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BDO SEIDMAN, LLP’S
December 2006
FINANCIAL REPORTING UPDATE
Speakers, Replay, and
CPE Information
• Speakers
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–
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Jeff Lenz
Jan Herringer
Liza Prossnitz
Reva Steinberg
• Replay Access
– www.bdo.com/about/publications/assurance
• CPE – Participation Verification
– 3 key words provided during the call must be
confirmed on the evaluation
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Agenda
• SEC Update
• Internal Control Reporting Update
– SEC
– PCAOB
• SEC Conference Report
• Questions and Answers
3
SEC UPDATE
December 2006
SEC Update – Agenda
• Rulemaking
• Personnel Changes
• Paulson Speech and Committee
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Recent Rulemaking – Final Rules
• Further Relief From the Section 404
Requirements for Smaller Companies and
Newly Public Companies (Release 338760)
– http://www.sec.gov/rules/final/2006/33-8760.pdf
• E-proxy rule amendments
(http://www.sec.gov/news/press/2006/2006-209.htm)
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404 – Compliance Dates (Final)
Type of filer
Due Date
Before
Extended Due
Date
Due Date
Before
Extended Due
Date
Management
Management
Auditor
Auditor
Yrs ending on or after
Yrs ending on or after
Yrs ending on or after
Yrs ending on or after
Nonaccelerated July 15, 2007
Dec. 15, 2007 July 15, 2007
Dec. 15, 2008
Accelerated FPI July 15, 2006
Unchanged
July 15, 2006
July 15, 2007
Large Acc FPI
July 15, 2006
Unchanged
July 15, 2006
Unchanged
Newly Public
Issuer
First 10-K
Second 10-K
First 10-K
Second 10-K
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404 Implementation Roadmap
Next Steps - SEC
• Defer compliance dates
– Completed – Release 33-8730A (http://www.sec.gov/rules/final/2006/338730a.pdf)
• Accelerated foreign private issuers
– Completed – Release 33-8760 (http://www.sec.gov/rules/final/2006/338760.pdf)
• Non-accelerated filers
• Newly public companies
• Obtain additional feedback (Concept Release)
– Completed
• Issue guidance on management assessments
– Proposal approved December 13, 2006
• Work in concert with PCAOB, revise AS 2
– Proposal issued December 19, 2006
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E-Proxy Rules
• Final rule adopted to allow (i.e., it is not
mandatory) companies to furnish proxy
materials to shareholders through a “notice
and access” model using the Internet
– Effective July 1, 2007
– Early adoption not allowed
– Final rule is not yet out, see SEC Press Release
2006-209
http://www.sec.gov/news/press/2006/2006209.htm
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Proposed Rules December 13
• Require notice and access model (not optional) for all
proxies not related to a business combination
transaction
– Comments are due 60 days after publication in the Federal
Register
– Press release 2006-209
http://www.sec.gov/news/press/2006/2006-209.htm
• Foreign Private Issuer Deregistration
– Base deregistration eligibility on average daily trading volume
– Press release 2006-207
http://www.sec.gov/news/press/2006/2006-207.htm
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Personnel Changes
• Deputy Chief Accountant Scott Taub leaving
December 31
– Replacement not yet announced
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Paulson Speech and Committee
Interim Report
• Secretary Paulson Nov. 20 speech
http://www.ustreas.gov/press/releases/hp174.htm
• Committee on Capital Markets Regulation
suggestions (the Paulson Committee)
http://www.capmktsreg.org/research.html
– Target Congress as well as regulators
– Risk-based approach; principles-based rules
– Address excessive criminal and civil liability for
companies, directors, officers, and auditors
– Exempt small companies from Section 404 if it’s too
burdensome
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BDO SEIDMAN, LLP
The SEC’s Proposed Interpretive
Guidance for Management to Improve
SOX 404 Implementation
December 2006
Introduction – Where We are today
• Section 404(a) requires each annual
report to include:
– A statement of management’s
responsibility for ICFR
– Management’s assessment of the
effectiveness of ICFR
• Rules adopted on June 5, 2003
– No specific method to follow in
performance of evaluation
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SEC Proposals
• Interpretive guidance for management regarding
evaluations of ICFR
• Amendments to Rules 13a-15 and 15d-15 clarify
that performance of the proposed procedures
satisfy annual evaluation
• Amendments to Reg S-X clarify auditor’s reporting
requirement pursuant to Section 404(b)
• Find the Press Release at
http://www.sec.gov/news/press/2006/2006-206.htm
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How the Interpretive Guidance was
Developed…
• Concept release issued July 18, 2006
• Comments on release submitted by
September 18, 2006
• Concept release published to better understand
the extent and nature of guidance for
management
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Comment Letters
• Comment letters available at
http://www.sec.gov/comments/s7-11-06/s71106.shtml
• Approximately 170 comment letters
were received by the SEC
• Feedback was requested on…
– Risk and control identification
– Management’s evaluation
– Documentation to support assessment
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Interpretive Guidance for
Management
• SEC voted on December 13th to propose
interpretive guidance
• Guidance based on cumulative feedback
from…
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–
–
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SEC Small Business Advisory Committee
GAO Report
COSO Guidance for Smaller Public Companies
Concept Release comment letters
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Proposed Interpretive Guidance – Two
Principles
Proposed Guidance is principles-based
that is organized around 2 principles
• Evaluate the design of controls
– Determine possibility of a material
misstatement
• Gather and analyze evidence of effective
operation of controls
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Smaller Public Companies
• Guidance intended to be scalable and flexible
• Small companies may be less complex
• Small companies are defined
20
Risk Based Approach
• Proposed guidance is risk based
• Addresses concerns raised to the
Commission about:
– Excessive testing of controls
– Excessive documentation of processes, controls
and testing
– Scalability of AS 2
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Four Topics included in Guidance
• Identification of risks to reliable financial
reporting
• Evaluation of operating effectiveness
• Results of management’s evaluation
• Documentation
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Identification of Risks to Reliable
Financial Reporting
• Risk-based approach
• Use of judgment to determine
– Areas that are both material and pose a risk to
reliable financial reporting
• Identify controls that address those risks
– Including fraud considerations
23
Evaluation of Operating Effectiveness
• Flexibility in how management supports its
evaluation
• Illustrations provided regarding:
– Daily interaction
– Self-assessment
– Ongoing monitoring activities
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Results of Management’s Evaluation
• Evaluation framework provided in proposed
guidance
• Situations that are considered strong
indicators of a material weakness are
provided
• Factors to consider in evaluating the severity
of deficiencies are described
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Documentation
• Nature and extent of evidential matter
• Includes methods and procedures used to
gather evidence
• Daily interaction…limited documentation
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Conclusion
• Coordination with PCAOB
• Comments to the SEC will be due 60 days
after publication in the Federal Register
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BDO SEIDMAN, LLP
PCAOB Proposed Auditing Standard on
ICFR and Related Other Proposals
December 2006
Background
• Auditing Standard No. 2
– Implementation monitored through
• Inspections
• Roundtables (held April 2005 and May 2006)
– Benefits
• New focus on corporate governance
• Improvements in processes and controls
– Costs
• Higher than expected
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PCAOB Proposals
• New auditing standard on internal control
– Supersedes AS No. 2
• New auditing standard on using the work of others
• New independence rule on non-audit services
• Related amendments to interim standards
• Find the Proposals at
http://www.pcaobus.org/Rules/Docket_021/index.aspx
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Proposal Objectives (for Revised AS 2)
• Focus the audit
• Eliminate unnecessary procedures
• Scale the audit for smaller companies
• Simplify requirements
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Focus the Audit
• Direct attention to most important controls
– Using the top-down approach
– Appropriate focus on controls that prevent or detect
fraud
• Emphasize risk assessment
– Sufficiency of evidence depends on risk assessment
– Consider results of substantive procedures in
determination of overall risk related to a control
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Focus the Audit - continued
• Revise definitions of Significant Deficiency and
Material Weakness
– Replace term “more than remote”
– Re-articulation of definition of material weakness
– Replace term “more than inconsequential”
• Revise strong indicators of a material weakness
• Clarify role of materiality
• Clarify role of interim materiality
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Eliminate Unnecessary Procedures
• Remove requirement to evaluate
management’s process
• Permit consideration of knowledge
obtained during previous audits
• Refocus Multi-location testing on risk
• Remove barriers to using work of others
34
Eliminate Unnecessary Procedures
and Other Objectives
• Refocus Walkthrough procedures
– Only for each significant process
– Use of probing inquiries
– Permit direct assistance
• Scaling of audit for smaller companies
• Reduced level of specificity in standard
provides flexibility
35
Other Proposed Standards and Rules
• Considering and Using the Work of Others in
an Audit
• Independence rule relating to the Audit
Committee Pre-Approval Process
• Certain amendments to interim standards
– Dating of Independent Auditor’s Report
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Conclusion
• Proposed changes are intended to…
– Preserve the benefits of the audit of internal control
while obtaining efficiencies
• Easier to read
– Reorganized to follow audit procedures
• Guidance is flexible and scalable
• Small business guidance should be out next
year
– Field testing draft guidance this year
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SEC Conference Report
December 2006
Agenda
• Conference themes
• Conference topics
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Conference Themes
• Use judgment
• Fight complexity
• Promote transparency
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Conference Topics
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Compensation Disclosure & Analysis
Non-GAAP financial information
Management’s Discussion & Analysis
Statement of cash flows
FIN 48
Backdating
Fair value and financial instruments
41
Compensation Disclosure & Analysis
• Effective for years ending on or after
December 15, 2006
• Applies to 2007 proxy season
• Principles-based overview
42
Compensation Disclosure & Analysis
•
Answer six broad questions
1. What are the objectives of the company’s compensation
programs?
2. What is the compensation program designed to reward?
3. What is each element of compensation?
4. Why does the company choose to pay each element
5. How does the company determine the amount (and
where applicable, the formula) for each element?
6. How does each element and the company’s decisions
regarding that element fit into the company’s overall
compensation objectives and affect decisions regarding
other elements?
•
Provide context for compensation policies and
decisions
43
Non-GAAP Income Statements
• Full non-GAAP income statements
• Corp Fin objects
– See Regulation S-K, Item 10(e) and Regulation G
– Refer to non-GAAP FAQ, Q8
http://www.sec.gov/divisions/corpfin/faqs/nongaapfaq.htm
– Generally not accompanied by disclosures
required by regulations
44
MD&A
• Current state, provide more
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Executive summaries
Tables and headers
Explanation and analysis
Critical accounting estimates
Liquidity information
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MD&A
• Liquidity
– Likelihood that historical cash use equals future
use
– Drivers of cash flow to provide understanding of
cash requirements and sources
– Underlying causes of change
• Credit terms changes
• New customers
• New securitizations
– Borrowings as a key component
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Statement of Cash Flows
• Focus of investors and analysts
• Questions on classification from the SEC
staff
• Classification
– Look to Statement 95 for examples
– If material issues, disclose why the classification
was chosen, the classification that was rejected
and support for your conclusion
47
FIN 48
• Interim period disclosures
• Preferability letter not required
• Statement 154, par. 17a disclosures not
required
• AICPA CPCAF Alert 138
http://www.aicpa.org/cpcaf/download/FIN48_CPCAFAlert138.pdf
• AICPA Practice Guide on Accounting for
Uncertain Tax Positions Under FIN 48
http://tax.aicpa.org/Resources/Professional+Standards+and+Ethics/Practice+
Guide+on+Accounting+for+Uncertain+Tax+Positions+Under+FIN+48.htm
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Backdating – Stock Options
• SEC staff letter
http://www.sec.gov/info/accountants/staffletters/fei_aicpa091906.htm
• Conference discussion and forthcoming
guidance
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Fair Value and Financial Instruments
• Fair value
• Hedge accounting
• EITF Issue No. 00-19
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Statement No. 157,
Fair Value Measurements
• Does not require any new fair value
measurement
• Defines fair value – exit not entry price
• Focuses on assumptions market place
participant would use
• Expands disclosure requirements
• Nullifies EITF Issue No. 02-3, “Issues Involved in
Accounting for Derivative Contracts Held for Trading Purposes and Contracts
Involved in Energy Trading and Risk Management Activities,” footnote 3
51
Statement No. 133 and
Hedge Accounting
• Hedge Documentation
– What is sufficient?
– Must it be perfect?
– When is a change in documentation a
redesignation?
52
Shortcut Method
• There is no spirit or principle
• Nine criteria must be met
• Examples of misapplication
– Trust preferred securities
– Cash flow hedges of variable-rate debt that
include a call option permitting the debtor to
repurchase the debt at interest reset date at par
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Other Methods that Assume No
Ineffectiveness
• Critical terms match
• Examples of misapplication
– FV hedge of an interest rate exposure using an interest rate
swap
– Settlement date of the forecasted transaction and the
hedging instrument differ by several days
– Variable rate debt and interest rate swap where interest
payment dates on the debt and swap don’t match
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EITF Issue No. 00-19, “ Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock”
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Instrument subject to EITF 00-19
Embedded features subject to EITF 00-19
Registered unit offerings
AICPA Practice Aid on Complex Financial
Instruments
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