SEC Modernizes MD&A and Related Financial Disclosure Requirements
Introduction
On November 19, 2020, the SEC issued a final
rule1 that modernizes and simplifies Management’s Discussion and Analysis
(MD&A) and certain financial disclosure requirements in SEC Regulation S-K.
Specifically, the final rule:
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Eliminates Regulation S-K, Item 301, “Selected Financial Data.”
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Simplifies Regulation S-K, Item 302, “Supplementary Financial Information.”
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Amends certain aspects of Regulation S-K, Item 303, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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Makes conforming changes to the forms used by foreign private issuers.
As noted in the final rule, the amendments are “intended to eliminate duplicative
disclosures and enhance MD&A disclosures for the benefit of investors, while
simplifying compliance efforts for registrants.” The amendments also “promote
the principles-based nature” of MD&A disclosures and give registrants the
flexibility to present a discussion of management’s perspective on the
registrants’ financial condition and results of operations.
The final rule stems from the SEC’s comprehensive review of the
disclosure requirements in Regulation S-K (the disclosure effectiveness initiative2), which began in 2013, and reflects public comment on the SEC’s January
2020 proposed rule.3 It also demonstrates the SEC’s continued focus on improving disclosure
effectiveness and modernizing the disclosure requirements in Regulation S-K. For
example, the SEC also recently modernized the disclosure requirements in
Regulation S-K, Item 101, “Description of Business”; Item 103, “Legal
Proceedings”; and Item 105, “Risk Factors” (see Deloitte’s September 3, 2020,
Heads Up
for further information).
Key Amendments to Regulation S-K
The following table summarizes the key amendments to Regulation S-K and compares
the disclosure requirements before and after the final rule’s amendments:
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Before the Amendments
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Final Rule
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Selected Financial Data
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Item 301 requires certain registrants to disclose
specific items in comparative tabular form for each of
their last five fiscal years as well as for any
additional fiscal years necessary to keep the
information from being misleading.
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Registrants are no longer required to provide
selected financial data; however, they are encouraged to
consider whether they may need to present trend
information within MD&A for periods earlier than
those periods presented in the financial statements.
|
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Selected Quarterly Financial Data
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Disclosure of Material Quarterly Changes
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Item 302(a) requires certain registrants to disclose (1)
select financial information for each quarter during the
two most recent fiscal years, (2) variances in results
from amounts previously presented on Form 10-Q, and (3)
the effect of any discontinued operations and any
unusual or infrequently occurring items as well as the
aggregate effect and nature of year-end or other
adjustments that are material to the results of that
quarter.
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Registrants generally are not required
to disclose select financial information for each
quarter during the two most recent fiscal years.
However, if a registrant reports a material retrospective change (or changes) for any
of the quarters within the two most recent fiscal
years, Item 302(a) requires the registrant to
disclose (1) an explanation for the material change(s)
and (2) select financial information reflecting such
change(s) for the affected quarterly periods, including
the fourth quarter. Material retrospective changes may
include, for example, a change in accounting principle
in accordance with ASC 2504 or a disposition of a business that is accounted
for as a discontinued operation in accordance with ASC
205-20.
While a first-time registrant undergoing
an IPO is not required to provide these disclosures, it
will need to do so “beginning with the first filing on
Form 10-K” after its initial registration statement.
In addition, a registrant must continue to consider the
guidance in ASC 270-10-50-2, which requires disclosure
of (1) the disposal of the components of an entity and
(2) unusual or infrequent items occurring during the
fourth quarter.
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Objective of MD&A
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Item 303 does not contain a succinct
objective for MD&A but instead provides
various instructions that explain its purpose.
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The final rule renames current Item 303(a) as Item 303(b)
and establishes a new Item 303(a), which concisely
states the purpose of MD&A. Further, the new content
(1) incorporates parts of current instructions and (2)
codifies the requirement in the SEC’s 2003 and 1989 interpretive releases5 that a registrant must provide a discussion and
analysis that allows an investor to see the company
“from management’s perspective.” Such disclosure must,
on the basis of “management’s assessment,” address
matters that are reasonably likely to have a material
impact on future operations.
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Liquidity and Capital Resources
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Item 303(a)(1) requires a registrant to disclose the
sources of liquidity and any “trends, demands,
commitments, events, or uncertainties” that are known
and will, or are reasonably likely to, result in a
material increase or decrease in the registrant’s
liquidity. Under Item 303(a)(2), a registrant must also
discuss (1) “its material commitments for capital
expenditures as of the end of the latest fiscal
period” (emphasis added) and (2) “the general purpose of
such commitments and the anticipated sources of funds
needed to fulfill [them].”
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The final rule creates a new Item 303(b)(1) that provides
overarching requirements related to liquidity and
capital resources. It codifies the guidance in the SEC’s
1989 interpretive release, which specifies that
short-term liquidity and capital resources should
address cash needs for known contractual or other
obligations for up to 12 months, while long-term
liquidity and capital resources should address cash
needs beyond 12 months.
The final rule also codifies the guidance in the SEC’s
2003 interpretive release, under which registrants must
disclose (1) material cash requirements as of the
end of the latest fiscal period, (2) the anticipated
source of funds needed to satisfy those cash
requirements, and (3) the general purpose of such
requirements.
Material cash requirements are intended to encompass
capital expenditures as well as expenditures for human
capital, intellectual property, contractual obligations,
off-balance-sheet arrangements, and other such
requirements. See Instruction 8 to Item 303(b).
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Results of Operations — Known Trends or
Uncertainties
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Item 303(a)(3)(ii) requires a registrant
to disclose (1) any known trends or uncertainties
that have had or that the registrant reasonably expects will have a material impact
on revenues or income and (2) any known events
that “will cause a material change in the
relationship between costs and revenues (such as known future increases in
costs. . .)” (emphasis added).
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Item 303(b)(2)(ii) requires a registrant
to disclose (1) any known trends or uncertainties
that have had or are reasonably likely to have a
material impact on revenues or income and (2) any
known events that are “reasonably likely to cause a material change in
the relationship between costs and revenues (such as known or reasonably likely
future increases in costs. . .)” (emphasis added).
Under the “reasonably likely” requirement, the registrant
would have to disclose a known trend or uncertainty if
it (1) is reasonably likely to occur and (2) would be
material to the registrant if it did occur (e.g., the
two-step test described in the SEC’s 1989 interpretive
release).
|
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Results of Operations — Net Sales and
Revenues
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Item 303(a)(3)(iii) requires a registrant to discuss
certain factors (e.g., changes in prices or volume) that
led to material increases in net sales or
revenues in the financial statements. In addition,
Instruction 4 to Item 303(a) requires discussion of the
causes of material changes from year to year in one or
more line items in the consolidated financial
statements.
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Item 303(b)(2)(iii) requires a registrant to discuss
certain factors (e.g., changes in prices or volume) that
led to material changes from period to period in
net sales or revenues in the statement of comprehensive
income.
The amendments (1) codify the guidance in the SEC’s 2003
and 1989 interpretive releases and (2) require
registrants to discuss the underlying reasons for
material changes in quantitative and qualitative
terms in situations in which one or more line
items in the financial statements reflect material
changes from period to period (including those in which
material changes within a line item offset one
another).
|
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Results of Operations — Inflation and
Price Changes
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Item 303(a)(3)(iv) requires a registrant to discuss the
impact of inflation and changing prices on (1) net sales
and revenues and (2) income from continuing
operations.
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In accordance with Item 303(b)(2)(ii), a registrant is
no longer required to discuss the impact of
inflation and changing prices; however, under the
principles-based disclosure framework, it must still
disclose the impact of inflation and price changes if
such conditions are part of a known trend or uncertainty
that has had, or is reasonably likely to have, a
material impact on revenues or income.
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Off-Balance-Sheet Arrangements
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Under Item 303(a)(4), a registrant must disclose its
off-balance-sheet arrangements in a separately captioned
section.
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Under Item 303(b)(1), a registrant is no longer
required to disclose its off-balance-sheet
arrangements in a separately captioned section; however,
in accordance with Instruction 8 to Item 303(b), a
registrant must disclose material off-balance-sheet
arrangements as part of the Liquidity and Capital
Resources discussion.
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Contractual Obligations Table
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Under Item 303(a)(5), certain registrants must disclose,
in a tabular format, the aggregate amount of their
contractual obligations by prescribed categories and
periods.
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Under Item 303(b)(1), a registrant is no longer
required to disclose the aggregate amount of its
contractual obligations in a tabular format; however, as
outlined above,
Item 303(b) specifies that the registrant must provide
an analysis of “material cash requirements from known
contractual and other obligations.” See also Instruction
4 to Item 303(b).
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Interim Periods
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Item 303(b) requires a registrant to discuss any material
changes in its results of operations presented in its
statement of comprehensive income for (1) the most
recent fiscal year-to-date period presented and (2) the
corresponding year-to-date period of the preceding
fiscal year.
The discussion must also cover material changes with
respect to (1) the most recently completed fiscal
quarter and (2) the corresponding fiscal quarter of the
prior fiscal year.
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Under Item 303(c), a registrant is still required to
discuss any material changes in its results of
operations presented in its statement of comprehensive
income for (1) the most recent year-to-date period
presented and (2) the corresponding year-to-date period
of the preceding fiscal year.
However, the amendments give registrants the flexibility
to disclose their results of operations of the most
recently completed fiscal quarter compared to either (1)
the corresponding fiscal quarter of the prior year (as
currently required) or (2) the immediately preceding
fiscal quarter.
A registrant that opts to compare the most recently
completed fiscal quarter to the immediately preceding
fiscal quarter should either (1) disclose summarized
financial information for the preceding fiscal quarter
or (2) identify the EDGAR filing that presents such
information so that it is readily accessible to a
reader.
Further, a registrant that changes the period used in its
comparison is required to explain the reason for the
change and present both comparisons in the filing in
which the change is announced.
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Critical Accounting Estimates
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The SEC’s 2003 interpretative release outlines the
circumstances in which registrants must disclose
critical accounting estimates (CAEs) or assumptions.
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The amendments codify the SEC’s 2003 interpretive release
to explicitly require disclosure of CAEs in MD&A.
Further, Item 303(b)(3) defines CAEs as “estimates made
in accordance with generally accepted accounting
principles that involve a significant level of
estimation uncertainty and have had or are reasonably
likely to have a material impact on the financial
condition or results of operations of the
registrant.”
For each CAE, the amendments require a registrant to
discuss, to the extent material and reasonably
available, (1) why the CAE is subject to uncertainty,
(2) how much the CAE or assumption (or both) has changed
during the relevant period, and (3) the sensitivity of
reported amounts to the methods, assumptions, and
estimates underlying the CAE’s calculation. Further,
Instruction 3 to Item 303(b) states that disclosure of
CAEs should “supplement, but not duplicate, the
description of accounting policies or other disclosures
in the notes to the financial statements.”
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Other Considerations
Other considerations related to the final rule include the following:
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Foreign private issuers (FPIs) — The final rule amends the instructions to Forms 20-F and 40-F to substantially align the financial disclosure requirements for FPIs with the changes discussed above, as applicable.
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Smaller reporting companies (SRCs) — Several of the eliminated requirements discussed above (e.g., those related to selected financial data) currently do not apply to SRCs. Therefore, after adoption of the final rule, the requirements for SRCs are largely aligned with those for other registrants. However, SRCs continue to be exempt from the amended requirements in Item 302.
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Oil and gas producing activities — The SEC proposed to eliminate Item 302(b), which addresses disclosures about oil and gas producing activities. The proposed elimination was subject to the FASB’s issuance of related amendments6 to U.S. GAAP that would have required disclosures that are substantially consistent with those required by Item 302(b). The FASB has not finalized the amendments, so Item 302(b) has been retained. The SEC may reconsider the proposal in the future.
Effective Date and Transition
The final rule is effective on February 10, 2021 (effective
date), and must be applied in a registrant’s first fiscal year ending on or
after August 9, 2021 (mandatory compliance date). For example, a calendar-year
registrant would be required to reflect the amendments in its periodic reports,
beginning with its Form 10-K for the year ending December 31, 2021. Because the
mandatory compliance date is based on the end of the registrant’s fiscal year,
Forms 10-Q for quarterly periods in 2021 need not reflect the amendments. Early
adoption on an Item-by-Item basis is permitted after the effective date;
however, a registrant must fully comply with each adopted Item in its entirety.
For example, it is acceptable for a registrant to early adopt the amendments to
Item 301, and thereby no longer provide selected financial data, but adopt the
amendments to other Items on the basis of the mandatory compliance date. In
addition, the final rule must be applied if a registration statement or
prospectus is initially filed with annual financial statements that reflect a
period on or after the mandatory compliance date.
Footnotes
1
SEC Final Rule Release No. 33-10890, Management’s Discussion and
Analysis, Selected Financial Data, and Supplementary Financial
Information.
2
See the SEC staff’s 2013 Report on Review of Disclosure Requirements in Regulation
S-K, its 2016 Report on Modernization and Simplification of Regulation
S-K, and the SEC’s 2016 Concept Release
Business and Financial Disclosure Required by Regulation
S-K.
3
SEC Proposed Rule Release No. 33-10750, Management’s
Discussion and Analysis, Selected Financial Data, and Supplementary
Financial Information.
4
For titles of FASB Accounting
Standards Codification (ASC) references, see
Deloitte’s “Titles of Topics and
Subtopics in the FASB Accounting Standards
Codification.”
5
SEC Interpretive Release Nos. 33-8350,
Commission Guidance Regarding Management’s
Discussion and Analysis of Financial Condition and
Results of Operations, and 33-6835,
Management’s Discussion and Analysis of
Financial Condition and Results of Operations;
Certain Investment Company Disclosures.
6
See FASB Proposed Accounting Standards
Update, Codification Amendments in Response to the SEC’s
Disclosure Update and Simplification
Initiative.