Here it is. On Tuesday, a sample letter sent to select firms by the Division of Corporation Finance’s chief accountant, Carol Stacey, was posted to the SEC’s website. “Select firms,” meaning the letter is in response “to inquiries from several public companies requesting filing guidance as they prepare to restate previously issued financial statements for errors in accounting for stock option grants.” Apparently, the SEC believes the information in the letter would benefit the firms that hadn’t requested guidance, too. (If they think to look at the SEC website.)
What’s important in it? First up, the letter warns companies that following the guidance won’t assure them that there’s no further review down the road. Next: if the firm would be filing its next “normal” 10-K is due within two weeks of filing an amended 10-K in response to this guidance, then it won’t have to file the amended financials as long as the current 10-K contains all the prescribed information. Miss that timing, and this information goes in the amended 10-K. And it’s a ton. Abstracted from the letter:
• A note at the beginning of the Form 10-K amendment discussing the reason for amendment.
• Selected Financial Data for the most recent five years, restated and with columns labeled “restated”.
• Management’s Discussion and Analysis based on the restated annual and quarterly financial information.
• Audited annual financial statements for the most recent three years, restated as necessary and with columns labeled “restated”.
• If interim period information for the most recent two fiscal years is required to be restated, the restated information should label it as such.
• Footnote disclosure reconciling previously filed annual and quarterly financial information to the restated financial information, on a line-by-line basis and for each material type of error separately, within and for the periods presented in the financial statements (audited), in selected financial data, and in the interim period information.
• The disclosure referred to in the Chief Accountant’s September 19, 2006 letter that applies to the restatement.
• Audited financial statement footnote disclosure of the nature and amount of each material type of error separately that is reported as an adjustment to opening retained earnings.
• Audited financial statement footnote disclosure of the restated stock compensation cost:
- For the most recent three years: restated net income and compensation cost and pro forma disclosures, required by paragraph FASB Statement No. 123 (the original standard, not 123R, in effect until last year), for each annual period presented in the financial statements for which the intrinsic value method of accounting in APB Opinion 25 was used, with columns labeled “restated” as appropriate.
- For each annual period preceding the most recent three years: disclosure of the information required by FASB Statement No. 123, the restated stock compensation cost that should have been reported for each fiscal year. The total of the restated stock-based compensation cost should be reconciled to the disclosure of the cumulative adjustment to opening retained earnings. The standard required only net-of-tax amounts, but material tax adjustments related to the accounting for stock-based compensation should also be disclosed by year. Firms may also choose to provide full restated information previously disclosed under Statement No. 123, for each period prior to the most recent three years, either in the audited financial statement footnotes or elsewhere in the filing.
- For companies that either adopted Statement No. 123 using the retroactive restatement method and/or FASB Statement No. 123R using the modified retrospective application method for all prior years for which FASB Statement No. 123 was effective: the disclosure outlined above should include the restated stock-based compensation pursuant to FASB Statement No. 123 and also the restated stock-based compensation cost that should have been reported under the accounting principle originally used for each period, presumably Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Adjustments to the firm’s previously issued internal control reports are suggested as well. Stands to reason: if a firm finds that it’s stated comp cost wrong for five to ten years, there’s a pretty good chance that some controls over financial reporting are broken.
A lesson or two from the letter. (No, not “backdating is bad.”) What is listed above is a heap of required information (and that’s just the Cliff’s Notes version of Carol Stacey’s letter.) Companies that have found themselves entangled in the web of backdating have been spending months sorting out past transactions they probably never expected to revisit, and now they’re faced with onerous reporting once they find out what their problems were. Expect corporate grumbling.
Hard to feel too sorry for them: much of the pain they’re going through was of their own doing. The re-reporting is going to be no less painful. And some firms might look less than Olympian once their earnings are restated to show all the costs they should have, and investors might question whether or not they’d ever have cared about those firms if all facts had been known.
The complexity involved in the reporting only highlights how bad standards can be when there are too many choices available: the optionality of employing Statement 123 in the first place, the plethora of adoption choices allowed when it was amended by Statement 148, and the continuation of multiple implementation choices permitted when Statement 123R came along. It was bad enough for investors when the original statements came out. Conceivably, many backdating episodes could have been uncovered if firms had been required to adopt the original Statement 123. Let’s hope future standards are more “standard-like” in their implementation approaches.