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SEC Staff Updates Guidance on Accounting and Disclosure Issues

The accounting staff members in the SEC's Division of Corporation Finance have updated their outline on accounting and disclosure issues. The outline includes guidance on recent rules, other current accounting and disclosure issues, and provides information about the Division. Among the topics covered is how to account for other than temporary declines in investment value.

The guidance notes that bright line or rule of thumb tests are not appropriate for evaluating other than temporary impairments. That determination must be made by using all of the evidence that is available to the investor, and not just the information related to the registrant, such as its financial condition and near-term prospects. The investor should also consider the severity and duration of the decline in fair value and the investors' intent and ability to hold an investment for a period of time sufficient for a forecasted recovery.

While securities may be segregated by the length of decline in value, the guidance notes that registrants should not infer that securities with declines of less than one year are not other than temporarily impaired, nor should they infer that declines of greater than a year are automatically impaired. An other than temporary decline could occur within a very short period, according to the guidance. Depending on the facts and circumstances, a decline in excess of a year might still be temporary.

The ability to hold an equity security indefinitely would not, by itself, allow an investor to avoid an other than temporary impairment. Market price recoveries that cannot reasonably be expected to occur within an acceptable forecast period should not be included in a management's assessment of recoverability. A recognized or potential other than temporary impairment may require a discussion in MD&A.

The staff noted that in several accounting and auditing enforcement releases, the SEC has taken action where other than temporary declines in value were not reported in a timely and appropriate manner. In these cases, the registrants' assessment of the realizable value of a marketable security should begin with the security's contemporaneous market price, the staff advised, because that price reflects the market's most recent evaluation of the total mix of available information.

The SEC expects registrants to use a systematic methodology that includes documentation of the factors that were considered. The methodology should provide evidence of the factors considered and should ensure that all of the information about declines in market values below cost are identified and evaluated properly. The guidance reminds auditors to closely examine the documentation about their clients' determinations of other than temporary declines in market values.

With respect to operating segments, the staff advises registrants to remember to identify the products and services from which each reportable segment derives its revenues, and to report the total revenues from external customers for each product or service, or groups of products and services. The staff has objected to an overly broad view of what constitutes similar products. Information about geographic areas is also required to be disclosed based on the country of domicile and for foreign countries.

The guidance also discusses a change of accountants and notes that a merger of accounting firms always results in a change in accountants due to the change in the legal entity of the firm that performs the audit. The merger, asset purchase or admission of a new partner from another firm who brings SEC clients to the admitting firm must be reported on Form 8-K within four business days. The staff reminds auditors and registrants to be aware of any independence issues that may arise as the result of a merger.

If neither the old firm nor the new firm is willing or able to reissue opinions on prior audited periods or to provide a consent to the use of a prior opinion, the registrant would have to request a waiver under 1933 Act rule 437C or seek a waiver of the reissuance of a prior opinion where no consent is needed. The staff advised that it generally limits the grant of waivers to hostile takeovers and tender offers.

The staff reminds firms that they must be registered with the PCAOB in order to issue a new opinion or update/dual-date an opinion on an issuer's financial statements after October 22, 2003. A firm does not have to be registered to reissue a report or to issue a consent to the use of a report that was issued before October 22, 2003. An unregistered firm may also issue a report or a consent on the financial statements of a material acquiree that is a private company if the financial statements are filed pursuant to Regulation S-X rule 3-05 or Regulation S-B rule 310(c).

An unregistered firm may be able to perform some audit services if the services represent less than 20% of the total engagement hours or fees provided by the principal accountant with respect to the issuance of all or part of the audit report.