Accounting Insights from the 2021 AICPA Conference

Materiality, auditor independence, and SPACs: transactions drive the SEC’s focus

Going into 2022, companies will continue to make the most of favorable market conditions. Paul Munter, the acting chief accountant of the SEC, remarked on matters related to the continued increase in capital market and mergers and acquisitions (M&A) activity. Although there has been no update to the authoritative guidance surrounding materiality, Munter and others in the SEC staff devoted time to this topic as an increase in transactions typically spurs more consultations on materiality. Further, the recent volume of restatements has a pronounced swing from “big R” restatements to “little r” revisions. As such, the SEC staff reminded preparers to approach materiality analyses from an objective perspective. Specifically, companies should ground any assessment of the materiality of an error by using quantitative metrics first before moving to qualitative factors.

An uptick in M&A activity also drives more auditor independence evaluations. As transactions involving international entities rise, conference discussion highlighted the difference between international independence standards and Rule 2-01 of Regulation S-X, noting Rule 2-01 uses principles-based standards, and these present a high hurdle to reach a conclusion that an accountant could remain objective and impartial. Independence is the responsibility of auditors, management, and boards. Preparers considering acquisitions and capital market transactions must obtain appropriately evaluated auditor independence in advance of those events to avoid costly delays.

Although the volume of SPAC mergers has declined from the peak earlier in the year, they remain a popular vehicle through which to access the capital markets. The SEC offered some key considerations related to the unique risks and challenges a private company could encounter when entering the public markets through such a merger. A SPAC process presents an accelerated timeline to prepare the regulatory reporting and listing requirements, and once the target company is identified for the merger, it is imperative that a target company has a comprehensive plan in place to address the resulting demands of becoming a public company. Here, focus areas will include financial reporting, internal control, and an increase in independent auditor procedures. In addition, it is essential to carefully evaluate the status of various functions, including the people, processes, and technology that will meet the SEC filing requirements post-merger. Companies should ensure they have an audit committee that understands the SEC reporting and internal controls requirements of being a public company.

Feedback and other factors shaping accounting standards-setting

Both the SEC and Financial Accounting Standards Board (FASB) have primarily focused on ensuring recent changes to standards are properly implemented and adopted, rather than rolling out sweeping new changes.

In the current higher volume capital markets environment, the SEC staff has focused on the application of guidance, highlighting several areas in addition to materiality, such as changes to management discussion and analysis (MD&A), segment reporting, non-GAAP measures, and stock-based compensation. On more recent rulemaking, SEC Chief Accountant of the Division of Corporate Finance Lindsay McCord examined the continued adoption and compliance of the new rules related to MD&A, and this year will mark the first for many issuers to apply those rules in year-end reporting. McCord highlighted nuances preparers should be aware of, especially regarding retrospective application of guidance; for instance, supplementary financial information that should be included in MD&A disclosures when issuers lose their emerging growth company (EGC) status.

The FASB also emphasized the continued prioritization of stakeholder feedback in the process of developing new standards and revising existing guidance. The FASB specifically cited the following recently issued or proposed standard updates, each of which focuses on updating the more significant new standards such as revenue, leases, and CECL:

• Eliminating the need to fair value contract assets and liabilities accounted for under ASC 606 in purchase accounting (ASU 2021-08)
• Permitting non-public entities to apply incremental borrowing rate practical expedients at an asset class level under ASC 842 (ASU 2021-09)
• Revisiting certain gross write-off disclosures required under CECL, including the requirement to disclosure write-offs by vintage (not yet issued)

FASB panelists including chair Richard Jones, technical director Hilary Sato, and deputy technical director Helen Debbeler gave some forward-looking insight into new projects the board is considering, most of which represent agenda topics the FASB has been considering for the past few years. These include:

• Revising the accounting for goodwill model, potentially moving to an amortization plus impairment model
• Revising the level at which goodwill impairment analysis is performed, moving to either the reportable or operating segment level from the reporting unit level
• Updating the expiration date of the reference rate reform guidance to align with LIBOR’s expected extended life
• Revisiting segment reporting and expanded disclosures related to expense line items

Despite ample feedback regarding the accounting model for digital assets and the ability to record at fair value, the panel indicated the FASB does not currently have a project on its agenda to address the accounting for digital assets. As the crypto market gains interest among investors, the FASB could consider this topic more closely in the future.

ESG reporting and corporate framework

Environmental, social, and governance (ESG) reporting was a key theme throughout this year’s conference and has become a focal point for both users of the financial statements and accounting standards setters. The International Sustainability Standards Board (ISSB) was created this year to formulate a new baseline for sustainability reporting that meets investor needs. The ISSB has been working with the International Financial Reporting Standards Foundation (IFRS) and the FASB to develop a unified global set of climate and general standards to provide preparers a common framework for ESG reporting.

As the ISSB finalizes its reporting standards, companies should begin or continue to identify critical ESG metrics that are material to the business and sector. Companies will need a robust corporate governance structure around these critical ESG metrics and related disclosures. Governance structure should include an IT infrastructure with proper general controls (ITGCs), a sufficient internal control framework, and reporting procedures akin to those in place around the financial reporting environment. During a panel on ESG reporting, Fortune 500 finance executives emphasized the importance of having a cross-functional team and a process for collecting, validating, and consistently presenting data as part of a company’s ESG reporting program.

According to IASB and AICPA representatives and other key accounting leaders, the push for increased ESG reporting has occurred in response to investor demands, and the trend is expected to increase. A growing desire to understand financial results and its environmental and social impacts will mandate companies and their finance functions to invest in developing ESG governance and related controls. Not only will companies need to develop these capabilities, organizations should also prepare for investors’ expanding demand for assurance over ESG reporting.