Closing the GAAP: The Ingenium Blog

Avoiding Restatement Entaglement

The PCAOB recently issued its report on inspections of smaller audit firms from 2007-2010.  In addition to citing some statistical information, the PCAOB identified some specific areas of audit deficiencies.

While the PCAOB only provides oversight of audit firms, the SEC’s Corporation Finance staff frequently issues comments in the same areas, often resulting in costly restatements.

In addition to the high level overview of some of the issues identified in the PCAOB’s report as noted below, future posts will provide a more in-depth discussion of the issues, samples of actual comments, and an intro into the approaches that we have previously used in getting the items resolved.

The primary deficiencies that could impact issuers are as follows:

  1. Revenue recognition – this area has been a hot-button issue with the SEC since the beginning of time.  Areas of frequent comment relate to the four basic criteria as published in Topic 13 of SEC’s Staff Accounting Bulletins (“SAB”).  Many times the required milestones appear to have been met within the period, for example the receipt of the payment, but within the world of GAAP it does not always mean recognition is appropriate.  Additionally, issuers will disclose their accounting policy simply as the four basic criteria, not providing much useful information as to how it is applied on a specific transactional basis.


  1. Share-based payments and equity financing instruments – For smaller reporting companies, with limited cash resources, being able to negotiate share-based payments with vendors is crucial to survival.  Slight nuances in terms could result in radical differences in treatment.  One frequent and important recognition criteria for share-based payments is the service provider consequence for non-performance has to be significantly greater than the share forfeiture, even with the threat of litigation.  In these situations, the application of the guidance can result in recognition that does not always seem to be reflective of the economic substance of the transaction.  A technical inquiry discussion with the FASB Staff emphasized a case by case analysis.


  1. Convertible debt instrumentsA seemingly safe way to interpret the terms of these instruments is to assume that the issuance will result in the recognition of more than one liability.  Assuming this recognition is the easy part, the recognized value of the instruments requires significant management judgment.


  1. Fair value measurements The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.  The definition itself seems simple until the real-world application is considered, especially involving debt and equity instruments of thinly-traded stocks.


  1. Business CombinationsKey things to remember that are not readily GAAP obvious – who is the acquirer for accounting purposes, many times not the legal acquirer; acquisition and measurement dates may be triggered in periods earlier than first thought; determination of consideration deemed part of the combination v. treated as a future obligation applicable to the on-going operations of the combined entity.


  1. Impairment of long-lived assetsFocus on substantive arguments and assumptions that are supportable and realizable in the near term to start.  Be subjective and realistic.  Non-quantitative analysis may prove to be sufficient.


The next post will provide a more detailed discussion of transaction terms that should be considered when entering into share based payments and equity financing arrangements, inclusive of some recent experiences with auditors and issuers.