This week’s GAAP Flash is all about the Securities and Exchange Commission (SEC). It includes articles on improperly accounting for accruals and impairments under ASC 450, indefinitely reinvested foreign earnings under ASC 740, use of management judgment in applying ASC 606, and other accounting news provided to help increase business acumen of CPAs.

SEC Settles Pair of Accounting Fraud Cases (April 19, 2016) – Accounting Today (@AccountingToday)

The SEC announced penalties in two financial fraud cases against companies and their former executives. In one case, Logitech International agreed to pay a $7.5 million penalty for fraudulently inflating its fiscal year 2011 results to meet earnings guidance and committing other accounting-related violations during a five-year period. In the other, three former executives of Ener1 agreed to pay penalties for the company’s materially overstated revenues and assets for the year-end 2010 and overstated assets in the first quarter of 2011.

How It’s Relevant: Both Logitech and Ener1 were improperly accounting for accruals under ASC 450. In the case of Logitech, they deliberately minimized the write-downs of millions of dollars of excess component parts for a product of which the company had excess inventory. In addition, Logitech failed to properly amortize intangible assets acquired in an acquisition in accordance with ASC 350. Ener1 failed to impair investments and receivables related to one of their largest customers. “We are intensely focused on whether companies and their officers evaluate judgmental accounting issues in good faith and based on GAAP,” said Andrew Ceresney, director of the SEC’s Division of Enforcement.

It should also be noted that the engagement partner on the Ener1 engagement was suspended from appearing and practicing before the SEC as an accountant. Auditors should include corroborating evidence in the audit documentation that supports the judgments made by management. “Auditors play a critical role regarding the accuracy of financial statements relied upon by investors, and they must be held accountable when they fail to do everything required under professional auditing standards,” said Michael Maloney, chief accountant of the SEC’s Division of Enforcement.

Cabela’s, CFO, Settle SEC Accounting Charges (April 26, 2016) – WSJ CFO Journal (@CFOJournal)

In another case of improperly applying U.S. GAAP, outdoor recreation retailer Cabela’s Inc. agreed to pay a $1 million civil penalty to settle SEC allegations that the company and its CFO misled investors. The SEC alleged that in 2012, the company failed to eliminate an intercompany promotions fee with a wholly owned banking subsidiary, which had the effect of increasing the company’s gross margins. In addition, Cabela’s also under-accrued loan loss reserves at its banking subsidiary.

How It’s Relevant: There is really no excuse for not eliminating intercompany transactions, which is fairly straightforward and something that is taught in your first accounting class in college. However, we’ll give Cabela’s the benefit of the doubt with respect to accruing loan loss reserves in accordance with ASC 450 (loans collectively assessed for impairment) or ASC 310 (loans individually assessed for impairment), as this is tricky stuff requiring tons of judgment (there’s that word again!).

We should also point out that the SEC said that Cabela’s understated its state income tax expense by $674,000, but, rather than fixing the error, they added an additional $5 million to what it deemed to be indefinitely reinvested foreign earnings (the so-called “APB 23 exception” to deferred tax recognition). This resulted in lowering its tax expense by, you guessed it, $674,000.

SEC Asking Fewer Questions about Foreign Earnings (April 27, 2016) – WSJ CFO Journal (@CFOJournal)

The SEC is becoming less aggressive in asking companies to justify their disclosures about indefinitely reinvested foreign earnings (sorry Cabela’s). This is based on research of SEC comment letters by Audit Analytics. Last year, comment letters related to this topic fell by 26% to 75 from 95 in 2014. The 2015 figure is only about a third of the peak in 2011, when the SEC sent out 266 comment letters.

How It’s Relevant: Credit Suisse estimated that in 2015, S&P companies had nearly $2.3 trillion stashed away in overseas subsidiaries. Normally, these foreign earnings create a taxable temporary difference as it is assumed the earnings will be repatriated and taxed, eventually, in the U.S. However, if companies can prove that these earnings are “indefinitely reinvested,” then they do not have to record any U.S. tax expense on these earnings BUT this assertion must be supported by evidence. We further discuss the APB 23 exception (ASC Section 740-30-25) related to indefinitely reinvested foreign earnings in this post.

Revenue Judgments Must Be Well-Reasoned, SEC’s Bricker Says (May 5, 2016) – Journal of Accountancy (@AICPA_JofA)

SEC Deputy Chief Accountant, Wesley Bricker, said the SEC staff would carefully scrutinize judgments made by management as they implement the new revenue recognition standards. ASC 606 and IFRS 15 are principles-based standards that require companies to make a significant amount of judgment. Mr. Bricker stated that the SEC would respect well-reasoned, practical judgments that are grounded in the standard’s principles and consider the usefulness of information to investors. “Conversely, aggressive interpretations that appear to be taken to achieve a specific outcome, such as preserving existing reporting, will not be well-received,” Mr. Bricker said in prepared remarks at the 2016 Baruch College Financial Reporting Conference in New York.

How It’s Relevant: Implementing the new revenue recognition standards (ASC 606 or IFRS 15) will require significant effort for companies in a variety of industries. Given the effective date of 2018 and the fact that public companies need to provide comparative financial information, companies need to be starting now! We also recommend that companies follow the progress of the Transition Resource Group (TRG) during implementation, as we discuss in this post. For more information of the new revenue recognition standard (ASC 606), check out our series of blog posts beginning with this post related to Step 1 of the new revenue model. We’ve also developed a revenue recognition workshop that is tailored for various industries to help companies implement ASC 606.

Companies Wind Up in the ‘Penalty Box’ on Executive Pay (April 20, 2016) – The Wall Street Journal (@wsj)

It’s annual meeting season, a time when disgruntled shareholders can express their anger over the outlandish compensation received by corporate officers. Although say-on-pay votes are nonbinding, corporate boards fear a thumbs down vote as they feel it may suggest a deeper investor discontent. The article lists several companies that have received a number of “thumbs down” votes on their executive compensation packages. Some have made significant changes in their executives’ pay packages. Others, more or less, told shareholders to “take a hike.”

How It’s Relevant: Part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the “say-on-pay” rule, was adopted by the SEC in 2011. These rules specify that say-on-pay votes must occur once every three years. Companies are also required to hold a “frequency” vote at least once every six years in order to allow shareholders to decide how often they would like to be presented with the say-on-pay vote. Following the frequency vote, a company must disclose on Form 8-K how often it will hold the say-on-pay vote.

In my humble opinion, this rule, along with other rules like disclosing the CEO pay-ratio, is evidence of social activism that has made its way into accounting and reporting. Has the say-on-pay rule helped reduce exorbitant executive pay? Hardly! Since its inception, studies have shown that executive pay packages have a 97% approval rating from shareholders and executive pay has actually risen during that time. I didn’t become a CPA to be a social activist! These needless rules do not “fix” the causes they purport to champion, but instead just make doing business in America more expensive. That’s just my two cents…