This week’s GAAP Flash includes articles about fraud and how it might have been prevented with proper internal control over financial reporting, making hedge accounting under ASC 815 (FAS 133) a bit easier, non-GAAP financial measures (again), and the need for more guidance regarding classification items within the cash flow statement.

5,300 Wells Fargo Employees Fired Over 2 Million Phony Accounts – (September 9, 2016) CNN Money (@CNNMoney)

Most of us use banks and expect them to safeguard our money. Who would have imagined the shenanigans that were taking place behind the scenes by what appears to be a large number of employees? The details of this scandal are rather shocking! According to the article, a consulting firm hired by Wells Fargo discovered that 1.5 million unauthorized bank and credit card accounts were not only created without the customers consent, but also resulted in customers being charged banking fees. According to the Director of the Consumer Financial Protection Bureau, these practices were done “to hit sales targets and receive bonuses.” Greed is a funny thing!

How It’s Relevant: This situation highlights the importance of having proper internal controls over financial reporting (ICFR) within an entity. In their Internal Control – Integrated Framework, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) broadly defines internal controls as:

“A process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the…categories [of]

1. Effectiveness and efficiency of operations,
2. Reliability of financial reporting, [and]
3. Compliance with applicable laws and regulations.”

Entities should implement internal controls that are sufficient and robust enough to provide reasonable assurance that transactions are executed and assets are accessed and accounted for in accordance with appropriate authorization.

Internal controls over financial reporting (ICFR) continue to be area of focus for the SEC. The SEC has reminded registrants about their responsibilities and indicated that they will continue to focus on their assessment of ICFR. Auditors have been warned too! Their audit of ICFR continues to be a focus area of inspections and, based on the recent inspection results, they continue to see problems in this area during their inspection of audits.

FASB Proposes Targeted Changes to Hedge Accounting Rules (September 8, 2016) – Journal of Accountancy (@AICPA_JofA)

Hedge accounting is hard! Hard to do and even harder to qualify for, as we discussed in this post. Luckily, the FASB has issued an exposure draft with the intention of making hedge accounting a bit easier! The objective of the proposed rules is to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities and to make certain targeted improvements to simplify hedge accounting.

Simplifications include:

• Relaxing the timing of when initial prospective quantitative assessment of hedge effectiveness must be completed,
• Allowing entities to hedge the risk component for non-financial items, and
• Requiring subsequent qualitative effectiveness assessments only if facts and circumstances change.

How It’s Relevant: Since 2005, the FASB has had a long-term objective to improve and simplify the reporting for financial instruments in the following three areas:

1. Classification and measurement,
2. Impairment, and
3. Hedging.

The FASB issued guidance on classification and measurement in January 2016 (ASU 2016-1) and guidance on impairment in June 2016 (ASU 2016-13). New guidance on hedge accounting is the last piece of the puzzle. Visit the FASB website here, for the final ASUs on the first two phases and the proposed ASU on hedge accounting. The comment period on the hedge accounting proposed ASU ends November 4, 2016 so let the FASB know what you think!

Executives Charged with Inflating Performance of Real Estate Investment Trust (September 8, 2016) – SEC (@SEC)

The SEC is holding true to their word about “cracking down” on the growing problem of companies using misleading and improperly disclosed non-GAAP financial measures. In this case, formal charges have been filed related to the intentional misuse of a key non-GAAP measure that investors and analysts used to assess the performance of this REIT. The SEC alleges two former accounting executives manipulated a key non-GAAP financial measure to conceal an overstatement in the reporting of the metric in one quarter and report better performance of the metric in another quarter.

How It’s Relevant: To say that non-GAAP financial measures have received a lot of press lately is an understatement. Companies are using them more and more and the SEC has taken notice! The SEC has warned companies about misusing non-GAAP financial measures to mislead investors and, if they are used, to ensure they are disclosed. If prominently featuring non-GAAP measures in your financial statements, we recommend that you stay abreast of the SEC rules, regulations, and interpretations.

The Cash-Flow Clash (September 7, 2016) - CFO (@CFO)

This article discusses the new guidance released by the FASB regarding the statement of cash flows. The guidance, found within ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, was issued to address diversity in practice in classification of cash flows as operating, investing, or financing within the statement of cash flows. The articles uses ASU 2016-15 to highlight a controversial issue about whether “adding rules rather than creating a system that rests on broad general principles increases GAAP complexity”.

How It’s Relevant: Principles-based or rules based? That is the question! We think it will continue to be a balancing act, as it is tough to say that one approach is the best in all circumstances. With respect to classification of cash flows, having a set of rules seems to be what was needed, as this is an area where the SEC has consistently found errors and seen diversity in practice. The eight areas addressed in ASU 2016-15 should curtail this diversity, resulting in consistent treatment across financial reporting in these areas.

Want more on cash flows? No problem! Check out this post discussing how to prepare a statement of cash flows when an entity has more than one functional currency.