Financial reporting briefs - oil and gas
This edition highlights the latest developments for the oil and gas industry in financial reporting and alerts you to some important considerations for 2014.
Transitioning to the new COSO framework
If your entity is public and uses what is known as the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework to assess internal control over financial reporting, you should start thinking about making the transition to the 2013 Internal Control — Integrated Framework that COSO issued last year.
COSO has said that after 15 December 2014, it will consider its original 1992 framework to have been superseded by the 2013 version. The staff of the Securities and Exchange Commission (SEC or Commission) has indicated that the longer issuers continue to use the 1992 framework after 15 December 2014, the more likely they are to receive questions about whether their use of the 1992 framework satisfies the SEC’s requirement to use a suitable, recognized framework to assess internal control over financial reporting (ICFR).
The amount of effort required to make the transition will depend on an entity’s size, the complexity of its operations and the quality of both its internal controls and its documentation of those controls.
We suggest that oil and gas entities take the following steps:
→ Create a document that maps the entity’s internal controls to each of the new framework’s five components and 17 principles. In some cases, entities may be able to use other documentation to show that their controls address the framework’s components and principles.
→ Evaluate whether there are any gaps or deficiencies in controls based on whether existing controls fully demonstrate that controls are present and functioning for each component and principle.
→ Identify additional controls or enhancements to existing controls, if any, to address the identified gaps.
→ Update internal control documentation and the entity’s internal control assessment and testing plan to help it evaluate whether controls are present and functioning to address the framework’s 17 principles.
We believe entities will benefit from reviewing their controls and documentation at a time when the SEC staff is increasing its focus on ICFR. As part of the assessment, management may benefit from considering what the Public Company Accounting Oversight Board (PCAOB) said late last year in Practice Alert No. 11 about matters such as the evaluation and documentation of both the precision of controls (particularly review controls) and controls that ensure the completeness and accuracy of information in system-generated data or reports used in the execution of controls.
New revenue recognition standard is coming soon
The Financial Accounting Standards Board (FASB or Board) and the International Accounting Standards Board (IASB) (collectively, the Boards) will soon issue a joint revenue recognition standard that is intended to increase comparability across industries and jurisdictions. The Boards plan to appoint members of a joint transition resource group soon after they issue their standards, but an oil and gas industry group at the American Institute of Certified Public Accountants (AICPA) is gearing up to address implementation. Stay tuned.
FASB aims to reduce the number of discontinued operations The FASB is expected to soon issue final guidance that will raise the threshold for qualifying as a discontinued operation and require new disclosures for both discontinued operations and disposals of individually material components that don’t qualify as discontinued operations. The standard also will allow for significant continuing involvement with a discontinued operation and eliminate substantially all of the scope exceptions that currently exist, including the scope exception for unproved oil and gas properties accounted for under the successful efforts method. The scope exception related to the full cost method will remain. The guidance will define a discontinued operation as (1) a component of an entity or group of components that has been disposed of or is classified as held for sale in a single transaction and represents a strategic shift that has or will have a major effect on an entity’s financial results or (2) an acquired business that is classified as held for sale on the date of the acquisition. For public business entities, the guidance will be effective for fiscal years beginning on or after 15 December 2014 and interim periods within those years. For other entities, it will be effective for annual periods ending on or after 15 December 2015 and interim periods thereafter. The guidance is to be applied prospectively, and early adoption will be permitted.
Fewer companies qualify for ‘private’ company relief
The FASB issued a broad new definition of a public business entity (PBE) late last year and began using it in new guidance this year. The final guidance on PBEs makes clear that entities whose financial statements or financial information is included in a registrant’s SEC filing are PBEs for that purpose but can use private company accounting alternatives in their standalone financial statements.
The FASB is using the term PBE prospectively, meaning it does not change whether an entity is considered public or nonpublic for earlier US GAAP requirements. However, the FASB has asked the Private Company Council (PCC) to consider researching whether to change or consolidate the various definitions of public and nonpublic entities used in earlier guidance.
The PBE definition will result in fewer entities qualifying for private company relief than in the past because it includes a number of entities that are not SEC registrants or issuers. The FASB began using the term to consider which entities qualify for accounting alternatives developed by the PCC and for other private company relief (e.g., disclosure, transition, effective date differences) it provides in new standards. As we’ve said before, entities also should carefully consider whether they might become PBEs before electing PCC alternatives because the FASB and the SEC have not provided transition guidance. Absent such guidance, entities that become PBEs would have to retrospectively apply public entity accounting and reporting requirements.
FASB sets path on financial instruments
The FASB tentatively decided to retain the separate models in current US GAAP for classifying and measuring loans and debt securities rather than overhaul its guidance in this area, as it had proposed in 2013. In a change from today’s accounting, however, equity securities would be measured at fair value with changes in fair value recognized in net income. The FASB also confirmed that its proposed “current expected credit loss” (CECL) model would be applied to financial assets that are debt instruments measured at amortized cost (i.e., loans and debt securities). Impairments on financial assets measured at fair value through other comprehensive income would follow a slightly different approach. The FASB had proposed applying the CECL model to all debt instruments.
The decisions capped several months of redeliberations in which the FASB has moved away from an effort to converge parts of financial instrument accounting between US GAAP and IFRS. The IASB is moving ahead with its proposals and expects to issue final guidance in the coming months. The FASB expects to issue final guidance in the second half of 2014. Separately, FASB Chairman Russell Golden decided, in consultation with the other Board members, that the FASB staff will perform research on the hedging phase of the project. The IASB issued its final guidance on hedging late last year.
FASB narrows scope of insurance contracts project
The FASB decided that any new guidance will apply only to the insurance industry and not to contracts issued by noninsurance entities such as certain environmental indemnities and certain warranties and guarantees in oil and gas contracts, as the FASB had originally proposed. However, the Board said it may reconsider at a later date whether noninsurance entities should apply the guidance to certain contracts.
Boards back away from some key aspects of leases proposal
In redeliberations, the FASB and the IASB backed away from the lessee accounting model they proposed in May 2013. But the IASB supported a single on-balance sheet model, while the FASB supported a dual on-balance sheet model that would use IAS 17’s classification principles, which are similar to current US GAAP but without bright lines. Despite this fundamental difference, the Boards reiterated their commitment to seek a converged solution. The Boards also indicated that they do not intend to significantly change lessor accounting. Instead, they supported retaining a dual classification model. The Boards also reached certain tentative decisions on lease term, a short-term lease exception and other ways to simplify their 2013 proposal. Oil and gas entities should monitor redeliberations on the accounting model and the definition of a lease, which could affect whether drilling or storage contracts, rights of way or other arrangements are considered leases.
The Boards remain committed to putting leases on the balance sheet of lessees, but are looking for ways to simplify the accounting in response to feedback that their 2013 proposal would have been too complex and costly to apply. We expect redeliberations to continue through much of 2014.
Private companies can choose simpler accounting under US GAAP
The FASB issued three standards developed by the PCC that allow certain private companies to simplify their accounting under US GAAP. Eligible private companies can now elect to amortize goodwill acquired in a business combination and qualify more easily for hedge accounting for certain interest rate swaps. Eligible private companies also can choose to be exempt from evaluating lessors in certain common control leasing arrangements for consolidation under the variable interest entity guidance.
The PCC is still working on a proposal to simplify the accounting for intangible assets acquired in a business combination by requiring fewer of them to be recognized separately from goodwill. At a recent meeting, the PCC dropped consideration of a second approach to make it easier for private companies to qualify for hedge accounting for certain interest rate swaps.
FASB proposes a framework for considering disclosure requirements
The FASB proposed adding a chapter to its conceptual framework that would discuss information that should be included in the notes to the financial statements and list a series of questions the FASB would use to evaluate disclosure requirements. The new chapter also would discuss considerations for the Board to use in evaluating interim disclosures. Comments are due by 14 July 2014. In a second phase of the project, the Board will provide guidance to entities on how to decide which disclosures they need to provide. As part of this phase, the FASB staff conducted a field study of entities’ decisions about which disclosures to provide. The FASB plans to use these results and feedback it received on a 2012 Invitation to Comment on the topic to develop a proposed Accounting Standards Update (ASU).
FASB discusses simplifying goodwill accounting for everyone
The FASB began discussing whether to simplify the subsequent measurement of goodwill for PBEs and not-for-profit entities in a project that grew out of the goodwill accounting alternative the FASB issued for certain private companies.
The FASB directed its staff to research two possible approaches for PBEs: a simplified one-step impairment test and a direct write-off. For the first, the staff is focusing on the level at which the test would be performed (e.g., reporting unit, operating segment, entity level). For the second, the staff is focusing on where the write-off would be recorded (e.g., income statement, other comprehensive income, equity) and what disclosures would be required. Before discussing this project again, the FASB will consider its research on accounting for identifiable intangible assets in a business combination and the IASB’s post-implementation review of its business combinations standard.
Action on EITF issues
The FASB issued final guidance on a consensus developed by its Emerging Issues Task Force (EITF) on Accounting for Service Concession Arrangements (Issue 12-H), among other matters. Operating entities should not account for certain service concession arrangements with public-sector entities as leases and should not recognize the related infrastructure as property, plant and equipment.
The EITF reached a final consensus that a performance target that affects the vesting of a share-based award and can be achieved after the requisite service period is a performance condition (Issue 13-D). The EITF also reached a consensus-for-exposure that all reporting entities would have the option to apply pushdown accounting (i.e., a new basis of accounting) in their standalone financial statements if an acquirer obtains control of them (Issue 12-F). Both decisions are subject to ratification by the FASB.
In other matters, the EITF reaffirmed its conclusion that all stated and implied substantive terms and features of a hybrid financial instrument issued in the form of shares should be considered when determining whether the host contract is more akin to equity or debt (Issue 13-G). However, the EITF decided to discuss at a future meeting whether guidelines should be developed to help companies evaluate the terms and features of such an instrument.
Reminder about setting effective tax rates
With companies once again setting their annual effective tax rates, we’d like to remind you of some basic principles. The tax provision for the year is the same whether a company prepares only annual financial statements or interim and annual statements. The tax expense for ordinary income in an interim period is measured using an estimated annual effective tax rate. At the end of each interim period, a company must make its best estimate of the annual effective rate for the full year and apply that rate to year-to-date ordinary income.
The calculation can be affected by:
→ Operations in multiple jurisdictions
→ Expectations about whether current-year losses are realizable
→ The tax benefit of an operating loss carryforward from a prior year that is realized because of current-year ordinary income
→ Tax law changes enacted in the period that affect taxes payable or refundable for the current year
Effective tax rates and deferred tax balances for the first quarter of 2014 may be affected by the expiration on 31 December 2013 of provisions known as tax extenders. The extenders include the research and development tax credit, the active financing exception for financial services businesses, the CFC look-through exception for Subpart F, the New Markets Tax Credit, a host of renewable energy incentives and bonus depreciation. Congress may reinstate the provisions, as it has in the past, but companies need to exclude the benefits of the expired provisions from their estimated annual effective tax rates, regardless of whether they expect the provisions to be reinstated. If the extenders are reinstated (even if reinstatement is retroactive), companies would have to wait until the enactment date of any legislation before factoring the effects of a reinstatement into their annual effective tax rate calculations. Oil and gas companies should monitor the situation so they can recognize any reinstatement in the appropriate interim and annual periods.
FASB reorganizes its agenda
The FASB reorganized its agenda, adding a disclosure-only project on accounting for government assistance and dropping several other projects, including earnings per share and a short-term convergence project on income taxes. The Board also removed a number of projects from the EITF’s agenda, including a project on emissions trading schemes.
The FASB’s Mr. Golden decided, in consultation with the other Board members, that the staff will perform research on several projects, including accounting issues in employee benefit plan financial statements, cash balance pension plans, financial statement presentation, the simplifications initiative and, as we said above, hedging. Mr. Golden said these decisions will allow the FASB to direct its resources to financial reporting issues that its stakeholders believe are most important.
The FASB also is working on a variety of topics, including consolidation, requiring management to assess going concern uncertainties and development stage entities.
EU moves forward with mandatory audit firm rotation
Entities with operations in the European Union (EU) could be affected by an EU plan to require the rotation of auditors every 10 to 24 years and to prohibit audit firms from providing certain non-audit services, including tax and advisory services. The rules would apply to entities with debt or equity securities that are traded on a regulated market in the EU and to financial institutions, even if their corporate parents aren’t based in the EU. The goal is to improve competition and audit quality.
Members of the European Parliament agreed on the plan in December 2013, but it still requires approval by the full Parliament in a vote scheduled for early April 2014. If the legislation is adopted, the requirements would likely be phased in beginning in 2016. Under the plan approved in December, entities would be required to change auditors every decade, but extensions could be available for those that seek bids on their external audits or hire a second auditor to perform a joint audit. The plan would also cap fees audit firms can earn from providing non-audit services. In comment letters to various regulators on proposals to require audit firm rotation, we have consistently said we believe there are a number of reasons why mandatory audit firm rotation does not enhance auditor independence or improve audit quality.
First conflict minerals reports due soon
Entities will have to make their first disclosures under the SEC’s conflict minerals rule by 2 June 2014, unless a federal appeals court hearing a challenge to the rule filed by business groups decides otherwise. The disclosures will cover calendar year 2013.
The rule requires roughly 6,000 registrants to disclose the use of certain “conflict minerals” in their products and whether any of those minerals originated in the Democratic Republic of the Congo (DRC) and surrounding countries and financed or benefited armed groups. Companies that determine that their products contain conflict minerals sourced from those countries must obtain an independent private sector audit of their conflict minerals reports. This year, however, companies may file unaudited reports if they only have products that are “DRC conflict undeterminable.”
The AICPA recently issued a series of questions and answers to clarify that the audit is intended to provide assurance on whether (1) the design of the due diligence framework described in the conflict minerals report materially conforms with the criteria in a recognized framework and (2) the entity performed the due diligence measures described in its report.
SEC staff revises guidance to reduce disclosure volume
As part of an effort to help entities reduce disclosures, the SEC staff in the Division of Corporation Finance updated its Financial Reporting Manual (FRM) to say that an entity that conducts an initial public offering (IPO) should scale back its disclosures in management’s discussion and analysis (MD&A) relating to events and developments that affected the estimates it used to value shares underlying stock-based compensation awards granted before the IPO. The revised guidance on what is often called cheap stock also states that, while the SEC staff will continue to issue comments to help it understand unusual valuations, the staff will not expect expanded disclosure in MD&A related to these events and business developments.
SEC staff recommends comprehensive review of disclosure requirements
The change in the FRM followed the SEC staff’s recommendation that the Commission launch a comprehensive review of its disclosure requirements for all entities. The staff made the recommendation in a study of Regulation S-K disclosure requirements for emerging growth companies that was required by the Jumpstart Our Business Startups Act (JOBS Act). We agree that a comprehensive reconsideration of the current reporting regime is needed to make disclosures less costly for preparers and more relevant for investors, but we believe the SEC should simultaneously use a targeted approach to eliminate or substantially streamline certain disclosures.
Comments are in on SEC’s Regulation A+ proposal
Comments are in on an SEC proposal to amend Regulation A to allow private entities to make public offerings of up to USD 50 million in a 12-month period without registering with the SEC, as required by the JOBS Act. The proposal would create a new second tier of Regulation A offerings (known as Regulation A+) that would require more robust initial and ongoing reporting than current Regulation A offerings but would provide relief from state law registration and qualification requirements. Many of the existing requirements, including the USD 5 million cap on offerings in a 12-month period and state law registration requirements, would continue to apply to what would be called Tier 1 offerings. In our comment letter, we said the SEC should consider additional opportunities to leverage disclosure requirements in existing SEC rules and regulations for registered offerings and scale those disclosure requirements for purposes of unregistered offerings conducted under Regulation A. We also encouraged the SEC to clarify some of the terminology and disclosure requirements in the proposal that would be difficult or confusing for potential issuers to interpret and apply.
Comments are also in on SEC crowdfunding proposal
Comments are also in on the SEC’s proposal to allow entities to raise up to USD 1 million in a 12-month period by selling shares to investors over the internet, as required by the JOBS Act. In our comment letter, we recommended that the SEC reconsider the financial reporting requirements it proposed for issuers that use the new crowdfunding exemption. We said the proposal would impose disproportionate compliance costs on crowdfunding issuers and could make other existing and proposed exemptions or financing alternatives such as venture capital or private equity investment more attractive than crowdfunding.
In our letter, we recommended that the SEC require crowdfunding issuers offering more than USD 100,000 in securities to provide only one year of financial statements prepared in accordance with US GAAP rather than two, as proposed, and that it extend the deadline for crowdfunding issuers to file annual financial statements, among other things. To minimize offering and compliance costs, we also recommended that audits be required only for issuers that have issued an aggregate of USD 5 million in equity securities in crowdfunding transactions or will exceed that amount with a proposed offering. The SEC has proposed requiring audits for offerings of more than USD 500,000.
Cybersecurity in the spotlight
The SEC hosted a roundtable to discuss how market participants and public companies are addressing and disclosing cybersecurity threats and incidents after recent breaches. In 2011, the staff of the SEC’s Division of Corporation Finance issued guidance that addressed when entities might need to disclose cybersecurity risks and incidents. More recently, several entities have received shareholder proposals seeking more information about their boards’ oversight of privacy and data security risks, and we expect that trend to continue.
Public oil and gas entities should consider which cybersecurity risks are material when updating their risk factor disclosures. Some oil and gas entities may face additional cybersecurity risks related to the highly automated systems they use to operate critical infrastructure.
Preparing for proxy season
While there are no new requirements for proxy statements this year, many entities listed on the New York Stock Exchange and NASDAQ will have to comply by their annual meetings with new exchange rules on compensation committee independence. (The rules are effective at the earlier of 31 October 2014 or the first annual meeting after 15 January 2014.) We also expect more entities to disclose more information about their audit committees’ oversight of the independent auditors this proxy season. During the 2013 proxy season, the majority of Fortune 100 companies whose proxy statements we reviewed disclosed more information than was required, and many companies provided more disclosures on this topic than they did in 2012. As a reminder, the SEC is still reviewing comments on its proposal that would require a registrant to disclose the ratio of its principal executive officer’s total annual compensation to the median annual compensation of all other employees, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Chinese affiliates of Big Four appeal decision in SEC case
The Chinese affiliates of the Big Four accounting firms have asked the SEC to review an administrative law judge’s decision that they violated the Sarbanes-Oxley Act by refusing to turn over audit workpapers in connection with SEC investigations of their clients. The firms, including Ernst & Young Hua Ming LLP, say Chinese law bars them from complying with the SEC’s requests. In their petition, the firms said the judge’s decision contained “erroneous conclusions of law and findings of fact.” In a ruling in January, the judge suspended the firms from practicing before the SEC for six months. The suspension is stayed, pending the appeal.
New chief accountant of SEC Enforcement Division
Michael Maloney was named chief accountant of the SEC’s Division of Enforcement. Before joining the SEC staff, Mr. Maloney served as a managing director at Navigant Consulting, Inc., where he oversaw the firm’s forensic accounting practice. Mr. Maloney succeeds Howard Scheck, who left the SEC in 2013.
PCAOB to get more feedback on proposal to change the auditor’s report
The PCAOB will hold a roundtable discussion in early April 2014 on its proposal to require more information in the auditor’s report than the traditional pass-fail opinion. We and other firms also are working with several companies we audit to field test the proposal and to provide input to the PCAOB based on the results of that testing. Given the significance of this proposal, we encourage oil and gas entities to monitor the project and consider providing input to the PCAOB. In our comment letter, we expressed support for efforts to make the auditor’s report more useful but expressed concerns, including that aspects of the proposal could require auditors to disclose original information about an entity and could be interpreted as providing a piecemeal opinion on certain information.
PCAOB gets comments on proposal to identify engagement partners
Comments are in on a PCAOB proposal to require auditors to identify the engagement partner and certain other audit participants in the auditor’s report. In our comment letter, we supported identifying non-signing firms that have a significant role in an audit, but we did not support the proposed requirement to identify the engagement partner because we believe it would not provide meaningful information to investors. The proposal indicates that both the engagement partner and the non-signing firms would need to consent to the inclusion of their names in an auditor’s report filed with or incorporated by reference in a registration statement. As a result, we said that including this information in the auditor’s report would create operational challenges that would significantly increase the cost, complexity and amount of time required for an entity to access the capital markets.
On the agenda at the PCAOB
The PCAOB updated its standard-setting agenda to reflect its intent to adopt a final audit standard on related parties and to issue proposals related to the organization of its auditing standards and the auditor’s responsibilities with respect to others who assist in the performance of an audit (e.g., component audit teams, specialists) in the first half of 2014. The PCAOB also is expected to issue a concept release soon on audit quality indicators. Other active projects include going concern, quality control standards, auditing accounting estimates, confirmation, subsequent events and auditor independence, objectivity and professional skepticism.
New requirements for using the work of internal auditors
If your external auditor wants your internal auditors to provide direct assistance in the audit, your entity will be asked to provide a written agreement stating that your internal auditors will be allowed to follow the external auditor’s instructions and the entity won’t intervene in the work they perform for the external auditor. The agreement is required by a new standard issued recently by the AICPA’s Auditing Standards Board for audits of financial statements for periods ending on or after 15 December 2014. The standard also requires external auditors that want to use internal auditors’ work as audit evidence to evaluate whether the internal audit function applies a systematic and disciplined approach, including quality control, in addition to determining that the internal auditors are competent and objective.