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Replay: Reporting reset–Presentation fundamentals · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC's National Office.
• 0:07
  SPEAKER_02: Hello, and welcome back to PWC's Accounting Podcast.
• 0:11
  SPEAKER_02: I'm Heather Horn.
• 0:13
  SPEAKER_02: Last week we wrapped up our year-end reporting series, where we covered a range of topics designed to help you navigate the year-end reporting process.
• 0:21
  SPEAKER_02: This week we're taking a step back to highlight another set of conversations that are especially relevant in year-end reporting.
• 0:29
  SPEAKER_02: Last year, we hosted a series on financial statement presentation and disclosure, which focused on basics for key accounting topics and explored broader reporting considerations that cut across the financial statements.
• 0:41
  SPEAKER_02: Given how closely presentation and disclosure considerations tie into year end reporting, this felt like a great opportunity to bring that series back to the forefront.
• 0:54
  SPEAKER_02: To highlight these episodes, today we're bringing you a replay of the kickoff to the series.
• 0:58
  SPEAKER_02: Guest host Diana Stoltzfis, a partner in our national office, is joined by Pat Durbin, a deputy chief accountant in our national office.
• 1:06
  SPEAKER_02: Please listen in as they look at foundational reporting principles and key disclosure considerations.
• 1:12
  SPEAKER_02: In addition, please check out the show notes for links to each episode in the series.
• 1:17
  SPEAKER_02: With that, let's start the episode.
• 1:20
  SPEAKER_03: Welcome, Pat, and thanks so much for joining me for this conversation today.
• 1:24
  SPEAKER_01: Thanks, Diana.
• 1:25
  SPEAKER_03: Before we dive into the details, can you discuss the rules that serve as a foundation for the financial statement presentation?
• 1:32
  SPEAKER_01: Sure.
• 1:32
  SPEAKER_01: So the gap rules sort of set the foundation or the baseline for what we need to be thinking about.
• 1:38
  SPEAKER_01: They're relatively brief and uh I fair say, you know, from a former era, let's say.
• 1:45
  SPEAKER_01: They're uh codified in ASC 205.
• 1:48
  SPEAKER_01: And then the SEC has their own set of rules that are sort of incremental to those gap rules for public companies, although I would say in the absence of more specific gaps, sometimes we borrow from those rules for private companies as well.
• 2:03
  SPEAKER_01: Um so we can start with sort of what makes up a full set of financial statements.
• 2:08
  SPEAKER_01: Um under ASC 205, that's the section of the codification that deals with this.
• 2:13
  SPEAKER_01: Um a full set of financial statements includes a balance sheet, or sometimes we call it a statement of financial position, an income statement, a statement of comprehensive income, and sometimes those two are combined into one statement of comprehensive income.
• 2:28
  SPEAKER_01: Um, statements of changes in equity, um, and then a statement of cash flows.
• 2:33
  SPEAKER_01: If you're an SEC filer, the SEC regulation um SX Rule 401 has some additional SX specific requirements.
• 2:45
  SPEAKER_01: They basically tell you that you should include whatever detail is warranted in your particular circumstances to ensure that the financial statements are not misleading and to make sure the financial statement disclosures are relevant for the specific user class.
• 2:59
  SPEAKER_01: So it's sort of an overarching principle that even though we've set out these minimum requirements, you need to think about what else might be necessary.
• 3:08
  SPEAKER_03: Okay, great.
• 3:09
  SPEAKER_03: Well, now that we've covered what makes up a full set of financial statements, how does a company determine what period should be included?
• 3:16
  SPEAKER_03: Since the requirements differ for private companies and public companies, maybe you can break that down for us.
• 3:22
  SPEAKER_03: The concept of comparatives will also come up in other areas I know that you're talking about later in the podcast.
• 3:28
  SPEAKER_03: So although basic, I think it's good to set the stage for the rest of the discussion.
• 3:33
  SPEAKER_01: Sure.
• 3:34
  SPEAKER_01: So for private companies, um, generally can just depend on who your users are, sort of what um obligations you have to those users to deliver financial statements.
• 3:45
  SPEAKER_01: There's no actual requirement within GAP for the specific periods to be presented, although ASC205 does give us a steer that comparative financial statements are encouraged and they tend to be more useful.
• 3:59
  SPEAKER_01: You sort of have some context.
• 4:00
  SPEAKER_01: You know, you're not looking at just one per period in isolation.
• 4:04
  SPEAKER_01: You can sort of compare the two or more periods together.
• 4:08
  SPEAKER_01: So I would say customarily, private companies most will provide comparative financial statements.
• 4:13
  SPEAKER_01: Again, that's sort of the preference, and that's what's encouraged.
• 4:16
  SPEAKER_01: For public companies, the SEC rules, sort of the general model for call it your large corporate companies, would be three years for the income statement, statement of cash flows, statement of changes in shareholders' equity, anything that sort of measures performance or changes for periods, and then two years of the balance sheet.
• 4:36
  SPEAKER_01: Now, there's some uh variations to that for certain smaller reporting companies or SRCs or emerging growth companies or EGCs, where the SEC has relaxed those requirements to sort of make it easier for those companies to either access the public capital markets or to give them some time to sort of mature into a full-scale public company with uh the full three-year track record.
• 5:02
  SPEAKER_01: Um on the other extreme, if we go back to the private companies for a second, there there is a scenario where you might even present a single year.
• 5:10
  SPEAKER_01: Again, that's permitted, um, generally not preferable, but we do see that.
• 5:14
  SPEAKER_01: So you could sort of have anywhere from one year for a private company all the way to the full three years in the primary financial statements for a public company.
• 5:22
  SPEAKER_03: Okay.
• 5:22
  SPEAKER_03: Well, I think I think that's helpful in setting the stage.
• 5:25
  SPEAKER_03: So maybe we can start with the balance sheet.
• 5:28
  SPEAKER_03: Can you talk through the basic requirements for public companies to present certain items separately?
• 5:33
  SPEAKER_03: And are there best practices that many companies follow as well?
• 5:37
  SPEAKER_01: Yeah, and maybe one thing just to hit on the balance sheet specifically.
• 5:42
  SPEAKER_01: Um, we sometimes talk about a classified versus an unclassified balance sheet.
• 5:47
  SPEAKER_01: A classified balance sheet means you classify assets and liabilities as current and non-current.
• 5:52
  SPEAKER_01: So you sort of have two sections on each side of the balance sheet.
• 5:56
  SPEAKER_01: Um that's typically how commercial industrial companies, or what we call Article V companies, would report.
• 6:04
  SPEAKER_01: Um, some specific industries, particularly financial institutions, they typically present an unclassified balance sheet.
• 6:11
  SPEAKER_01: So that's sort of an overarching presentation model for the balance sheet.
• 6:16
  SPEAKER_01: Um and then within uh Regulation uh SX Rule 5 or Article 5, Rule 502, that talks about the specific captions then that you need to have on your balance sheet.
• 6:29
  SPEAKER_01: And so they they give you a pretty specific list of those captions that you should have, and then sort of, of course, catch all for anything else that you think you need to have that's material.
• 6:40
  SPEAKER_01: But some of these are required to be separate, obviously, if they are material.
• 6:44
  SPEAKER_01: Um, cash, accounts receivable, accounts and notes receivable, inventories, that there's a long list you can look in Rule 502.
• 6:53
  SPEAKER_01: Um, it also prescribes sort of the threshold for when you need to further disaggregate some of those lines.
• 7:00
  SPEAKER_01: For example, like an other assets line or an other liabilities line, you need to further disaggregate that.
• 7:06
  SPEAKER_01: If it's a current asset or liability, if it's 5% or more of that subtotal, then you would need to separately disclose, or rather, separately present that asset or liability.
• 7:18
  SPEAKER_01: Similarly, if it's in the sort of non-current category, then your threshold goes up to 5% of total assets as opposed to that particular subcategory.
• 7:28
  SPEAKER_01: Um, and then if you have a um note receivable or a balance of notes receivable that's more than 10% of total receivables, you need to break notes receivable out separately from accounts receivable.
• 7:41
  SPEAKER_01: I'd say most people tend to separate those two anyway because they sort of are different in nature, but that's just a requirement that you can't aggregate them if the balances are too large.
• 7:52
  SPEAKER_01: And then for intangible assets, you need to disaggregate them by the class of intangibles.
• 7:58
  SPEAKER_01: So perhaps think like goodwill versus other amortizable intangibles or maybe some, you know, brands versus um acquired technology, if um they're greater than 5% of total assets.
• 8:10
  SPEAKER_01: So again, you're back to that 5% of total assets threshold for further breakout.
• 8:16
  SPEAKER_03: Okay, well, that's really helpful.
• 8:18
  SPEAKER_03: We hear a lot of questions about netting assets and liabilities on the balance sheet.
• 8:22
  SPEAKER_03: When is a company allowed to offset these balances?
• 8:25
  SPEAKER_01: So there's some specific rules about when you can um offset assets and liabilities.
• 8:30
  SPEAKER_01: I would say that's definitely an exception rather than the rule.
• 8:34
  SPEAKER_01: Um, and the specific criteria, and it really runs to um receivables and payables.
• 8:40
  SPEAKER_01: Those are really the only things that would usually ever qualify for offsetting.
• 8:45
  SPEAKER_01: Um so in that context, if you have obviously two parties need to owe each other amounts of money, right?
• 8:51
  SPEAKER_01: Otherwise, it wouldn't really make sense.
• 8:53
  SPEAKER_01: So that's step one.
• 8:55
  SPEAKER_01: Um, you need to have the right under whatever the relevant parameters are of your relationship with that other party to set off those amounts.
• 9:04
  SPEAKER_01: Um, you as the reporting entity need to have an intent that you will set them off, meaning I'm not gonna actually write you a check.
• 9:11
  SPEAKER_01: I'm gonna just apply it against the balance that you owe me.
• 9:14
  SPEAKER_01: Um, and then that that right that you have, presumably under the contract, is enforceable at law.
• 9:21
  SPEAKER_01: So I would say some of those are a little bit more um objectively determinable.
• 9:26
  SPEAKER_01: Um, the intent one obviously is your intent.
• 9:29
  SPEAKER_01: Um, I think that's important that you um think through what your intent really is.
• 9:34
  SPEAKER_01: So it's a fairly high bar to get to a conclusion that you could set off.
• 9:40
  SPEAKER_01: And obviously, since it's based on your intent, in some ways it's not really obligatory, right?
• 9:44
  SPEAKER_01: It's sort of what you intend to do.
• 9:47
  SPEAKER_01: Um, and you might need to involve um some legal um counsel just to make sure that your right is enforceable at law because that's one of the criteria.
• 9:56
  SPEAKER_03: Right.
• 9:56
  SPEAKER_03: So we've talked about some of the different uh requirements for the balance sheet.
• 10:00
  SPEAKER_03: I know you've referenced the SEC rules a few times.
• 10:03
  SPEAKER_03: Um, so that would apply for public companies.
• 10:05
  SPEAKER_03: But are there any other significant differences between the requirements for public companies and private companies that our listeners should keep in mind?
• 10:13
  SPEAKER_01: Yeah, so probably the biggest one on the balance sheet is what we refer to as the mezzanine section of the balance sheet.
• 10:21
  SPEAKER_01: Um so you might think of that like you're in a theater or something, you're in the mezzanine.
• 10:25
  SPEAKER_01: But if you think of a balance sheet, you sort of have liabilities above equity.
• 10:29
  SPEAKER_01: There's this area in between that we refer to as the mezzanine.
• 10:34
  SPEAKER_01: And that's a special place for certain um they're usually redeemable preferred stock is the most classic form of mezzanine equity.
• 10:43
  SPEAKER_01: It's not really necessarily equity, it's sort of in between liabilities and equity.
• 10:47
  SPEAKER_01: That's why we call it the mezzanine.
• 10:49
  SPEAKER_01: But if you have preferred stock that has a contingent redemption feature, it's not fully or mandatorily redeemable, in which case it'd be a liability.
• 10:58
  SPEAKER_01: But if it's contingently redeemable, it's also not permanent equity.
• 11:01
  SPEAKER_01: So that's why it gets this special classification as mezzanine.
• 11:06
  SPEAKER_01: That's really um the result of an SEC interpretation that's not really sort of codified necessarily in GAP.
• 11:14
  SPEAKER_01: And so therefore it doesn't technically apply to private companies.
• 11:17
  SPEAKER_01: Um, that's obviously a big change that most private companies will need to make if they're contemplating going public.
• 11:24
  SPEAKER_01: And a lot of these types of instruments tend to reside mostly in private companies and maybe those that do intend to go public.
• 11:32
  SPEAKER_01: So oftentimes we will counsel those companies that going ahead and presenting it as a mezzanine, even as a private company, likely makes sense because you're going to have to do that eventually.
• 11:44
  SPEAKER_03: Right.
• 11:44
  SPEAKER_03: Okay.
• 11:45
  SPEAKER_03: So I think we've wrapped up a little bit on the balance sheet.
• 11:48
  SPEAKER_03: So maybe we'll switch over to the income statement.
• 11:51
  SPEAKER_03: Um, maybe in the spirit of going back to basics, can you discuss some of the foundational rules that are in place to how the income statement is prepared?
• 12:00
  SPEAKER_01: Yeah, and I would say just a recurring theme here is we don't have a lot of really detailed gap on presentation of the financial statements.
• 12:08
  SPEAKER_01: And that goes for both the balance sheet and the income statements.
• 12:11
  SPEAKER_01: So what's actually codified is fairly high level and some general guidelines, and then there's these supplemental SEC rules that are applicable to public companies, but I would say by and large have kind of informed how practice just puts together the income statement.
• 12:28
  SPEAKER_01: Um a lot of diversity in how companies actually decide to format their income statement again, because there's no real prescriptive guidance.
• 12:37
  SPEAKER_01: Um the one or sort of a couple of basic requirements are that you need to have a total amount for net income as well as the components that make up that net income.
• 12:50
  SPEAKER_01: Um, you know, what are those components?
• 12:53
  SPEAKER_01: Um there's some specific guidance in the SEC rules and regulation SX that give you some specific line items.
• 13:00
  SPEAKER_01: So revenue, costs and expenses applicable to revenue, all other operating costs and expenses, and then you know, other income gains and losses.
• 13:09
  SPEAKER_01: Those are sort of your basic categories, a provision for income taxes, uh, depending on whether or not you've had a discontinued operation, you may have that.
• 13:18
  SPEAKER_01: Um, so there's like a lot of different variations if you look at an income statement.
• 13:22
  SPEAKER_01: I would say what you most commonly see revenue, cost of revenues, selling general administrative expenses, maybe RD expenses, and then other income and loss, and that's sort of your sort of pre-tax income components.
• 13:37
  SPEAKER_03: Right.
• 13:37
  SPEAKER_03: Okay.
• 13:38
  SPEAKER_03: Well, maybe maybe we can just start then in following that order that you just talked to.
• 13:42
  SPEAKER_03: So, you know, you started with revenue.
• 13:45
  SPEAKER_03: Um, are there some key presentation requirements related to revenue that our listeners should be aware of?
• 13:50
  SPEAKER_01: So again, and this is largely focused on commercial industrial companies, Article 5 companies under SX.
• 13:57
  SPEAKER_01: There are some different articles for different industries, but sort of I'd say in the main, commercial industrial companies applique apply or 503 applies to them.
• 14:05
  SPEAKER_01: And so that's this is the guidance that would apply to them.
• 14:09
  SPEAKER_01: So you start with um revenues, which consist of revenue from products, revenue from services, and there's a requirement to separate those if um you know there's more than 10% of total revenues coming from either of those categories.
• 14:25
  SPEAKER_01: Uh rental income, so think lease revenue, um, income from operating public utilities, obviously a little bit more narrow in focus.
• 14:34
  SPEAKER_01: Um, and then again, this overarching requirement that if any of those categories are more than 10% of total revenues, they can't be combined with another category.
• 14:43
  SPEAKER_03: Okay.
• 14:44
  SPEAKER_03: Well, maybe continuing down our income statement, uh, maybe we should move on to expenses and the rest of the income statement.
• 14:51
  SPEAKER_03: So what do we typically see here?
• 14:54
  SPEAKER_01: So I'd say typically we see some line that's called cost of revenues, particularly if you're selling goods, you're selling services.
• 15:02
  SPEAKER_01: I would say some of the what we might refer to as newer economy companies where there's maybe very little marginal cost to deliver revenue.
• 15:11
  SPEAKER_01: Somebody's operating a technology platform, for example, um, they may or may not have a cost of sales line.
• 15:19
  SPEAKER_01: I'd say that's, you know, maybe not as uncommon as it used to be, but usually you see a cost of sales line.
• 15:25
  SPEAKER_01: And then the next big question you need to think about if you're going to present cost of sales is do I want to have what we refer to as a two-step income statement?
• 15:35
  SPEAKER_01: So I have sort of revenue, cost of sales, and I show a subtotal for gross margin, or do I just want to do a single step where I have my revenue and then a whole bunch of costs and expenses listed to come all the way down to operating income?
• 15:50
  SPEAKER_01: If you elect that first approach where you have a gross margin subtotal, it definitely puts a lot more pressure on the definition of cost of revenue, meaning, did you really get all of the costs in that cost of revenue line that you were supposed to?
• 16:05
  SPEAKER_01: And the one that maybe tends to come up more frequently in that context is depreciation and amortization.
• 16:12
  SPEAKER_01: Obviously, by definition, they're sort of um not directly applicable to any individual revenue transaction, but they need to be allocated to cost of revenue if they're part of that part of your business.
• 16:24
  SPEAKER_01: Um, there is a specific SEC rule that if you don't include depreciation and amortization and cost of sales, you need to actually note that uh on the face of the income statement, the cost of sales excludes depreciation and amortization.
• 16:38
  SPEAKER_03: Oh, that's interesting.
• 16:40
  SPEAKER_03: Okay, so maybe now getting into some of the areas that might require more judgment, operating income.
• 16:47
  SPEAKER_03: This has been an area of focus for users of the financial statements.
• 16:51
  SPEAKER_03: And so what should companies keep in mind when deciding whether an item belongs in operating income versus non-operating income?
• 16:59
  SPEAKER_01: Yeah, so this is an interesting one because it does come up with some frequency.
• 17:04
  SPEAKER_01: And I would say the general bias sometimes is hey, if it's something that's kind of out of the ordinary, non-recurring, um, there's perhaps a preference to call that non-operating.
• 17:17
  SPEAKER_01: There is no gap definition of operating income or loss.
• 17:22
  SPEAKER_01: You're not required even to have a subtotal of operating income or loss.
• 17:28
  SPEAKER_01: But if you have one, then it does matter whether you decide if something's operating or or non-operating.
• 17:35
  SPEAKER_01: And I would say the general bias from the SEC perspective, at least, would be kind of by default, everything is operating, unless you can really demonstrate that it isn't.
• 17:46
  SPEAKER_01: In particular, things like the sales or gains or losses from the sale of fixed assets, that's an operating item.
• 17:54
  SPEAKER_01: Um, a restructuring charge, that's an operating item.
• 17:58
  SPEAKER_01: A loss on the settlement of litigation, that's an operating item.
• 18:01
  SPEAKER_01: Like it doesn't necessarily feel like it's part of your day-to-day operations, but it's it's operating.
• 18:07
  SPEAKER_01: Um, things that are non-operating tend to be more what I would call um financial uh income or loss.
• 18:13
  SPEAKER_01: So gains and losses on uh sales of investments, interest income, interest expense, those types of things would be non-operating in nature.
• 18:23
  SPEAKER_03: Okay.
• 18:24
  SPEAKER_03: Well, I know there's been a lot of discussion around the FASB's um DICE standard, and it's been issued, but it's not effective yet.
• 18:32
  SPEAKER_03: So looking ahead, can you give us an overview of what it means for the income statement presentation and disclosure once companies have to adopt it?
• 18:40
  SPEAKER_01: Yeah.
• 18:41
  SPEAKER_01: So the disaggregated income statement expense standard um is exactly that.
• 18:46
  SPEAKER_01: It's a requirement to disaggregate in the footnotes the income statement expenses that are on the face of the income statement.
• 18:55
  SPEAKER_01: The standard doesn't actually in any way affect how you need to construct your income statement.
• 19:01
  SPEAKER_01: So whatever line items you have on your income statement are, assuming they're consistent with GAAP today, are fine.
• 19:08
  SPEAKER_01: Uh they don't need to be changed.
• 19:10
  SPEAKER_01: Just whatever those lines are will drive what which line items you need to disaggregate in the footnotes.
• 19:16
  SPEAKER_03: Okay, that's really helpful.
• 19:17
  SPEAKER_03: Another presentation topic, which is uh pervasive to both the income statement and balance sheet, is the presentation of related party balances and transactions.
• 19:27
  SPEAKER_03: Uh, what can you tell us about those?
• 19:30
  SPEAKER_01: So the FASB guidance has a requirement to disclose related party transactions if they're material.
• 19:39
  SPEAKER_01: The SEC rules require material related party transactions to actually be separately presented on the face of the income statement.
• 19:47
  SPEAKER_01: So if you had revenue from related parties, you'd need to state that separately.
• 19:50
  SPEAKER_01: If you had receivables from related parties, if you have borrowings from related parties, right, those would need to be separately disclosed.
• 19:57
  SPEAKER_01: So then the question is what you know, what's a related party?
• 20:01
  SPEAKER_01: And it's actually a fairly broad definition.
• 20:04
  SPEAKER_01: It could be an affiliate, maybe that seems obvious.
• 20:08
  SPEAKER_01: That's basically a party that you're under common control with or have a common owner.
• 20:12
  SPEAKER_01: So think uh brother-sister company scenario, um, an equity method investee, uh, maybe that's obvious, employee benefit trusts, principal owners of the company and their families, management of the entity and their families.
• 20:28
  SPEAKER_01: Now remember, there's an overarching materiality screen on all of this.
• 20:32
  SPEAKER_01: So think like, well, I pay compensation to management.
• 20:35
  SPEAKER_01: Well, if you're thinking of an individual management employee, oftentimes their compensation might not be material, or if it is, it's probably subject to some specific compensation arrangement that is disclosed.
• 20:47
  SPEAKER_01: So you typically don't see like a separate line for those types of things.
• 20:52
  SPEAKER_01: And then there's a couple of other categories that are pretty broad, um, which are sort of any other party that um you might deal with if one party controls or can significantly influence the other, um, or other parties that can significantly influence um the management or operating policies of the entity itself.
• 21:13
  SPEAKER_01: So sort of an inside and outside in, inside out, and outside in look um that can sweep in a lot of companies, so or potential other parties.
• 21:22
  SPEAKER_01: So you really need to think carefully about who you have transactions with to make sure you're complying with those presentation requirements.
• 21:29
  SPEAKER_03: It's a good reminder.
• 21:31
  SPEAKER_03: So maybe thinking about um what happens if there's changes to accounting and presentation items.
• 21:39
  SPEAKER_01: So if we go back to our earlier discussion about the value of sort of having comparative financial statements, um, that idea that you should have some consistency in the accounting policies used from period to period sort of uh plays right into that concept.
• 21:56
  SPEAKER_01: Now, there is a concept in gap that you can change.
• 22:00
  SPEAKER_01: Change your accounting principles if there are options available in GAP, and you can justify that the policy that you want to change to is preferable to the one you are applying.
• 22:13
  SPEAKER_01: Assuming you can get through those gates, then GAAP would tell you you should present all of the financial statements that are being presented for comparative purposes on that same basis.
• 22:23
  SPEAKER_01: So essentially retrospectively adjusting the prior period financial statements to conform to the current period presentation.
• 22:31
  SPEAKER_03: And is that preferability analysis?
• 22:33
  SPEAKER_03: Is that for both public companies and private companies?
• 22:36
  SPEAKER_01: So the requirement to justify preferability is a gap requirement that applies equally to both.
• 22:43
  SPEAKER_01: The one difference for a public company is if a public company makes a material accounting change, they are required to file a letter from their uh independent auditor that essentially affirms their preferability judgment.
• 23:00
  SPEAKER_01: It's sometimes referred to as a preferability letter.
• 23:02
  SPEAKER_01: So it's ultimately the company's responsibility to justify that it's preferable, to disclose the reasons for the change in their footnotes, to make all the adjustments to the financial statements, but then there's an additional requirement that they have their auditor essentially affirm that they concur with that conclusion and include that letter in their SEC filing.
• 23:24
  SPEAKER_03: Okay.
• 23:24
  SPEAKER_03: What happens if a company wants to make a change in how they're accounting for certain transactions or make a change to the presentation or there's a change in accounting principle?
• 23:33
  SPEAKER_03: What does a company need to be thinking about in those situations?
• 23:37
  SPEAKER_01: Yeah.
• 23:37
  SPEAKER_01: So really it's down to how do you demonstrate preferability?
• 23:41
  SPEAKER_01: And those justifications or arguments for preferability tend to vary a lot depending on the circumstances of the company, the nature of the change.
• 23:53
  SPEAKER_01: Um, one that we see with some frequency will be a change in inventory costing methods.
• 24:00
  SPEAKER_01: There frankly aren't that many places in GAP where you have choices.
• 24:04
  SPEAKER_01: Inventory happens to be one.
• 24:05
  SPEAKER_01: Maybe that's why we see it more commonly, and one that we probably have seen more frequently than others is a change from the LIFO method or last in first out method to the FIFO method, first in, first out method, or some other call it more current cost method.
• 24:23
  SPEAKER_01: Um, a lot of times the justification for that is um trying to get a better depiction of really the true cost of the goods that are being sold based on how a company operates its business, or perhaps to create better comparability with their peers.
• 24:40
  SPEAKER_01: If sort of they're the outlier using LIFO, it might be better for their users to present more comparative information with their peers.
• 24:49
  SPEAKER_01: So um that could be a rationale, but again, there's a fairly wide range.
• 24:54
  SPEAKER_01: The SEC does have some guidance in one of their SAB topics on considerations, but it's again pretty general, pretty high level.
• 25:01
  SPEAKER_01: So there's not really a hard and fast set of criteria for what equals preferability.
• 25:07
  SPEAKER_03: Okay.
• 25:07
  SPEAKER_03: So we've talked about, you know, accounting changes and preferability, but you know, estimates are used pretty pervasively throughout the financial statement.
• 25:17
  SPEAKER_03: So maybe can you talk to us a little bit about uh instances when there's changes in estimates?
• 25:22
  SPEAKER_01: Yeah.
• 25:23
  SPEAKER_01: So um there's a I guess the gap uh codification section is ASC 250, which covers both changes in accounting principle as well as changes in estimates.
• 25:33
  SPEAKER_01: It also covers um errors, accounting errors.
• 25:36
  SPEAKER_01: So they're all kind of sometimes lumped together, but they're all actually very different.
• 25:40
  SPEAKER_01: So we talked about the voluntary changes in accounting policy.
• 25:44
  SPEAKER_01: A change in estimate is by definition a change in the measurement of an estimated amount in the financial statements that just is a result of new information that became available during the period.
• 25:57
  SPEAKER_01: And those are um routine in accounting, they happen all the time.
• 26:01
  SPEAKER_01: They're not indicative that you had a bad estimate necessarily in a prior period.
• 26:05
  SPEAKER_01: It just means you now have better information about how that um uncertainty has evolved.
• 26:12
  SPEAKER_01: You update your estimate, and in most cases that has uh an effect of you know running through the PL in the current period.
• 26:20
  SPEAKER_01: So that's that's a change in accounting estimate.
• 26:22
  SPEAKER_01: I mean, usually if there's a material one, you want to have some disclosure that describes the nature of it and also sort of the nature of the remaining uncertainty, just so the reader has a sense of what's still in play.
• 26:35
  SPEAKER_03: Right.
• 26:35
  SPEAKER_03: And and another thing you mentioned, you kind of mentioned that last category now of errors.
• 26:40
  SPEAKER_03: And so maybe do you want to talk to us a little bit about the implications there?
• 26:44
  SPEAKER_01: Yeah, so errors are usually never anybody's favorites topic.
• 26:48
  SPEAKER_01: Um, but they do happen.
• 26:50
  SPEAKER_01: Um, you know, no one is uh perfect, even well-controlled organizations sometimes, um, you know, they can't necessarily contemplate everything.
• 26:59
  SPEAKER_01: So so errors happen, and in fact, gap gives you a framework for how to report accounting errors.
• 27:06
  SPEAKER_01: Um the general model is if you had an error, you need to go correct the error.
• 27:11
  SPEAKER_01: Now, like everything in in GAAP, there's a materiality overlay.
• 27:15
  SPEAKER_01: So if you find an immaterial error, um, you might be able to just correct that in the current period as an out-of-period adjustment.
• 27:22
  SPEAKER_01: Um, that's what we would call that.
• 27:24
  SPEAKER_01: It's technically an error, but if it wasn't material to the prior year, not material to the current year, you can just correct it and move on.
• 27:32
  SPEAKER_01: If you find a material misstatement in those prior periods, then you need to restate those prior periods.
• 27:39
  SPEAKER_01: So that means um, you know, going back, fixing the error, fixing all the financial statements and all the disclosures for all the years and carrying that through.
• 27:47
  SPEAKER_01: If you're a public company, because you've made those public financial financial statements available publicly, you need to then prominently restate them, which means you need to file an 8K that says those old financial statements are no longer reliable.
• 28:01
  SPEAKER_01: You need to file a 10KA typically to put the new financial statements on file.
• 28:07
  SPEAKER_01: Um, and so it you know can be quite an exercise to go through the financial statements as they're restated, need to include specific labels that say as restated, you need to include disclosures in the footnotes that say specifically what the error was and all the line items that were affected.
• 28:25
  SPEAKER_01: Obviously, for public companies, there's also internal control ramifications of all of that.
• 28:30
  SPEAKER_01: Um, and again, that's if it's a material error.
• 28:33
  SPEAKER_01: Um, we talked about the immaterial ones where you could potentially correct them through an out-of-period adjustment.
• 28:39
  SPEAKER_01: There's one other flavor, which technically is a restatement, but because the conclusion was it wasn't material to the error that I discovered, whatever it was, wasn't material to the prior years, but correcting it entirely as an out-of-period adjustment in the current period would result in a material misstatement to the current period.
• 29:02
  SPEAKER_01: The only option available then would be to restate those prior periods.
• 29:07
  SPEAKER_01: But if I was looking at those prior periods individually, I would say, well, none of them are materially misstated.
• 29:12
  SPEAKER_01: So the mechanism in that case is what we would refer to as a revision.
• 29:16
  SPEAKER_01: So technically it's just the same as a restatement, except you don't have to label the financial statements as restated.
• 29:23
  SPEAKER_01: You still need the disclosure that talks about the change.
• 29:26
  SPEAKER_01: You would go back and change those prior periods, but you wouldn't necessarily have to file a 10KA.
• 29:32
  SPEAKER_01: You would just adjust those financial statements when you next presented them for comparative purposes.
• 29:38
  SPEAKER_01: So it's a a little bit less onerous than a than a restatement, but from a technical point of view, it's it's sort of similar in that regard.
• 29:47
  SPEAKER_03: Sometimes people like to call it a little R.
• 29:49
  SPEAKER_01: Yes.
• 29:50
  SPEAKER_01: Little R restatement versus big R restatement.
• 29:52
  SPEAKER_03: Right.
• 29:53
  SPEAKER_03: So we've talked a lot about historical periods, presenting the financial statement and what type of information gets disclosed within those periods.
• 30:01
  SPEAKER_03: But what do companies need to think about when they're thinking about information or events that happen after the balance sheet date or subsequent events?
• 30:10
  SPEAKER_01: Sure.
• 30:10
  SPEAKER_01: So um obviously, you know, we stop the clock on the financial statements as of the end of the year, but um the world moves on, things happen.
• 30:18
  SPEAKER_01: Um, it takes us a little while to issue the financial statements.
• 30:21
  SPEAKER_01: So oftentimes there are events that occur after the balance sheet date, but before the financial statements are issued, which by definition that's what we refer to as subsequent events.
• 30:31
  SPEAKER_01: And there are two types of those subsequent events.
• 30:34
  SPEAKER_01: There are uh recognized subsequent events, or what uh maybe some old timers would remember as type one subsequent events.
• 30:42
  SPEAKER_01: We don't call them that anymore, but sometimes people still refer to them that way.
• 30:46
  SPEAKER_01: Or the non-recognized subsequent events or uh type two.
• 30:51
  SPEAKER_01: So recognized subsequent events are those that give us new information about conditions that existed at the balance sheet date, and therefore we should take that new information into account in measuring assets or liabilities, typically liabilities at the balance sheet date.
• 31:09
  SPEAKER_01: The most classic example of this would be the post-balance sheet settlement of a litigation contingency.
• 31:16
  SPEAKER_01: So maybe I had a loss accrued, um I've been in litigation over some matter, I settle it after the balance sheet date.
• 31:23
  SPEAKER_01: Well, obviously the event had occurred that gave rise to the litigation, the litigation was in place.
• 31:28
  SPEAKER_01: I just now have confirmation of what it cost me.
• 31:32
  SPEAKER_01: I should reflect that in my financial statements.
• 31:35
  SPEAKER_01: Non-recognized subsequent events are sort of everything else.
• 31:38
  SPEAKER_01: It's sort of something that happened and it could be potentially very important to the business, but it didn't relate to any condition or circumstance that existed at the balance sheet date.
• 31:49
  SPEAKER_01: So the classic example of this would be a natural disaster destroys one of my facilities after the balance sheet date.
• 31:57
  SPEAKER_01: Well, obviously that's a pretty important event, and I probably should disclose that, but clearly it didn't happen as of the balance sheet date, so it shouldn't affect the amounts in the financial statements at the balance sheet date.
• 32:11
  SPEAKER_03: Right.
• 32:11
  SPEAKER_03: Is there some judgment, Pat, in determining, you know, the that second type, that non-recognized event, like when you need to disclose versus not disclose?
• 32:20
  SPEAKER_01: Yes.
• 32:20
  SPEAKER_01: I mean that and the guidance is is pretty high level, but it's generally like if the financial statements would be misleading if you didn't disclose it, then you need to disclose it.
• 32:32
  SPEAKER_01: And so that's definitely a judgment call.
• 32:34
  SPEAKER_01: I would say people tend to sort of err on the side of caution in that regard.
• 32:39
  SPEAKER_01: Another one that comes up pretty regularly would be like a material business combination after the balance sheet date, which maybe some of those seem kind of obvious because they're they're they're big issues, but there's definitely some judgment involved.
• 32:52
  SPEAKER_03: Okay, well, great.
• 32:53
  SPEAKER_03: Well, this has been a really great conversation.
• 32:56
  SPEAKER_03: Maybe as we're wrapping things up, uh I know we've talked about a number of different areas, and in some of them we've highlighted some of the differences between public and private companies, but uh maybe we'll do that here too with subsequent events.
• 33:08
  SPEAKER_03: So anything specific?
• 33:10
  SPEAKER_01: Sure.
• 33:10
  SPEAKER_01: So the the basic requirement is that you need to evaluate subsequent events that occur after the balance sheet date, but prior to issuance of the financial statements.
• 33:20
  SPEAKER_01: And that's the general model.
• 33:22
  SPEAKER_01: Um if you're an SEC registrant, the date you issue the financial statements is the date you file the 10K.
• 33:29
  SPEAKER_01: It sort of becomes obvious then, okay, that was the date through which you evaluated the subsequent events.
• 33:35
  SPEAKER_01: Because in the private context, there's not an actual formal filing.
• 33:39
  SPEAKER_01: You don't necessarily have a date stamp on when you issued the financial statements.
• 33:43
  SPEAKER_01: You're required to disclose in the financial statements the date through which you evaluated the subsequent events.
• 33:51
  SPEAKER_01: So generally speaking, that would coincide with the date you issued it.
• 33:55
  SPEAKER_01: But again, because there's not the sort of statutory requirement to file the financial statements anywhere, um, you're also bound by disclosing or evaluating subsequent events through the date you issued or the date that the financial statements were available to be issued.
• 34:11
  SPEAKER_01: So you disclose the date that it was, even if you don't issue them on that date, but they were available to be issued.
• 34:17
  SPEAKER_01: That's the sort of point at which the clock stops on subsequent events.
• 34:21
  SPEAKER_03: Okay.
• 34:22
  SPEAKER_03: Well, thanks so much for joining me today, Pat.
• 34:24
  SPEAKER_03: This has been a really interesting conversation.
• 34:26
  SPEAKER_01: Yeah, thanks, Diana.
• 34:27
  SPEAKER_01: My pleasure.
• 34:28
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• 34:31
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• 34:51
  SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
• 34:55
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