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, U.S. Securities and Exchange Commission

New York, NY

Nov. 14, 2017

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

Introduction

Good morning and thank you Heather Dixon for the kind introduction. Before I begin, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or my colleagues on the Commission staff.

Let me also express a word of gratitude to the entire OCA team for the work they do providing advice to the Commission regarding accounting and auditing matters arising in the administration of the federal securities laws and for their valuable assistance in preparing me to make today’s remarks.

The SEC is steadfastly devoted to its mission—protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation—which is the foundation of everything we do. In the course of this work, our agency engages with many of your companies. For example, the SEC is responsible for selectively reviewing the disclosures and financial statements of over 8,100 public companies, of which 4,300 are exchange-listed.[1] Of the top 100 public companies in the world, 77 fall under the SEC’s reporting requirements.[2] Consistent across the range of the SEC’s regulatory activities is the importance of reliable financial reporting in our capital markets. Without reliable financial information, supported by high quality accounting and auditing, investors cannot properly judge the opportunities and risks of investment choices to allocate capital to public companies, a key part of the American economy. Accounting and auditing may not readily grab the general public’s attention, but they are nonetheless important to the livelihoods of all Americans.

Effective Financial Reporting

The work that you do to produce high quality financial information is critical to the companies that you serve and is important to all stakeholders. An effective finance function is necessary for the preparation of accurate, reliable, relevant, and timely financial information. The finance function benefits from the support of an organization’s board of directors, CEO, CFO, and other senior leaders as it performs it’s day-to-day duties as well as in its work to address the impact of changes to its business and changes to relevant legislation and reporting obligations. Investors value your work and it is necessary to maintaining our well-functioning markets.

The processes necessary to develop the estimates and related assumptions underlying a set of financial statements can be quite involved, and it is frequently the collaboration between the finance function and an operational or business function that leads to the best judgments and results as opposed to the finance function making those judgments in isolation. This collaboration is also necessary to successfully implement the new accounting standards, which I will discuss this morning.

New GAAP Standards

As a private sector standard setter, the Financial Accounting Standards Board (“FASB”) clearly plays an important role in financial reporting. Its mission is to establish and improve financial accounting and reporting standards in order to provide useful information to investors and other users of financial statements and to educate stakeholders on how to most effectively understand and implement those standards.

Revenue, leases, and financial instruments are three significant areas where FASB standards have most recently been updated and improved. Earlier this year, some companies adopted the new accounting standard related to revenue, with most remaining public companies to follow in 2018.[3] Implementation of the other significant new accounting standards on leases[4] and credit losses[5] are also on the horizon. A successful transition to the new accounting standards will require engagement across your organization and will require the very best from your accounting function.

I have spoken on multiple occasions,[6] along with Deputy Chief Accountant Sagar Teotia[7] and other OCA Staff,[8] regarding the implementation of the new accounting standards and related internal control over financial reporting. Today, I will continue the discussion by touching on a few matters related to each of these three standards.

Revenue

I commend the many companies that have expended great effort to make significant progress in implementing the new revenue standard. To recap quickly our several themes since the standard was first released in 2014:

  • During 2015, we highlighted the approach to interpretations, including with the FASB and the International Accounting Standards Board (“IASB”) Joint Transition Resource Group (“TRG”);
  • During 2016, we highlighted the importance of implementation planning and dialogue;
  • Now, during 2017, we are focusing on the final stages of implementation.

Some public companies may need to accelerate the pace of their work to complete their implementation timely. Where there is a risk of material misstatement, companies need to have internal controls that address the judgments and estimates required of management to implement and, subsequently, apply the new standard. The effectiveness of internal controls over the transition adjustment and ongoing application of the new standard should be supported by appropriate documentation of significant judgments and decisions.[9]

Audit committees should anticipate receiving, as part of required communications, information from the auditor about any concerns with the anticipated implementation. It can be valuable for audit committees to listen for any differences in assessment of implementation status, milestones, or issue resolution between management’s and the auditor’s presentations. Increasingly through the third and fourth quarter reporting, I anticipate companies to be in a position to disclose in their SAB 74 disclosures the anticipated impact, at least qualitatively and directionally, of adoption of the revenue standard.

If companies have questions regarding their particular accounting policies, OCA Staff continues to be available for consultation on formal or informal bases to both domestic and foreign registrants. Consistent with existing practice, we will continue to accept well-reasoned judgments.

Leases

I anticipate that your companies’ implementation of the new leases accounting standard, effective in 2019 for calendar-year companies, will also be a significant effort. The new leases standard will result in assets and liabilities being recorded for most leases. Implementing the leases standard will require several steps, including (but not limited to): identifying relevant legal contracts, evaluating whether an arrangement is or contains a lease, and applying the new leases standard to arrangements within its scope.[10] Like the revenue standard, the leases standard will require reasonable judgment in certain areas, and developing well-reasoned judgments frequently requires time. Companies should identify the accounting questions relative to their arrangements and begin working through those questions in a timely manner.

While not required, we have observed a best practice is for companies to commence efforts to implement the new leases standard concurrently (or partially concurrently) with the new revenue standard. Companies that wait to begin addressing the new leases standard until after they have implemented the new revenue standard may find that they have limited their time for implementation. Insufficient time could impact, among other items, the ability of a company to make reasonable judgments and to complete its accounting analysis.

As I noted in discussing revenue, OCA Staff stand ready to consult on leasing questions as well.

Current Expected Credit Losses (“CECL”)

With regard to the credit loss standard, the FASB’s objective was to significantly improve the usefulness of financial instrument reporting for users of financial statements by developing a credit loss model that results in timelier reporting of credit losses.[11]

The FASB’s six year development of this standard, as with its others, was a deliberative and inclusive process. It is imperative that the standard-setting process include consideration of the views of a broad array of stakeholders.[12] With the credit loss standard, the FASB’s outreach included stakeholders representing large and small financial institutions, public and private companies, large and small practitioners, investors, other users of financial statements, and regulators. Through this stakeholder input, as well as issuing several public consultation documents, the FASB honed its thinking with the goal of improving the financial accounting and reporting standards in a way that provides transparent and useful information to investors and other users of financial statements.

When formulating accounting standards, the FASB does not seek to influence the outcome of investor capital allocation decisions or actions taken by management; rather, it seeks standards that provide better information to inform those decisions and actions. Specifically, the FASB states that it weighs whether the expected improvement in the quality of the information provided to users justifies the cost of preparing and providing that information. I believe that it is appropriate for the FASB to focus on the quality of the information provided to investors. The alternative, whereby FASB would set standards that privilege certain economic activities or market participants, could cause investors to lose confidence in the accuracy or quality of reported information, which could thereby impair capital formation, and in turn negatively impact economic activity.

During the FASB’s development of the credit loss standard, some considered whether it should be changed to address financial stability, pro-cyclicality or the availability of certain loan products. Keep in mind that accounting is concerned with reporting the economics of transactions and management decisions. The economy runs in cyclical patterns; bank management of underwriting and other operations can have a pro-cyclical effect since they incorporate the reality that some borrower’s ability to repay generally declines during an economic downturn. The FASB appropriately focused on designing a standard so that financial reporting is unbiased and transparent in all market cycles and useful in the course of an investor’s decision making.

Standard setting, particularly in the FASB’s private sector role, is a process of bringing together input and expert views and then reaching decisions about the best way forward on tough issues. This process works. For example, the FASB had to consider the scope of information to incorporate into the credit loss measurement. The FASB heard from financial institutions that they wanted to use forward-looking information and record expected credit losses on a timelier basis. Many institutions, for example, use forward looking information in underwriting, collateral determinations, servicing, and asset-liability management practices, but in reporting incurred credit losses under today’s standard use only a subset of that information. In addition, management has a tremendous amount of information from its risk management systems, again, only a subset of which is currently used in financial reporting. Today, investors are on their own to develop an assessment of expected credit losses. After adoption of CECL, management will provide their estimate of expected credit losses, which reduces information asymmetry for investors.

As another example, the FASB considered how to report the economics of lending transactions. In doing so, the FASB decided, based on a largely consistent view expressed by stakeholders, that reporting should retain the approach today of reporting interest income recognition separately from recognition of losses.[13] Still, some contended that the resulting approach of reporting the loan’s net realizable value (i.e., the cash expected to be collected) on the balance sheet apart from the loan’s income over time on the income statement is not consistent with the economics of lending.

In most loan portfolios, lenders do not expect dollar-for-dollar collection of a portfolio of loans, since lending inherently exposes the lender to credit risk even at origination. Under CECL, the balance sheet addresses this circumstance by requiring reporting of the lender’s expectation of the amount they expect to collect on the loans – the long-standing concept of “net realizable value.”


The FASB also balanced the input from financial institutions and investors alike reflecting that both groups have developed their systems for analyzing return of investment and return on investment as separate processes and preferred a continuation of that approach. The credit loss standard will maintain the existing approach of reporting interest revenue without separating it into component parts, such as a base rate and a credit spread component.

The standard does not prescribe that organizations use specific estimation methods in most circumstances, which helps minimize preparation costs. Many of the loss estimation methods applied today will continue to be relevant under the new standard, although changes to certain inputs and assumptions will be necessary. While forward-looking information must be considered, an organization may revert to historical loss information in periods in which a reasonable and supportable forecast cannot be obtained. Organizations will continue to use reasonable judgment to determine which loss estimation method is appropriate for their circumstances.

If companies need additional guidance regarding challenging or complex issues in this area, the OCA Staff remain available for consultation.

One last comment: I have expressed my support for the review by U.S. prudential regulators, called upon by the U.S. Treasury, with a view towards harmonizing the application of the standard with regulators’ supervisory efforts. OCA Staff and FASB are engaged with prudential regulators to provide any assistance they may require as they undertake their process for reviewing their standards. The staff of the federal banking agencies have been actively communicating about how CECL will be incorporated into their regulatory measures, including, for example, instructions by the Federal Reserve that firms should exclude the effect of CECL for purposes of preparing both the 2019 Dodd-Frank Act Stress Test (DFAST) and the 2019 Comprehensive Capital Analysis and Review (CCAR).

The Auditor’s Reporting Model

Now, I want to touch on the Commission’s recent approval of a PCAOB standard that will provide significant changes to the independent auditor’s report.[14] The standard changed over the seven years of development to reflect valuable input received, including three public consultations. I encourage you to read the final standard.

Under the standard, beginning this year-end, the auditor’s report will contain clarifications regarding independence, auditor responsibilities, and communication of an auditor’s continuous years of service to the company.[15] 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, reports on large accelerated filers will include communication about critical audit matters.[16] 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. I 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 independent audit committee.

I support the new PCAOB standard, which was unanimously approved by the Commission.[17] However, to achieve its full potential, the requirements must be effectively implemented.

As part of getting started, I encourage auditors to update their methodologies, provide training, and, at the engagement team level, use the transition period to engage in dialogue with audit committees so that audit committees have time to understand the types of matters that may be communicated as critical audit matters in the audit reports.

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.

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 audit reporting standard.

The requirements of the auditor’s reporting standard will be phased in over time. The first phase will add revisions to clarify the auditor’s role and responsibilities and make the auditor’s report easier to read and disclosure of audit firm tenure. Many audit committees disclose to investors auditor tenure in the proxy statement. In other cases, research and information service companies collect and make the data available.

Regardless of where, or whether, prior years of service of an audit firm is disclosed, the years of experience may be one data point that is balanced among the various factors considered by the audit committee in weighing their selection or retention of the external auditor and their oversight of the audit relationship.

Consistent with the Commission’s approval order, [18] I 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.

Distributed Ledger Technology Applications

Let me now turn to technology. Neither the accounting profession nor ourselves as regulators control changes in technology that affect commerce, but each of us can control how we seek to understand, prepare for, and respond to these changes. We need to begin this process by “lighting a lamp,” if you will, and using it to see what is happening around us. This morning, I want to discuss one such lamp that we, in OCA, have recently lit. This lamp is allowing us to better see the emerging area of distributed ledger (blockchain) technology for its impact on financial reporting.

In the near term, our interest in blockchain technology applications stems from the fact that the sponsors of this work may be utilizing capital from investors, in particular our Main Street investors, to develop possible applications in light of the fact that financial information is important to investor decision making. Thus, OCA is investing time to understand blockchain technology applications such as cryptocurrencies, coins, tokens and so forth as they are offered, bought, held, sold, and traded.[19] I suggest that it is warranted for the accounting profession to also invest time in understanding these areas. I have not heard particularly good rationales for turning off—or never turning on—the profession’s lamps at this time.

While the OCA Staff is working to better understand this area of blockchain technology applications, we are indeed journeying with a compass; namely, the Commission’s existing accounting and auditing requirements, books and records requirements, auditor independence rules, and the federal securities laws more generally. These collectively form a framework for us, and they should as well for everyone, because these requirements apply to all matters within the purview of the SEC, even if they were developed prior to the emergence of the types of facts and circumstances, including blockchain technology applications. In this vein I also refer you to the remarks that I made in September, in which I spoke about these requirements as they relate to capital raising that involves so-called coins or tokens.[20]

I understand that many of your organizations and many others may be currently undertaking research and development related to blockchain technology and its applications. I realize that none of us can foresee exactly how these technologies may be developed and applied in the coming months and years. Nonetheless, let me conclude by emphasizing that, as with the OCA Staff, I think it is important that those in the accounting profession invest the time to understand new trends and developments in technology and commerce to identify their potential effects on financial reporting to investors. I look forward to the meaningful dialogue that will result.

Closing

I want to thank you again for the opportunity to be with you today. We all have a shared responsibility to advance the role of high-quality information in our capital markets, which leads to better decisions and outcomes for all investors.

I look forward to taking your questions. Thank you.


[1] See Jay Clayton, Chairman, U.S. Securities and Exchange Commission, Testimony on Examining the SEC’s Agenda, Operation, and Budget, Committee on Financial Services, United States House of Representatives (October 4, 2017), available at https://www.sec.gov/news/testimony/testimony-examining-secs-agenda-operation-and-budget.

[2] See U.S. Securities and Exchange Commission Fiscal Year 2018 Congressional Budget Justification and Annual Performance Plan; Fiscal Year 2016 Annual Performance Report (May 23, 2017), available at https://www.sec.gov/files/secfy18congbudgjust.pdf.

[3] SeeAccounting Standards Update (“ASU”) No. 2014-09,Revenue from Contracts with Customers (Topic 606) (May 2014), available at https://asc.fasb.org/imageRoot/32/79982032.pdf.

[4] See ASU No. 2016-02,Leases(Topic 842) (February 2016), available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true.

[5] See ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) (June 2016),available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168232528&acceptedDisclaimer=true.

[6] See, e.g., Wesley R. Bricker, Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 36th Annual SEC and Financial Reporting Institute Conference: “Advancing the Role of Credible Financial Reporting in the Capital Markets”, available at https://www.sec.gov/news/speech/bricker-remarks-financial-reporting-institute-conference-060817; and Remarks before the 2017 Baruch College Financial Reporting Conference: "Advancing Our Capital Markets with High-Quality Information", available at https://www.sec.gov/news/speech/remarks-2017-baruch-college-financial-reporting-conference-advancing-our-capital.

[7] See Sagar 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”, available at https://www.sec.gov/news/speech/speech-teotia-2017-09-21.

[8] See Sylvia E. Alicea, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the Bloomberg BNA Conference on Revenue Recognition, available at https://www.sec.gov/news/speech/alicea-remarks-bloomburg-bna-conference-revenue-recognition-050817.

[9] See, e.g., Committee of Sponsoring Organizations of the Treadway Commission (“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).

[10] SeeASU No. 2016-02,Leases(Topic 842) (February 2016), available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true.

[11] See ASU 2016-13, Basis for Conclusions at BC7 (identifying additional benefits of the standard).

[12] The FASB actively sought and received input from a broad range of stakeholders throughout the consideration of this project, including more than 3,300 unique comment letters in connection with multiple public documents. In addition to the feedback it received through comment letters, the FASB proactively conducted outreach with hundreds of organizations and professionals during consideration of the various public consultation documents. Overall, outreach activities included more than 10 public roundtables (including 1 roundtable exclusively for community banks and credit unions) attended by representatives from more than 100 organizations; more than 85 meetings with preparers during re-deliberations of a 2012 proposed ASU; and 25 fieldwork meetings with preparers from industries that includes banking institutions of various sizes, nonfinancial organizations, and insurance companies. Throughout the course of the project, the FASB met with more than 200 users of financial statements.

[13] There is an exception in the instance that management would elect to measure the loan in its entirety at fair value, or lower of cost or fair value, as some do today. When loans are measured at fair value under those approaches, the amount, timing, and uncertainty of all cash flows, whether a return of investment in the loan or a return on the investment in the loan would be recorded at a single amount in the financial statements, with no mismatch.

[14] See U.S. Securities and Exchange Commission (Release No. 34-81916; File No.PCAOB-2017-01),Public Company Accounting Oversight Board (“PCAOB”); 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 (October 23, 2017), available at https://www.sec.gov/rules/pcaob/2017/34-81916.pdf.

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

[16] Communication of critical audit matters in reports for most other public companies will come afterward, beginning with audits of fiscal years ending on or after December 15, 2020.

[17] See Jay Clayton, Statement on SEC Approval of the PCAOB’s New Auditor’s Reporting Standard (October 23, 2017), available at https://www.sec.gov/news/public-statement/clayton-statement-pcaob-new-auditor-reporting-standard; Michael S. Piwowar, Commissioner, U.S. Securities and Exchange Commission, Statement on Adoption of Auditor’s Reporting Model (October 23, 2017), available at https://www.sec.gov/news/public-statement/statement-piwowar-2017-10-23; and Kara M. Stein, Commissioner, U.S. Securities and Exchange Commission, Statement on PCAOB’s New Auditor’s Reporting Standard (October 23, 2017), available at https://www.sec.gov/news/public-statement/statement-stein-2017-10-23.

[18] See U.S. Securities and Exchange Commission (Release No. 34-81916; File No.PCAOB-2017-01),Public Company Accounting Oversight Board (“PCAOB”); 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 (October 23, 2017), available at https://www.sec.gov/rules/pcaob/2017/34-81916.pdf.

[19] In this regard, the Commission has resources available for investors, available at https://investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-initial-coin-offerings.

[20] See Wesley R. Bricker, Remarks before the AICPA National Conference on Banks & Savings Institutions: Advancing High-Quality Financial Reporting in Our Financial and Capital Markets (September 11, 2017), available at https://www.sec.gov/news/speech/speech-bricker-2017-09-011.