropriate resources to planning for the preparation of those disclosures and to incorporating any necessary updates to existing processes and controls. Companies may need to apply reasonable judgment when preparing the new disclosures so that the disclosures meet the objective described in the standard.

Third, it bears mentioning that some companies have early adopted (as permitted) and are now applying the new revenue standard. In those cases, investors are benefitting from enhanced financial reporting under the new revenue standard.

Leases

The new leases standard will also require careful implementation planning, management, and oversight. For companies that have not yet commenced their implementation efforts for leases, when you do begin, we would suggest that you consider starting by identifying the population of relevant contracts and evaluating whether or not those arrangements are or contain a lease. These steps can potentially be time consuming and are reminders of why getting started as soon as possible is important.

Additionally, we believe it is important for companies to be actively involved in raising accounting questions related to the new leases standard in order to maximize the preparers’ role in the profession’s current dialogue regarding the identification and resolution of accounting issues related to this new standard. This is another reminder of why being engaged in the implementation of the new leases standard is important.

Current Expected Credit Losses

The new credit losses standard clearly has an impact on banks and other financial institutions, but the impact goes beyond any particular industry group. OCA staff has spoken about CECL to describe areas we have worked on related to this new standard and some of the issues that have arisen during implementation. We encourage companies to read our speeches.[8]

As a reminder, the FASB established a TRG for CECL; this remains a forum for stakeholders to potentially work through and address implementation issues. As preparers, industry groups, and other stakeholders continue their implementation efforts, we encourage them to consider referring challenging issues to the TRG. OCA, of course, will continue to be involved as an observer at the TRG meetings.

Other Accounting Standards

In addition to the new revenue, leases, and credit losses standards, there are other new accounting standards as well.

The new recognition and measurement standard[9] for financial assets and financial liabilities enhances certain aspects of the recognition, measurement, and presentation and disclosure requirements for financial instruments. This new standard includes changes to how certain investments in equity securities are reported, as well as changes to the presentation of gains and losses on financial liabilities for which a fair value option has been elected. The new recognition and measurement standard is effective in 2018 for calendar year-end public companies.

In August 2017, the FASB issued new guidance for certain aspects of the hedging standard[10] to more closely align hedge accounting with companies’ existing risk management strategies, simplify the application of hedge accounting, and increase transparency regarding the scope and results of hedging programs. While the new guidance is not effective until 2019 for calendar year-end public companies, early adoption is permitted beginning in 2017. Companies should consider assessing the potential impact of this new standard in a timely manner.

Updated Guidance from the Commission and Staff

In 2017, the Commission updated guidance related to revenue recognition as well, including:

  • Guidance related to recognizing revenue in a bill-and-hold arrangement such that, upon adoption of the new revenue standard, an entity should no longer refer to the historical guidance related to recognizing revenue in a bill-and-hold arrangement because the new standard provides specific guidance on recognizing revenue for those arrangements;[11] and
  • Guidance for the accounting for vaccine stockpiles to assist vaccine manufacturers in determining when to recognize revenue and provide the disclosures required under the new revenue standard.[12]

In 2017, the Commission updated guidance related to revenue recognition as well, including:

  • SAB No. 116, which clarifies that SAB Topic 13, Revenue Recognition, and SAB Topic 8, Retail Companies, are no longer applicable upon a registrant’s adoption of the new revenue standard and also modifies Section A, Operating-Differential Subsidies, of SAB Topic 11, Miscellaneous Disclosure;[13]
  • Announced that the OCA staff would not object to certain public business entities adopting the new revenue and leases standards using the timeline for private companies;[14] and
  • SAB No. 117, which communicates the staff's view that, upon a registrant's adoption of ASC Topic 321, Investments—Equity Securities (“ASC Topic 321”),[15] SAB Topic 5.M is no longer applicable and that, subsequent to a registrant adopting ASC Topic 321, investments in equity securities that would have previously qualified for presenting changes in fair value within other comprehensive income will be measured at fair value, with changes in fair value presented immediately in net income.[16]

Interactions with Other SEC Divisions and Offices

During the year, we have worked with the SEC’s Division of Corporation Finance to evaluate commenters’ feedback on proposed amendments to update and simplify disclosure requirements, particularly where provisions of Commission rules and accounting guidance may be redundant, overlapping, outdated, or superseded in light of subsequent changes to Commission disclosure requirements, U.S. GAAP, International Financial Reporting Standards (“IFRS”), and technology. In the coming year, we anticipate working with the staff of the Division of Investment Management to identify recommendations for updates to staff guidance on the valuation of portfolio securities and other assets held by registered investment companies and the related audit guidance. Apart from this project, we will continue to monitor the effects of consolidation among pricing service providers, including the availability of independent prices for use by preparers and auditors.

PCAOB Matters

The PCAOB fills a critical role in our capital markets. The PCAOB’s mission is to oversee the audits of the financial statements of public companies and brokers and dealers in order to protect the interests of investors and further the public interest by promoting informative, accurate, and independent audit reports. The PCAOB’s responsibilities are broad as it pertains to the audit profession; they include standard-setting, registration and inspection of audit firms, and enforcement authority.

The SEC’s oversight of the PCAOB includes the appointment of its Board members, approval of PCAOB rules and standards, oversight of disputed inspection reports, and approval of the PCAOB’s budget and accounting support fees.

In October 2017, after soliciting public input, the Commission unanimously approved a PCAOB standard that will provide significant changes to the independent auditor’s report[17] The PCAOB honed its thinking on the standard over the seven years of its development to reflect valuable input received, including three public consultations. We encourage you to read the final standard.

Under the standard, beginning with audits for fiscal years ending on or after December 15, 2017, the auditor’s report will contain clarifications regarding independence, auditor responsibilities, and communication of an auditor’s continuous years of service to the company.[18] The auditor’s report will continue to provide a pass or fail opinion.

Beginning with audits of fiscal years ending on or after June 30, 2019, auditors’ reports for large accelerated filers will include communication about critical audit matters.[19] For each critical audit matter, the auditor will provide their perspective on matters communicated or required to be communicated with the audit committee that relate to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment. We believe investors will benefit from understanding more about the issues from the auditor’s unique perspective that were a focus of the dialogue between the auditor and the audit committee. However, to achieve its full potential, the requirements must be effectively implemented.

As you might note, expectations for timely, ongoing communication will continue to be an important element to the auditor-audit committee relationship as the auditors implement this new auditor reporting standard. In that regard, audit committees should have reasonable expectations that auditors prepare to take members through the application of the standard on their engagement. For example, what would the critical audit matters be this year? What would be the close calls? When could those matters have been raised, and which ones could have been identified at the start of the audit cycle? What does the auditor expect to say about those matters? When would we expect to see a draft report or at least a draft of the critical audit matters? These are illustrative examples of the communication planning and expectation setting that audit committee members may wish to consider as part of the transition period.

Consistent with the Commission’s approval order,[20] we expect that the PCAOB will conduct a timely and effective post-implementation review on the requirements of the new standard. During the phased effective dates—audit reports with communication of critical audit matters will be required for large accelerated filers 18 months before being required for all others—the Commission staff will review carefully the results of the post-implementation procedures and work with the PCAOB as it considers whether additional changes to the requirements are needed, including to the implementation date for non-large accelerated filers.

Auditor Independence

The auditor independence consultations we have engaged in have fluctuated in nature and number over time. In summary, while the total number of consultations has decreased over the last couple years, the nature of and complexity of consultations has changed due, in part, to the increasing use of technology by audit firms to deliver professional services and also due to the so-called “loan provision”[21] of the auditor independence rules.

These consultations help inform our development of staff guidance and recommendations to the Commission regarding the independence rules. For example, while consultations usually relate to a single company or auditor, trends tend to develop. When they do, we consider whether and how to address them.

One specific independence matter to mention is the no action letter issued by the Division of Investment Management on September 22, 2017,[22] extending the temporary relief that was provided in a June 20, 2016 no action letter.[23] We are actively working with our colleagues to develop recommendations for the Commission regarding potential amendments to the “loan provision” to address the circumstances that gave rise to the need for these no action letters.

A central focus in the evaluation of auditor independence is whether, under the general standard of independence, the auditor remains objective and impartial. Independent auditors are required not only to be independent in fact; but also to avoid situations that may lead outsiders to doubt their independence.[24] Absent independence, in fact and appearance, public confidence in the audit is diminished.

Keeping this in mind, audit firms should continue to invest in their policies, procedures, and training, among other elements of a quality control system, that provide an audit firm with reasonable assurance that independence is maintained (in fact and in appearance).

Independence is not only a legal requirement, but also a professional and ethical duty. Audit firms must promote ethical behavior by their staff, as a misstep here could impair the auditor’s independence in fact or appearance.

Internal Control Over Financial Reporting

Consistent with our previous communications, over the next several years internal controls will be particularly important as companies work through the implementation of the significant new accounting standards. Well-run public companies have effective internal controls not just because internal controls are a first line of defense against preventing or detecting material errors or fraud in financial reporting, but also because strong internal controls are good for business and can have an impact on costs of capital.[25] It is important for audit committees, auditors, and management to continue to have appropriately detailed discussions of ICFR in all areas—from risk assessment to design and testing of controls, as well as the appropriate level of documentation. If left unidentified or unaddressed, internal control deficiencies can lead to lower-quality financial reporting which can ultimately lead to higher financial reporting restatement rates and higher cost of capital.

Many companies have selected the framework published by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) to assess ICFR.[26] Companies that apply the COSO framework[27] might find its five components and related concepts and principles useful in developing a structured approach and meeting related documentation expectations.[28] Each of the five COSO components and relevant principles must be present and operating effectively to conclude that ICFR is effective under the COSO framework. Just as discussions between audit committees, auditors, and management on ICFR are important to financial reporting, it is also important that other stakeholders, including COSO, continue to actively monitor and consider whether changes in the financial reporting environment warrant updates or guidance to the control frameworks used in the evaluation of ICFR.

Audit Committees

Independent audit committees with appropriate oversight of the financial reporting and external audit processes also promote high quality financial reporting. Audit committee members must stay current as to relevant developments in accounting and financial reporting, whether financial, control, or disclosure related, and should consider continuing education and other means. In addressing certain important issues, some audit committees may need expert advisors as they carry out fully their responsibilities.

Also, audit committees of listed public companies have clear oversight authority and responsibility over the external auditor, which promotes auditor independence and greater alignment of the auditor’s interests with those of investors. The audit committee helps set the tone for the company’s relationship with the external auditor. Auditors are in a unique position to provide feedback to the audit committee about management, the company’s processes, accounting policies, and ICFR, among others. This oversight of management’s activities is crucial for investor protection, and it is important for both auditors and audit committees to keep and maintain the direct relationship they share.

The audit committee responsibilities include the authority and responsibility to directly oversee auditor engagement terms and compensation. As a result, the design and operation of some of management’s vendor procurement and monitoring approaches may be inappropriate if applied to the auditor selection, retention, and compensation decisions because of the direct oversight role of the audit committee. The audit scope and fees should be designed to be responsive over the course of the audit cycle to sufficiently identify and address audit risk arising in the financial statement audit. In the context of their important role, we continue to see encouraging trends toward voluntary, enhanced audit committee disclosure in the proxy or annual report regarding external auditor oversight.[29]

International Accounting, Audit, and Disclosure Matters

In today’s interconnected world economy, investors depend on high-quality accounting and auditing standards around the world. U.S. investors routinely invest in companies based outside the United States and listed in non-U.S. jurisdictions to diversify their portfolios.

Recent data indicates that U.S. investors have invested $9.58 trillion in foreign equity and long-term debt (out of which over $4 trillion is held by U.S. mutual funds, and over $1 trillion is held by U.S. pension funds).[30] To put this number into perspective, at the same time U.S. investors’ ownership of domestic equity and long-term debt is $61.4 trillion.[31]

Over 500 foreign private issuers, representing multi-trillions of dollars in aggregate market capitalization, report financial statement information to the SEC without reconciliation to U.S. GAAP, which makes the United States one of the largest markets for the securities of IFRS-reporting issuers. In addition, there are over 300 foreign private issuers that file financial statements with the SEC using U.S. GAAP.

International Financial Reporting Standards

Many U.S. companies and investors continue to have an ongoing interest in the quality of IFRS, as they produce and use financial information prepared in accordance with IFRS on a regular basis. Reduced differences between U.S. GAAP and IFRS make the preparation and use of financial statements considerably more effective and may lead to higher-quality financial reporting by U.S. registrants. Accordingly, we will continue to encourage the FASB and the IASB to work together to keep converged standards converged, to reduce differences in standards where they continue to exist, and to continually look for opportunities to improve standards in producing decision-useful information for investors.

We monitor the governance of the IFRS Foundation and the IASB, the development of IFRS, and the quality of the application of IFRS through participation in the IFRS Foundation Monitoring Board, through our role as official observer to the IFRS Advisory Council and to the IFRS Interpretations Committee, and also through our participation and leadership role on the International Organization of Securities Commissions’ (“IOSCO”) Committee on Issuer Accounting, Audit and Disclosure (“Committee 1”).

IFRS preparers are working to implement, among other standards, the new revenue standard, as are U.S. GAAP preparers. Transition disclosures are designed to keep investors informed, and are as important for IFRS preparers as for U.S. GAAP preparers. Financial statements prepared using IFRS as issued by the IASB are required to contain disclosure of information relevant to assessing the possible impact that application of the new IFRS will have on preparers’ financial statements in the period of initial application.[32] A useful source of information about implementation disclosures is the IOSCO Statement on Implementation of New Accounting Standards (“IOSCO Statement”).[33] The IOSCO Statement highlights the importance of the implementation process by issuers and their audit committees, and the importance of full, accurate, and timely disclosures of the possible impacts of adopting the new standards.

OCA regularly consults with U.S. registrants on matters involving the application of U.S. GAAP and IFRS, including some recent consultations with U.S. multinationals on the accounting policies they plan to adopt for the new revenue recognition standard under both U.S. GAAP and IFRS. We have not observed the same level of consultation activity originating from foreign private issuers that file with the SEC using IFRS or U.S. GAAP as we see from U.S. domestic companies. There may be various reasons for this to be the case, but this is a useful occasion to remind all issuers that OCA's consultation process is available to provide staff views on technical accounting positions.

International Audit and Ethics Standard Setting

In well-functioning capital markets, strong institutions are in place to govern corporate financial reporting and to provide investor protection. In the United States, for example, our legal systems, corporate governance, and the auditing profession are all important mechanisms that help facilitate compliance with U.S. accounting and auditing standards so that financial reporting in the United States provides useful information to investors. In countries in which enforcement of accounting and auditing standards through legal systems and corporate governance is not well developed, the strength of an independent audit may be especially important to the protection of shareholders, including U.S. investors.[34]

Independent auditors play a key role, acting in the public interest and contributing to the credibility of financial statements on which they report. The degree of credibility afforded by an audit depends on, among other factors, the technical quality of the standards that serve as the basis of the audit.

Accordingly, oversight and governance of international audit and related standards (audit and assurance, ethics, and education standards for accountants) are important so that standards and guidance for auditors support the delivery of high-quality audits. This in turn builds public trust and confidence in financial statements and financial reporting more broadly.

The Monitoring Group is a group of international financial institutions and regulatory bodies that is responsible for the overall governance of the international audit, ethics, and education standard-setting processes and the review of their implementation, effectiveness, and responsiveness to the public interest.[35] OCA provides input on Monitoring Group activities primarily through its participation and leadership roles in IOSCO’s Committee 1.

In early November 2017, the Monitoring Group issued a consultation paper for public comment, “Strengthening the Governance and Oversight of the International Audit-Related Standard-Setting Boards in the Public Interest.”[36] Constituents are encouraged to review that consultation paper and provide views and feedback to the Monitoring Group.

International Interest in Practices of Audit Committees

Through Committee 1, securities regulators from around the world are undertaking a work stream to produce a report on good practices of audit committees in their role of promoting and supporting audit quality. While the primary responsibility for audit quality lies with the auditor, members of Committee 1 recognize that the audit committee of a listed company can have a critical role in promoting and supporting audit quality. IOSCO has a long-standing interest in the role of audit committees, including through the work of its prior Audit Quality Task Force.

Committee 1 plans to include within the scope of its work how audit committees determine whether to appoint, reappoint, or dismiss the external auditors; how they assess the performance of the external auditors; how they consider and approve audit fees; how they evaluate auditor independence; and how they engage in communications with external auditors about key risks and judgment areas. Committee 1 may explore different areas as the project progresses. We encourage you to stay tuned for discussion in the coming year.

Innovations and Emerging Issues in Technology and Commerce

Turning now to innovations and emerging issues, perhaps a useful way for each of us to think about the effects of innovations in technology and commerce on an issuer’s financial reporting to investors is for each of us to organize our thinking along the following lines:

  • It is a role of the SEC staff and of the accounting profession to consider the possible effects of innovations in technology and commerce on the financial reporting obligations of issuers of securities to those who invest in the public capital markets.
  • In order for an issuer to appropriately report the financial statement effects of its innovation efforts to investors the issuer’s management and its auditor, in the context of their respective responsibilities, must understand the nature of the issuer’s innovations.
  • The very innovations in technology and commerce that the monies of those who invest in the public capital markets help to bring about can, not surprisingly, prompt questions regarding aspects of how management should prepare and how auditors should audit an issuer’s financial statements in accordance with the respective accounting and auditing standards.

It may be helpful to use an example to illustrate this approach to organizing one’s thinking about innovations in technology and commerce.

Considering the Possible Effects of Innovations

A useful way to illustrate the first point, above, may be to consider an innovation in technology and commerce that is of current interest in the business world; namely, distributed ledger—sometimes referred to as “blockchain”—technology. Distributed ledger technology may serve as a useful example because possibilities for its use are becoming more prevalent. These possible uses may involve an issuer’s books and records, its system of internal control over financial reporting, its application of accounting standards and, correspondingly, the audit of its financial statements.

Understanding the Nature of Innovations

A useful way to illustrate the second point, above, with respect to distributed ledger technology may be to briefly convey our perception of three commonly associated terms.[37] These terms are: “distributed ledger,” “coin,” and “token.”

The term “distributed ledger” can be used to describe an approach by which a transaction ledger captures all sides of a transaction in one place. Thus, the ledger provides a record of not only the aspects of an individual entity’s involvement in a transaction, but a record of the involvement of the other party or parties to the transaction as well. Moreover, a transaction ledger that is designed with this “distributed” architecture may accumulate multiple transaction entries into groups, or so-called “blocks.” These blocks append one to the next, thus the term “chain.” The resulting “chain” of “blocks” yields the sometimes associated moniker, “blockchain.”

The term “coin” can be used to describe a certain feature of a type of distributed ledger software program. The term “coin” arises because the rights and responsibilities associated with such a feature may be exchanged among the parties who make use of the software program. Exchanges that occur are tracked within the software program using a form of a distributed ledger.

The term “token” can refer to some manner of a claim against an entity (or against its assets, cash flows, residual value, future goods or services, and so forth) that arises from the use of distributed ledger technology. A “token” is referred to as such because it embodies or serves as a representation of the claim or claims. An entity may extend such a claim to others in exchange for proceeds of varying forms, obtained by offering the so-called “tokens” to others in exchange. The so-called “token” may be a security under the securities laws.

Applying the Accounting and Auditing Standards to the Financial Reporting Effects of Innovations

A useful way to illustrate the third point, above, may be to first observe that innovations in technology can be the ally of an issuer’s financial reporting activities, not their opponent. Accordingly, changes in technology need not work against the model for financial reporting to investors in the public capital markets as we currently know it. For example, even with the advent of innovations in technology, and in particular distributed ledger technology, the management of an issuer should:

  • Maintain appropriate books and records—whether by making use of distributed ledger technology or not—and maintain the necessary system of internal control over financial reporting on which the auditor, if required to do so, will continue to report.
  • Consider what a so-called “coin” is—as opposed to solely how it may be used—in determining how to account for any issuer participation in the “coin” aspect of a distributed ledger software program.
  • Produce financial statements that reflect the facts and circumstances of any manner of claim—whether the claim is referred to as being embodied in or represented by a “token” or not—in accordance with either U.S. GAAP or IFRS, as applicable.

Likewise, the auditor of an issuer should:

  • Assess the application of the financial reporting framework used by the issuer in the preparation of its financial statements.
  • Determine the nature and extent of the audit procedures to perform based on the circumstances of the issuer and the assurance standards used. This would entail understanding and assessing the access to records, the validity of transactions recorded, and the integrity of the transaction records, as a starting point.

In summary for this example, in addition to seeing the innovations in distributed ledger technology clearly there is a need for each of us to take what is learned and then act appropriately within the parameters of the existing internal control and financial reporting requirements of the securities laws. Distributed ledger technology, while on the one hand exciting to think about with respect to its possibilities for financial recordkeeping, does not alter this fundamental responsibility.

Looking Forward

Finally, we want to acknowledge the broader environment in which we are all working and also look ahead. We are living in a time of significant change. We have already discussed some accounting and auditing changes, but now the focus is on a much broader context.

  • We are living in a period of demographic change—for example, baby boomers are retiring, millennials are assuming greater roles and influence, and our population is broadening.
  • We are living in a period of technological change—for example, advances in artificial intelligence, big data, mobile devices, pervasive interconnectivity, cybersecurity risk, and virtual reality.
  • And, of course, we are living in a period of institutional change, not just in the United States but in other countries that are home to significant capital markets.

New tools, new competitors, new challenges, and new opportunities have created a transition for all of us. Even as we advance the high quality financial reporting in the capital markets, it is critically important to understand and maintain focus on the core principles that will move us forward even further, and to continue to act in accordance with them.

Having fair, orderly, and efficient capital markets that facilitate capital formation while protecting investors is a pillar of the U.S. economy, and the quality and performance of the U.S. economy supports and facilitates many of America’s other strengths, as well as public policy initiatives. However, keeping true to fundamental policy principles is not just important for those of us as regulators, but for all of us who play important roles in maintaining our system of credible financial reporting that supports our capital markets and their participants. We will go even further in saying that we all have important roles in upholding and contributing to the principles of accurate, honest financial information that are fundamental to the strength of our country and society.

Even as we work to ensure the public remains confident in financial reporting, we must also position ourselves and future generations of accountants, auditors, standard setters, and regulators to innovatively identify and solve the challenging and complex issues facing the evolving public interest

We anticipate that the profession will also continue to lead in the capital markets as we together foster the efficient functioning of our capital markets, which depend on the continuous flow of reliable financial information.

Appendix I

The following table presents a list of speeches given by OCA staff members during 2017. We encourage you to refer to these speeches for additional information regarding accounting and auditing matters. For the content of each speech, please refer to https://www.sec.gov/news/speeches.

Date

Title

Speaker

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Michael P. Berrigan

Professional Accounting Fellow

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Michal P. Dusza

Professional Accounting Fellow

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Joseph R. Epstein

Professional Accounting Fellow

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Nigel J. James

Associate Chief Accountant

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Barry Kanczuker

Associate Chief Accountant

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Robert B. Sledge

Professional Accounting Fellow

December 4, 2017

Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments

Ryan W. Wolfe

Senior Associate Chief Accountant

November 14, 2017

Remarks before the Financial Executives International 36th Annual Current Financial Reporting Issues Conference: Effective Financial Reporting in a Period of Change

Wesley R. Bricker

Chief Accountant

September 21, 2017

Remarks before the San Diego Chapter of the Financial Executives Institute

Sagar S. Teotia

Deputy Chief Accountant

September 11, 2017

Remarks before the AICPA National Conference on Banks & Savings Institutions

Wesley R. Bricker

Chief Accountant

June 9, 2017

Keynote Address before the 2017 Journal of Accounting and Public Policy Conference – “The Interaction between Regulatory Institutions and Accounting: A Public Policy Perspective”

Wesley R. Bricker

Chief Accountant

June 8, 2017

Remarks before the 36th Annual SEC and Financial Reporting Institute Conference: “Advancing the Role of Credible Financial Reporting in the Capital Markets”

Wesley R. Bricker

Chief Accountant

May 8, 2017

Remarks before the Bloomberg BNA Conference on Revenue Recognition

Sylvia E. Alicea

Professional Accounting Fellow

May 4, 2017

Remarks before the 2017 Baruch College Financial Reporting Conference: "Advancing Our Capital Markets with High-Quality Information"

Wesley R. Bricker

Chief Accountant

March 24, 2017

Remarks before the University of Tennessee’s C. Warren Neel Corporate Governance Center: “Advancing the Role and Effectiveness of Audit Committees”

Wesley R. Bricker

Chief Accountant

March 21, 2017

Remarks before the Annual Life Sciences Accounting & Reporting Congress: “Advancing Effective Internal Control and Credible Financial Reporting”

Wesley R. Bricker

Chief Accountant


[1] See 17 CFR 200.22.

[2] See Appendix I of this Statement for a list of the speeches given by OCA staff members during 2017. The content of each speech is available at https://www.sec.gov/news/speeches.

[3] See Policy Statement: Reaffirming the Status of the FASB as a Designated Private-Sector Standard Setter, Release No. 33-8221 (Apr. 25, 2003) [68 FR 23333], available at http://www.sec.gov/rules/policy/33-8221.htm (“2003 FASB Policy Statement”). The Commission has not designated the IASB as a private-sector accounting standard-setter.

[4] See Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (May 2014), codified in FASB Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers; ASU No. 2016-02, Leases (Feb. 2016), codified in ASC Topic 842, Leases; and ASU No. 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (June 2016), codified in ASC Topic 326, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.

[5] See Sagar S. Teotia, Deputy Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks Before the San Diego Chapter of the Financial Executives Institute: Addressing Implementation Matters to Improve Financial Reporting (Sept. 21, 2017), available at https://www.sec.gov/news/speech/speech-teotia-2017-09-21.

[6] Staff Accounting Bulletin (“SAB”) No. 74 has been codified in SAB Topic 11.M, Disclosure Of The Impact That Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrant When Adopted In A Future Period, available at https://www.sec.gov/interps/account/sabcodet11.htm#M.

[7] PCAOB Auditing Standard (“AS”) No. 1301, Communications with Audit Committees, paragraph 13f.

[8] E.g., the following speeches made by Wesley R. Bricker, Chief Accountant, U.S. Securities and Exchange Commission; Remarks before the 2017 Baruch College Financial Reporting Conference: Advancing Our Capital Markets with High-Quality Information (May, 4, 2017), available at https://www.sec.gov/news/speech/remarks-2017-baruch-college-financial-reporting-conference-advancing-our-capital; Remarks before the AICPA National Conference on Banks & Savings Institutions: Advancing High-Quality Financial Reporting in Our Financial and Capital Markets (Sept. 11, 2017), available at https://www.sec.gov/news/speech/speech-bricker-2017-09-011; Remarks before the Financial Executives International 36th Annual Current Financial Reporting Issues Conference: Effective Financial Reporting in a Period of Change (Nov. 14, 2017), available at https://www.sec.gov/news/speech/speech-bricker-2017-11-14.

[9] ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (Jan. 2016).

[10] ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (Aug. 2017).

[11] Commission Guidance Regarding Revenue Recognition for Bill-and-Hold Arrangements, Release No. 33-10402 (Aug. 18, 2017) [82 FR 41147].

[12] Updates to Commission Guidance Regarding Accounting for Sales of Vaccines and Bioterror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile, Release No. 33-10403 (Aug. 18, 2017) [82 FR 41149].

[13] SAB No. 116 (Aug. 18, 2017), available at https://www.sec.gov/interps/account/sab116.pdf.

[14] Minutes of the July 20, 2017 Meeting of the FASB Emerging Issues Task Force, available at http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176169274522.

[15] See ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (Jan. 2016).

[16] SAB No. 117 (Nov. 29, 2017), available at https://www.sec.gov/interps/account/staff-accounting-bulletin-117.htm.

[17] Public Company Accounting Oversight Board; Order Granting Approval of Proposed Rules on the Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and Departures from Unqualified Opinions and Other Reporting Circumstances, and Related Amendments to Auditing Standards, Release No. 34-81916 (Oct. 23, 2017) [82 FR 49886].

[18] The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, PCAOB Release No. 2017-001 (June 1, 2017), available at https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf.

[19] Communication of critical audit matters for audits of all other companies to which the requirements apply will begin in fiscal years ending on or after December 15, 2020.

[20] Release No. 34-81916.

[21] Rule 2-01 (c)(1)(ii)(A) of Regulation S-X.

[22] No-Action Letter from the Division of Investment Management to Fidelity Management & Research Company et al., (Sept. 22, 2017), available at https://www.sec.gov/divisions/investment/noaction/2017/fidelity-management-research-092217-regsx-rule-2-01.htm.

[23] No-Action Letter from the Division of Investment Management to Fidelity Management & Research Company et al., (June 20, 2016), available at https://www.sec.gov/divisions/investment/noaction/2016/fidelity-management-research-company-062016.htm.

[24] AS 1005, Independence.

[25] Weak internal control has been shown to be associated with poor financial reporting quality. See, e.g., Doyle, J., W. Ge, and S. McVay, Accruals Quality and Internal Control over Financial Reporting, 82 The Accounting Review 1141-1170 (2007). For how internal control improves investment efficiency through improving financial reporting, see Cheng, M., Dhaliwal, D., Zhang, Y., Does Investment Efficiency Improve after the Disclosure of Material Weaknesses in Internal Control Over Financial Reporting? 56(1) Journal of Accounting and Economics 1–18 (2013).

[26] While the Commission has not mandated the use of a particular framework to assess ICFR, most companies have selected the 2013 COSO framework. In 2013, in response to changes in business and operating environments that occurred since the inception of the original framework, COSO issued the 2013 Internal Control Integrated Framework, which superseded the original framework published in 1992. The executive summary of the 2013 COSO Framework is available at https://na.theiia.org/standards-guidance/topics/Documents/Executive_Summary.pdf.

[27] Although most registrants have made the transition to using the 2013 COSO framework, not all registrants have. Data gathered by Audit Analytics and Protiviti from fiscal 2016 annual reports show that the transition to the 2013 COSO framework for audited internal control over financial reporting is almost complete: 99 percent of companies reviewed used the 2013 Framework. The number of management-only filers adopting the 2013 framework increased to 63 percent in fiscal 2016 reports from 51 percent in fiscal 2015. See the report at: http://www.auditanalytics.com/blog/adopting-the-2013-coso-framework-fiscal-2016-update/.

[28] See, e.g., Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33-8810 (June 20, 2007) [72 FR 35324] (noting that, “[m]anagement is responsible for maintaining evidential matter, including documentation, to provide reasonable support for its assessment. This evidence will also allow a third party, such as the company’s external auditor, to consider the work performed by management”). See also, COSO, 2013 Internal Control — Integrated Framework, Framework and Appendices (2013), pp 30 and 102, (providing expectations for management’s documentation of internal control over financial reporting).

[29] See Center for Audit Quality and Audit Analytics, 2017 Audit Committee Transparency Barometer (Nov. 1, 2017), available at http://thecaq.org/2017-audit-committee-transparency-barometer.

[30] See U.S. Department of the Treasury, Report on U.S. Portfolio Holdings of Foreign Securities as of December 31, 2016, at pages 10 and 27 (Oct. 2017), available at http://ticdata.treasury.gov/Publish/shc2016_report.pdf.

[31] See U.S. Department of Treasury, Report on Foreign Portfolio Holdings of U.S. Securities as of June 30, 2016, at page 6 (April 2017), available at http://ticdata.treasury.gov/Publish/shla2016r.pdf.

[32] IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, paragraph 30.

[33] See IOSCO Statement on Implementation of New Accounting Standards (Dec. 2016), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD548.pdf.

[34] See Fan, J. and T. J. Wong, Do External Auditors Perform a Corporate Governance Role in Emerging Markets? Evidence from East Asia, 43 (1) Journal of Accounting Research 35-72 (2005); Choi, J. and T. J. Wong, Auditors' Governance Functions and Legal Environments: An Interactional Investigation, 24 Contemporary Accounting Research 13-46 (2007).

[35] The Monitoring Group is a collaboration of international financial institutions and regulatory bodies committed to advancing the public interest in areas related to international audit standard setting and audit quality. Members of the Monitoring Group are the Basel Committee on Banking Supervision, European Commission, Financial Stability Board, International Association of Insurance Supervisors, International Forum of Independent Audit Regulators, International Organization of Securities Commissions, and the World Bank. See https://www.iosco.org/about/?subsection=monitoring_group.

[36] See The Monitoring Group, Monitoring Group Consultation: Strengthening the Governance and Oversight of the International Audit-Related Standard-Setting Boards in the Public Interest, available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD586.pdf.

[37] Further information is contained in the SEC’s Investor Bulletin, Initial Coin Offerings (July 25, 2017), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings.