This Financial Reporting Update highlights key developments and issues that are relevant to Finance and Accounting Professionals.
Financial Accounting Standards Board
The FASB met on January 31, 2024, to discuss the status of two accounting standards projects and to release tentative decisions based on its staff’s findings. The first topic was disaggregation of income statement expenses – a project that was initiated in 2021 in response to investor feedback for more detailed expense information on financial statements to better assess entity performance. Among its tentative decisions, the board affirmed its stances on requiring entities to disaggregate relevant expense captions and to disclose amounts for employee compensation, depreciation, and intangible asset amortization for each relevant expense caption. It also affirmed its stances that an entity would be required to disclose total selling expenses and qualitatively describe the nature of “other expenses” to provide more transparency. Further, the board instructed its staff to provide clarifications and better examples for the affected categories, to further its work on the disaggregation of inventory and manufacturing expenses, and to begin writing implementation guidance for the proposed requirements. This is an important step and an indication that the proposed disaggregation of income statement expenses is nearing finalization.
The second topic discussed at the January 31 board meeting was the accounting for environmental credit programs and obligations. Based on FASB staff research and outreach, the board made decisions on the recognition, measurement, and presentation of environmental credit obligations (ECOs) on the balance sheet and statement of cash flows. An entity should only recognize a liability if an ECO exists on or before the balance sheet date, considering the balance sheet date as the end of the compliance period. The liability for an ECO is measured based on the carrying amount of environmental credits for funded portions (as of the balance sheet date) and using the fair value of environmental credits necessary to settle the liability for unfunded portions. In subsequent periods, entities will be required to update the liability amount at each balance sheet date and recognize any changes in earnings, along with any gains or loss on extinguishment when the liability is derecognized. The board decided that entities should not capitalize the cost of environment credits that will not be sold or used to settle ECO liabilities; however, any environmental credits that an entity expects to sell or trade within one year can be recognized as current assets.
Securities and Exchange Commission
On January 24th, 2024, the SEC put out a press release that adopted multiple rules to enhance investor protection related to IPOs that are carried out by SPACS (Special Purpose Acquisition Company). These rules were also put in place to protect investors from, “subsequent business combination transactions between SPACs and target companies (de-SPAC) transactions).” These rules are being implemented as the SEC responds to investor concerns regarding their protections related to SPACs. When implementing these rules, the SEC is focused on three key issues, including “addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions.” These changes will require that SPACs disclose much more information to potential investors. Once these rules are adopted, SPACs must provide enhanced disclosures about conflicts of interest, the amount of compensation given to sponsors of the SPAC, information on dilution, and extra information about the target company. The extra information that will be required will help to protect investors as well as allow them to make more informed voting and investment choices.
The regulations have been updated to align the disclosure requirements and potential legal liabilities more closely in de-SPAC transactions with those of conventional IPOs. For instance, the target company is required to sign a registration statement filed by a SPAC (or another shell company) during a de-SPAC transaction. This would make the target company a “co-registrant”, taking on the responsibility for the disclosures in that registration statement. Furthermore, the rules render the safe harbor from liability for forward-looking statements under the Private Securities Litigation Reform Act of 1995 inaccessible to certain blank check companies, including SPACs. In relation to de-SPAC transactions, the rules mandate disclosure requirements concerning projections, including the disclosure of all significant bases and assumptions underlying the projections. The rules also revise and broaden the guidance on the use of projections in all SEC filings.
The adopted release is available on SEC.gov and will be published in the Federal Register. The rules will come into effect 125 days after being published in the Federal Register. Compliance with the structured data requirements, which necessitate tagging of information disclosed under new subpart 1600 of Regulation S-K within the Inline XBRL, will be mandatory 490 days after the rules are published in the Federal Register.
On February 14th, 2024, the SEC put forth a proposal to revise the monetary threshold for a fund to be classified as a “qualifying venture capital fund” under the Investment Company Act of 1940. The proposed rule would raise the threshold to $12 million in total capital contributions and uncalled committed capital, an increase from the current $10 million standard. The Act does not consider qualifying venture capital funds as “investment companies”. The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 mandates the Commission to adjust this threshold for inflation every five years. The proposed rule aims to fulfill this legislative requirement and set the $12 million threshold based on the Personal Consumption Expenditures Chain-Type Price Index (PCE Index). The rule also proposes a mechanism for adjusting for inflation every five years in the future. The proposal will be made available on SEC.gov and in the Federal Register. Following its publication within the Federal Register, there will be a 30-day period for public comments.
American Institute of Certified Public Accountants
On February 22nd, 2024, according to a recent report by the International Federation of Accountants (IFAC),the American Institute of Certified Public Accountants (AICPA), and Chartered Institute of Management Accountants (CIMA), major global companies are enhancing the depth and detail of their sustainability reporting. Additionally, they are increasingly ensuring the accuracy of Environmental, Social, and Governance (ESG) disclosures. Despite the ongoing advancements, the report highlights the worldwide necessity for companies to embrace a consistent framework for disclosing sustainability information. Encouragingly, over 50% of companies currently adhere to frameworks outlined by the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD); this existing compliance is expected to ease the transition to the International Sustainability Standards Board (ISSB) standards that were introduced last year.
The report highlights other key points that demonstrate the progress of sustainability reporting as well. Nearly all companies (approximately 98%) provide information on sustainability, marking a significant increase from the 91% reported in 2019 when research first initiated in this area. However, the utilization of standalone sustainability reports has declined by 27 percentage points over the past 3 years. In 2022, only 30% of companies opted for standalone sustainability reports, as more organizations incorporate this information into their annual or integrated reports. Regarding assurance, 69% of companies obtained assurance for at least some of their sustainability disclosures, representing a 5 percentage-point rise from the previous year and an 18 percentage-point increase since 2019. Despite this progress, the scope of assurance remains somewhat limited.
Public Company Accounting Oversight Board
The Public Company Accounting Oversight Board (PCAOB) has announced fines amounting to $2 million for extensive quality control violations discovered during audits of Special Purpose Acquisition Companies (SPACs). The PCAOB’s investigation uncovered systemic shortcomings within audit firm WithumSmith+Brown (WSB’s) auditing processes, particularly concerning SPAC-related transactions. SPACs have gained considerable traction in recent years as an alternative route for companies to go public, making their auditing procedures increasingly crucial to ensure transparency and investor protection. SPACs and the firms who create, audit, and administer them have recently come under scrutiny – as highlighted above in our discussion of the new SEC rules meant to protect investors in SPAC IPOs. By imposing these fines, the PCAOB further underscores the critical need for stringent quality control measures in auditing practices, especially in complex financial transactions like those associated with SPACs.
These fines highlight the significance of the PCAOB’s strive to maintain rigorous standards in financial reporting. SPACs, characterized by their unique structure and complexity, require auditors to exercise heightened diligence and expertise to accurately assess the associated risks and financial implications. The PCAOB’s sanctions against WSB serve as a stern reminder to auditing firms of the extreme importance of upholding professional standards and ethical conduct in their engagements, particularly when dealing with intricate financial arrangements that can impact market integrity and investor confidence.