Accounting and Audit briefs
Consider these financial reporting issues before going private
Issuing stock on the public markets isn’t right for every business. Some public companies decide to delist — or “go private” — often due to the high costs of complying with the requirements of the Securities and Exchange Commission (SEC). But going private can be nearly as complex as going public, so it’s important to dot your i’s and cross your t’s.
The SEC scrutinizes going-private transactions to ensure that unaffiliated shareholders are treated fairly. A company that’s going private — together with its controlling shareholders and other affiliates — must, among other requirements, file detailed disclosures pursuant to SEC Rule 13e-3.
The SEC allows a public company to deregister its equity securities when they’re held by fewer than 300 shareholders of record, or fewer than 500 shareholders of record if the company doesn’t have significant assets. Depending on the facts and circumstances, a company may no longer be required to file periodic reports with the SEC once the number of shareholders of record drops below the above thresholds.
To comply with SEC Rule 13e-3 and Schedule 13E-3, companies executing a going-private transaction must disclose:
- The purposes of the transaction, including any alternatives considered and the reasons they were rejected,
- The fairness of the transaction, both substantive (price) and procedural, and
- Any reports, opinions and appraisals “materially related” to the transaction.
The SEC’s rules are intended to protect shareholders, and some states even have takeover statutes to provide shareholders with dissenters’ rights. Such a transition results in a limited trading market to be able to sell the stock.
Failure to act with the utmost fairness and transparency can bring harsh consequences. SEC scrutiny can lead to costly damages awards and penalties if your company is guilty of treating minority shareholders unfairly or making misleading disclosures.
Handle with care
Companies that pursue going-private transactions should exercise extreme caution. To withstand SEC scrutiny and avoid lawsuits, it’s critical to structure these transactions in a manner that ensures transparency, procedural fairness and a fair price.
In addition to helping you comply with the SEC rules, we can evaluate whether going private can help your company reduce its compliance costs or allow it to focus on long-term goals rather than satisfying Wall Street’s demand for short-term profits.
Is it time to adopt the new hedge accounting principles?
Implementing changes in accounting rules can be a real drag. But the new hedge accounting standard may be an exception to this generality. Many companies welcome this update and may even want to adopt it early, because the new rules are more flexible and attempt to make hedging strategies easier to report on financial statements.
Hedging strategies today
Hedging strategies protect earnings from unexpected price jumps in raw materials, changes in interest rates or fluctuations in foreign currencies. How? A business purchases futures, options or swaps and then designates these derivative instruments to a hedged item. Gains and losses from both items are then recognized in the same period, which, in turn, stabilizes earnings.
The existing rules require hedging transactions to be documented at inception and to be “highly effective.” After purchasing hedging instruments, businesses must periodically assess the transactions for their effectiveness.
The existing guidance on hedging is one of the most complex areas of U.S. Generally Accepted Accounting Principles (GAAP). So, companies have historically shied away from applying these rules to avoid errors and restatements.
In turn, investors complain that, when a business opts not to use the hedge accounting rules, it prevents stakeholders from truly understanding how the business operates. The new standard tries to address these potential shortcomings.
Future of hedge accounting
Accounting Standards Update (ASU) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, expands the strategies that are eligible for hedge accounting to include 1) hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities, 2) hedges of the portion of a closed portfolio of prepayable assets not expected to prepay, and 3) partial-term hedges of fixed-rate assets or liabilities.
In addition, the updated standard:
- Allows for hedging of nonfinancial components, such as corrugated material in a cardboard box or rubber in a tire,
- Eliminates an onerous penalty in the “shortcut” method of hedge accounting for interest rate swaps that meet specific criteria,
- Eliminates the concept of recording hedge “ineffectiveness,”
- Adds the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate to a list of acceptable benchmark interest rates for hedges of fixed-interest-rate items, and
- Revises the presentation and disclosure requirements for hedging to be more user-friendly.
ASU 2017-12 also provides practical expedients to make it easier for private businesses to apply the hedge accounting guidance.
The update will be effective for public companies for reporting periods starting after December 15, 2018. Private companies and other organizations will have an extra year to comply with the changes. But many companies are expected to adopt the amended standard for hedge accounting ahead of the effective date.
If you use hedging strategies, contact us to discuss how to report these complex transactions — and whether it makes sense to adopt the updated rules sooner rather than later. While many companies expect to adopt the amendments early, the transition process calls for more work than just picking up a calculator and applying the new guidance.
Using analytical procedures in an audit provides many benefits
Analytical procedures can make audits more efficient and effective. First, they can help during the planning and review stages of the audit. But analytics can have an even bigger impact when used to supplement substantive testing during fieldwork.
Defining audit analytics
AICPA auditing standards define analytical procedures as “evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.” Analytical procedures also investigate “identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.” Examples of analytical tests include trend, ratio and regression analysis.
Using analytical procedures
During fieldwork, auditors can use analytical procedures to obtain evidence, sometimes in combination with other substantive testing procedures, that identifies misstatements in account balances. Analytical procedures are often more efficient than traditional, manual audit testing procedures that typically require the business being audited to produce significant paperwork. Traditional procedures also usually require substantial time to verify account balances and transactions.
Analytical procedures generally follow these five steps:
- Form an independent expectation about an account balance or financial relationship.
- Identify differences between expected and reported amounts.
- Investigate the most probable cause(s) of any discrepancies.
- Evaluate the likelihood of material misstatement.
- Determine the nature and extent of any additional auditing procedures needed.
When using analytical procedures, the auditor must establish a threshold that can be accepted without further investigation. This threshold is a matter of professional judgment, but it’s influenced primarily by the concept of materiality and the desired level of assurance.
For differences that are due to misstatement (rather than a plausible explanation), the auditor must decide whether the misstatement is material (individually or in the aggregate). Material misstatements typically require adjustments to the amount reported and may also necessitate additional audit procedures to determine the scope of the misstatement.
Your role in audit analytics
Done right, analytical procedures can help make your audit less time-consuming, less expensive and more effective at detecting errors and omissions. But it’s important to notify your auditor about any major changes to your operations, accounting methods or market conditions that occurred during the current accounting period.
This insight can help auditors develop more reliable expectations for analytical testing and identify plausible explanations for significant changes from the balance reported in prior periods. Moreover, now that you understand the role analytical procedures play in an audit, you can anticipate audit inquiries, prepare explanations and compile supporting documents before fieldwork starts.
Spotlight on auditor independence and hosting arrangements
With Independence Day coming up, it’s a good time to check up on auditor independence issues. This is especially important in 2018. Why? New rules go into effect this fall that may warrant changes to the services provided by your audit firm. If you discover potential issues now, there’s still plenty of time to take corrective action before next year’s audit begins.
Independence is one of the most important requirements for audit firms. It’s why investors and lenders trust CPAs to provide unbiased opinions about the presentation of a company’s financial results. The AICPA and the Securities and Exchange Commission (SEC) have rules regarding auditor independence. Even the U.S. Department of Labor has issued independence guidance for auditors of employee benefit plans.
The AICPA specifically goes to great lengths to explain how auditing firms can maintain their independence from the companies they audit. In short, auditors can’t provide any services for an audit client that would normally fall to management to complete. Auditors also can’t engage in any relationships with their clients that would compromise their objectivity, require them to audit their own work, or result in self-dealing, a conflict of interest, or advocacy.
Independence is a matter of professional judgment, but it’s something that accountants take seriously. A firm that violates the independence rules calls into question the accuracy and integrity of its client’s financial statement.
Today, some businesses have chosen to host their company’s data with their audit firm. In response, the AICPA’s Professional Ethics Executive Committee announced a change to the profession’s independence rules. As of September 1, 2018, to maintain independence, auditors can’t perform any of the following services for their audit clients:
- Serve as the sole host of a client’s financial or nonfinancial records.
- Function as the primary custodian of a client’s data, meaning that a company must access the data in the CPA’s possession to possess a complete set of records.
- Provide business continuity and disaster recovery support services.
Not all custody or control of a client’s records results in hosting services, however. The new rule narrowly interprets hosting services to mean the audit firm has accepted responsibility for maintaining internal control over data an audit client uses to run the business. Accepting responsibility to perform a management function explicitly compromises auditor independence.
Finding a host with the most
Is your audit firm responsible for managing your company’s data? If so, it may be time for a change. Data migration isn’t necessarily time consuming, but it may take time to find a new hosting company with the right balance of security and services to meet your data storage and access needs. Contact us to evaluate your hosting arrangement and, if necessary, identify an alternate provider to stay in compliance with the AICPA independence rules.