Highlights of the 2024 AICPA & CIMA Conference on Current SEC and PCAOB Developments (December 15, 2024)

During the panel discussion on the OCA’s current projects, Senior Associate Chief Accountant Gaurav Hiranandani commented on the complexities that issuers face when evaluating whether a financial instrument should be classified as a liability or equity and, more specifically, whether a warrant instrument may be considered indexed to an entity’s own equity in accordance with ASC 815-40. Mr. Hiranandani noted that the SEC staff has observed evolving terms and features in warrant agreements that may affect the settlement amounts of warrants and, therefore, the application of the indexation guidance in ASC 815-40. He discussed the following examples:

• “Greater of” inputs — Upon the occurrence of a fundamental transaction of the issuer (e.g., a change in control), a warrant agreement may entitle the warrant holders to a settlement amount calculated on the basis of a standard option pricing model (such as the Black-Scholes option pricing model). In certain agreements, the option pricing model would use market-based explicit inputs that are current as of the settlement date, except that the volatility input is prespecified as the “greater of” a prespecified volatility (e.g., 100 percent) or historical volatility for the underlying equity over a defined period. In other agreements, the option pricing model would prespecify the share price used in the option pricing model as the “greater of” share price on different dates. The “greater of” inputs to the option pricing model affect the settlement amount of the warrants.
• Distributions participation feature — A warrant exercisable into common stock may include a feature that entitles the warrant holder to participate in distributions to common stockholders (e.g., cash dividends) based on the number of common shares into which the warrants are exercisable, without regard to the exercise price of the warrants.

During the OCA session on current projects, Mr. Hiranandani clarified the scope of certain ASUs recently issued by the FASB, including, for example, those related to segment reporting, income tax disclosures, and the disaggregation of income statement expenses. He noted that some industry groups have questioned whether they are subject to the ASUs and stated that unless an ASU, or specific industry guidance, explicitly excludes an entity from its scope, the ASU’s broad requirements would apply to an entity. For example, the segment reporting requirements in ASC 280, including the recent segment reporting improvements in ASU 2023-07, apply to all entities that meet the ASC master glossary’s definition of a public entity, which includes investment companies that are required to file financial statements with the SEC (e.g., those filed under the Investment Company Act of 1940 or the Securities Exchange Act of 1934).

In November 2023, the FASB issued ASU 2023-07, which amends ASC 280 to improve the information that a public entity discloses about its reportable segments, including new requirements for single reportable segment entities. During a Q&A session, Deputy Chief Accountant Melissa Rocha reiterated comments made at the 2023 conference related to an entity with one reportable segment whose chief operating decision maker (CODM) evaluates the business and makes capital allocation decisions on a consolidated basis. She emphasized that in these circumstances, the SEC staff would expect the registrant to conclude that consolidated net income is the measure most consistent with GAAP and is therefore the required measure (of segment profit or loss).

In his opening remarks, Mr. Munter reiterated his previous remarks regarding the statement of cash flows (SoCF) and its importance for investors. He reminded both preparers and auditors “to ensure that the statement of cash flows and related cash and non-cash disclosures are provided the same quality focus as other components of the financial statements.”

During the OCA’s discussion of current projects and recent consultations, OCA Professional Accounting Fellow Jonathan Perdue shared a fact pattern related to a registrant’s sale of one of its consolidated subsidiaries to a third party. In this fact pattern, the subsidiary did not meet the definition of a business in ASC 805, and it had significant assets that were typically sold by the registrant as part of the registrant’s ordinary course of business. The question under consultation was whether the sale of the subsidiary as a whole should be accounted for under ASC 606.

During the panel discussion on current OCA projects, Mr. Hiranandani noted that the OCA receives a number of questions related to the acquisition, sale, and wind down of legal entities that meet the definition of a business under ASC 805. The accounting for these transactions depends upon facts and circumstances since no two transactions are alike. Mr. Hiranandani highlighted an example related to a registrant that was winding down a subsidiary by selling some of the subsidiary’s assets and liabilities to a third party. The registrant had been reporting the results of the subsidiary on a three-month lag under ASC 810-10-45-12. The registrant proposed eliminating the lag reporting as of the date of the sale by (1) adjusting its shareholder’s equity to recognize the subsidiary’s income statement activity for the lag period (three months) and (2) adjusting the subsidiary’s assets and liabilities to reflect a carrying value without a lag in reporting as of the sale date. Upon the sale of the net assets held by the subsidiary, the registrant would recognize a net gain or loss on the basis of the new carrying value of the assets and liabilities (i.e., the carrying value as of the sale date without a lag). Under this proposed accounting, (1) the registrant would recognize the net gain or loss incurred during the lag period related to the assets and liabilities that are disposed directly against shareholder’s equity and (2) the registrant’s income statement would only include the net gain or loss on the sale on the basis of the adjusted carrying value of the net assets that were sold. The staff objected to the registrant’s proposed accounting under these facts and circumstances.

ASU 2022-04 requires enhanced transparency about an entity’s use of supplier finance programs. Under the ASU, the buyer in a supplier finance program is required to disclose information about the key terms of the program, outstanding confirmed amounts as of the end of the period, a rollforward of such amounts during each annual period, and a description of where in the financial statements outstanding amounts are presented.

FinREC Chair and Deloitte & Touche LLP Managing Director Mark Crowley explained that, as indicated on the AICPA’s Web site, the Financial Reporting Executive Committee (FinREC) is the AICPA’s senior technical committee for financial reporting and its mission “is to determine the [AICPA’s] technical policies regarding financial reporting standards . . . , with the ultimate purpose of serving the public interest by improving financial reporting.” FinREC accomplishes this mission, in part, by releasing nonauthoritative financial reporting guides to help preparers apply accounting standards.

Mr. Jones and multiple SEC staff members discussed the FASB’s upcoming agenda consultation and related ITCs, emphasizing that it is critical for the Board to engage with various stakeholders in establishing the priorities for its technical agenda as well as the scope of potential new projects. For example, the following topics were highlighted during the conference:

• Principal-versus-agent considerations — Mr. Jones acknowledged that an entity must use significant judgment in performing the principal-versus-agent evaluation under ASC 606 and that questions remain on this topic. Regarding potential standard setting in this area, Mr. Jones asked stakeholders to provide feedback and to consider whether they prefer a different outcome (compared with that under the current model) or use of a simplified model to achieve the same outcome (including a tolerance for potential different outcomes under a simplified model).
• Statement of cash flows — As part of his continuing focus on the importance of the statement of cash flows, Mr. Munter invited stakeholders to provide thoughtful feedback related to the FASB’s current research project on this topic. He noted that he supports the FASB’s efforts to improve consistency and comparability in this area (e.g., cash flow classification, information about noncash transactions). Mr. Munter also highlighted the need to “dig deeper” into stakeholder feedback to better understand investors’ informational needs. For example, he noted that he has heard some investors say that the direct-method cash flow statement is unnecessary and others say that they want more information about certain cash flows, including cash collected from customers, cash paid to employees, and cash paid to suppliers and other creditors.
• Intangible assets — Mr. Jones noted that the FASB intends to issue an ITC related to its current research project on accounting for intangible assets. The ITC would request feedback on two key issues: (1) whether there should be one accounting model for all intangible assets (as opposed to the multiple models currently employed) and (2) whether the method of acquisition (e.g., internally developed, acquired in a business combination) should result in different accounting outcomes.
• Financial key performance indicators (KPIs) — Mr. Jones highlighted that the FASB often has heard stakeholders raise questions regarding non-GAAP and GAAP metrics and has issued an ITC on financial KPIs. The ITC requests stakeholder feedback on the FASB’s role in standardizing financial KPIs and whether entities should be required or permitted to disclose such KPIs in the financial statements.

Under ASU 2023-07, public entities may disclose “more than one measure of a segment’s profit or loss” as long as at least one is the segment profit or loss measure that is “most consistent with GAAP measurement principles” (the “required measure”). In some cases, measures beyond the required measure may not be determined in accordance with GAAP.

During the panel addressing Division developments, Ms. Rosenberger emphasized that non-GAAP measures continue to be one of the topics upon which the SEC staff comments most frequently, and both she and Ms. Lowe highlighted the following:

• Prominence — The SEC’s non-GAAP rules require presentation of the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to any related discussion and analysis of a non-GAAP measure, including a ratio, table, chart, or graph that includes a non-GAAP measure.
• Excluding normal, recurring, cash operating expenses — A non-GAAP measure could be misleading if it excludes normal, recurring, cash operating expenses that are necessary for business operations. Ms. Lowe gave examples of adjustments that may be considered normal or recurring, such as losses on purchase commitments or inventory, rent expense when leased assets are integral to a company’s operations and generation of revenue, and cash compensation such as annual bonuses.
  Ms. Rosenberger clarified that C&DI Question 100.01 indicates that if a registrant presents a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business, the measure could be considered misleading. However, she emphasized that “normal, recurring, and cash” are examples of factors and not all three need to be present for the exclusion of the expense to be misleading. For example, a write-down of inventory as an adjustment may not be a “cash” item, but it may still be both normal and recurring; therefore, exclusion of the write-down could be considered misleading.
• Individually tailored accounting principles — Adjustments that represent the application of individually tailored accounting principles are not limited to adjustments that accelerate revenue recognition. For example, the following could also be considered tailored accounting adjustments: changing the accounting for a lease from a sales-type lease to an operating lease, removing accelerated depreciation from measures other than EBITDA, and reversing the effects of purchase accounting after an acquisition.
• Clear labeling — When presenting non-GAAP measures, registrants should ensure that (1) they appropriately label each adjustment and (2) the accompanying disclosures provide investors with the information they need to clearly understand the nature of the measure or adjustment, including why the adjustment is being made.

Division Deputy Director of Disclosure Operations Cicely LaMothe briefly discussed disclosures related to current macroeconomic conditions that registrants may consider providing in the MD&A and risk factors sections, such as those associated with inflation, supply chain disruptions, and disruptions in the commercial real estate and banking industries. She also addressed disclosures about artificial intelligence (AI) and Pillar Two tax implementation.

Throughout the conference, the SEC staff and other speakers discussed recent final SEC rules. For a summary of SEC rulemaking initiatives and relevant Deloitte resources, see Appendix A.

Ms. Rosenberger discussed an example consistent with previous discussions at the March 2018 CAQ SEC Regulations Committee joint meeting with the SEC staff. The example concerns audit requirements related to pretransaction periods after a reverse merger involving two operating companies. In these situations, the target’s premerger financial statements included in a related Form S-4, proxy statement, or Form 8-K may be audited in accordance with AICPA standards. However, once the financial statements of the target are presented as the registrant’s historical financial statements (i.e., once the reverse merger is reported in an SEC filing), any reissuance of audited premerger target financial statements would have to be audited in accordance with PCAOB standards.

In her keynote remarks, Ms. Williams highlighted recent progress made by the Board to support the PCAOB’s key mission to protect investors. She reflected on the Board’s priorities, objectives, and recent actions taken through standard setting, noting that such actions are starting to manifest in the form of positive trends in inspection results. Ms. Williams stated, “[In the past,] I have raised concerns about the unacceptable rise in deficiency rates that put investors at risk. . . . Today, I am pleased to stand before you and deliver the news that PCAOB inspectors are seeing significant improvements in the aggregate Part I.A deficiency rate from the largest firms.” She further shared that she expects this positive trend to continue and urged auditors to keep up the momentum.

The PCAOB continues to actively pursue its mission to protect investors and further the public interest as it advances its standard-setting, research, and rulemaking agendas, which were updated in November 2024. Ms. Williams emphasized the need for auditing standards that are responsive to the needs of investors. In her keynote remarks, she observed that “[t]his year alone, the Board has taken more formal actions on standard-setting and rulemaking than any year since 2003 when the PCAOB was created — actions that investors deserve as they make decisions about their investments in the marketplace.”

During the session on PCAOB inspection updates, Christine Gunia, director of the PCAOB’s Division of Registration and Inspections (the “Inspections Division”), commented on the current state of audit quality, specifically remarking that inspections are the number one way that the Inspections Division drives improvements in audit quality. She noted that the Inspections Division is seeing improvements in deficiency rates in 2024 inspections.

William Ryan, chief counsel of the PCAOB’s Division of Enforcement and Investigations, gave an update on the PCAOB’s continued strength of enforcement, which included (1) expansion in both the types of cases pursued and the geographic reach of the PCAOB’s enforcement program and (2) imposition of meaningful sanctions. He shared highlights of enforcement activity from 2024 and the key areas that resulted in sanctions in 2024, including improper answer sharing on internal training exams, independence-related quality control violations at audit firms, failures in audit firms’ quality control systems, violations of PCAOB standards in connection with auditing revenue and receivables, and failure to cooperate with investigations. Public enforcement orders doubled from 2021 to 2022, and that level of activity has remained essentially the same in 2023 and 2024. However, as of November 30, 2024, the PCAOB increased civil penalties by $15 million, from $20 million in 2023 to $35 million in 2024. This represents three successive years of record penalties imposed by the PCAOB. The Board has also increased its global reach on enforcement, since 45 percent of the Board’s 2024 disciplinary orders concerned non-U.S. firms or associated persons. Public enforcement orders also included the first-ever sanctions for partners of a mainland China–based global network firm.

Auditor independence was once again a recurring and important theme of the conference. Mr. Munter and others in the OCA emphasized the importance of auditor independence in both their prepared remarks and the Q&A sessions. In his keynote remarks, Mr. Munter stated that “[f]or auditors, the foundation of . . . trust lies in the auditor’s required independence. Every member of an audit firm [regardless of service line] should keep this in mind, and audit firm leadership should reinforce this message by actively championing the principles in the auditor independence rules.” Shehzad Niazi, SEC deputy chief counsel, took this sentiment further and stated that the audit committee and entity management also share responsibility with respect to auditor independence.

Many conference speakers emphasized the importance of audit quality. During his prepared remarks and in a Q&A session, Mr. Munter stressed that audit quality — in both the audit execution and the development of auditing standards — is important in protecting investors and supporting capital formation. In his keynote address, Mr. Munter stated the following:

The need to foster talent and build the pipeline for the audit profession was discussed during multiple conference sessions, beginning with AICPA Board Member Wesley Bricker’s welcome remarks and Mr. Munter’s keynote address. Mr. Munter stated that he believes that the profession is at an inflection point regarding the attraction and retention of talented individuals who are dedicated to serving the public interest. During the PCAOB keynote session, Ms. Williams also suggested that audit firms consider how the remote and hybrid work environment has affected the apprenticeship model for on-the-job training and development of professionals. Mr. Bricker emphasized the profession’s responsibility in supporting and developing both the current and the next generation of accountants, focusing on education, apprenticeship, and the many opportunities that the accounting profession offers. Further, during the CAQ update, panelists highlighted the importance of engaging with students, at various points in their academic careers, about the accounting profession and understanding what motivates them in choosing a career. Panelists cited their research findings that fulfillment, stability, and corporate culture were the top three motivators.

The importance of maintaining a culture of professionalism and a commitment to the public interest was a central theme at the conference. In his remarks, Mr. Munter emphasized the critical role of a strong ethical culture and tone at the top in empowering accountants to exercise professional skepticism and challenge management when necessary. Both Mr. Munter and Ms. Doutt discussed the concept of the “mood in the middle” and “buzz at the bottom,” emphasizing that immediate supervisors play a crucial role in influencing staff behavior and that leaders not only need to set a positive tone at the top but also ensure that such tone flows through the rest of the organization. Ms. Doutt called for operationalizing ethical behavior at all levels to create an environment in which questioning and probing are encouraged.

The transformative potential of generative AI and emerging technologies was highlighted throughout the conference. During the panel on expert insights and solutions, participants addressed challenges hindering widespread adoption of generative AI models, including the reliability of model outputs. In the session, and in another panel on the future of AI, participants discussed the broad and diverse applications of these innovations and emerging technologies in accounting, including the power of generative AI, the ways they currently use it, and potential future uses. When asked about the impact of these technologies on the workforce, panelists expressed optimism and emphasized the critical importance of upskilling.

The table below lists the six short-term standard-setting projects on the PCAOB’s agenda, many of which address updates to the interim auditing standards that the Board adopted in 2003. Each project is under active development by the PCAOB (i.e., action, such as the issuance of a proposed or final standard, is expected within 12 months).