Unaudited Earnings Announcements and Insider Trading –
An earlier issue of Simply Stated (Feb/2019) reported on a new study by Indiana University’s Kelley School of Business that found over two-thirds of U.S. public companies now announce annual earnings prior to audit completion. The study suggested that this practice has the potential to increase pressure in auditor/client negotiations over post-announcement audit adjustments.
The researchers said “Auditors will likely internalize their clients’ desire to avoid subsequent revisions to publicly released earnings (to avoid negative market reactions), or they may anticipate tougher negotiation positions from managers regarding potential audit adjustments (related to subjective accounting estimates).”
Now, MarketWatch is reporting that a new working paper, “Audit Process, Private Information, and Insider Trading,” “provides evidence that corporate insiders in some companies exploit the window between the earnings announcement and the 10-K filing for personal gain by trading based on material private information about any audit findings”. The paper was authored by accounting professors Salman Arif and Joseph Schroeder of the Kelley School of Business at Indiana University and John Kepler and Daniel Taylor of the Wharton School at the University of Pennsylvania,
Though researchers offered a couple simple solutions — aligning the announcement of earnings with the filing of the 10-K and audit report, and further limiting trading for key personnel involved with the audit — the problem could get worse. Researcher Joseph Schroeder told MarketWatch that “beginning with the 2019 annual reporting season, auditors will be required to include critical audit maters (CAMs) into the audit report, which will provide more information” and “increase the incentive to engage in opportunistic insider trading. This is an important thing for regulators and company counsels to monitor as we implement the new CAM disclosures,” he said.
The Lease Accounting Struggle Continues
A follow-up study conducted by accounting firm Deloitte, and reported in Accounting Today, has found that both public and private companies are struggling to implement the new lease accounting standard.
The survey found about 30% of private companies are on schedule to implement the new standard, 33.2% are unprepared, and 43.8% are only somewhat prepared – overall, not much change from Deloitte’s October of 2018 survey. Private companies have until January of 2020 to implement the new standard which moves most leases to the balance sheet.
Although public companies are already supposed to be operating under the new standard this year, the survey found that they too are struggling — with 23.9% saying they will have to invest more effort. Almost a third of the surveyed public companies are still relying on manual processes for complying, and nearly 13% reported that they are still trying to figure out the best approach going forward.
Fifty-two percent of public companies were using leasing software for compliance, compared to only 13.4% of privately held companies.
Move to Restrict Stock Buybacks
Stopping or restricting a public company from repurchasing its own stock is gaining some political momentum.
Leading the pack, Senate Minority Leader, Charles Schumer (D-NY) has teamed up with presidential hopeful Senator Bernie Sanders (I-Vt) to co-sponsor a bill that would prohibit buybacks unless the company commits to specific employee benefits such as a higher minimum wage, providing a minimum number of paid sick leave days, providing “a decent pension,” as well as “solid health benefits.” “The goal is to curtail the overreliance on buybacks while also incentivizing the productive investment of corporate capital,” they co-wrote.
Junior U.S. Senator Tammy Baldwin of (D-WI) has re-introduced her Reward Work Act that would ban open-market stock buybacks that she said “overwhelmingly benefit executives and activist hedge funds at the expense of workers and retirement savers.” It would also “empower workers by requiring public companies to allow workers to directly elect one-third of their company’s board of directors,” said Baldwin.
U.S. Senator Chris Van Hollen (D-MD) last month announced that he had new findings from Democrat SEC Commissioner Robert Jackson showing that “corporate executives can use buybacks to cash out at high prices to the detriment of their company and investors.” Van Hollen said he wrote to Jackson last December asking how executives use buybacks. According to the data laid out by Jackson, “not only can corporate executives use buybacks to enrich their personal wealth, but in doing so they decrease the value of the stocks in the long-term.” Van Hollen has called for SEC Chairman Clayton to host a roundtable and review current buyback rules.
City Council May Get Canned Over Soda Tax
Philadelphia may be known as the city of brotherly love, but not so much if you tax their sodas. You may remember Philly Mayor Jim Kenney’s city tax grab when back in 2016 he pitched the benefits of a soda tax. It was for the children — a way to stop unhealthy drinks and fund pre-K programs. The tax went into effect in January of 2017.
“The Soda Tax Fizz Out” headlines a recent editorial by the Wall Street Journal (WSJ: 3/27/19). Noting that Philadelphia fought all the way to the Pennsylvania Supreme Court to keep its soda tax, the WSJ reports that city council members are now fighting to keep their seats. Primary elections are coming in May.
One council member wants to slash the 1.5-cent-per-once tax or phase it out. Another wants to conduct a study of the economic consequences of the tax. A third council member complained that soda-tax proponents like herself are now under “an insurmountable amount of heat” and described the study as “political weaponry.”
The reality is that the soda tax has not shifted consumers to healthier drinks so there was no reduction in calorie and sugar intake. The Tax Foundation said in some cases the tax had made beer cheaper than soda. As for the new revenue, the WSJ reports that “between Jan. 1, 2017 and Dec. 31, 2018, the tax brought in more than $149 million in revenue, but only $38.2 million went to Pre-K, according to Philadelphia’s controller.” The rest went into the city general fund.
Retail employees took a hit too as Philly residents did their grocery shopping outside the city to skirt the tax. A ShopRite supermarket near the border in West Philly was forced to close after sales plunged 23% since the tax took effect, and the Brown’s Super Stores CEO said it had to eliminate 300 jobs because of the tax, cites the WSJ.
A poll last month of Democrat primary voters by the American Beverage Association found 59% now oppose the soda tax. City council members are rightfully nervous. Philly knows phony when they see it. As Coke would say, “You can’t beat the real thing.”
Tax the Rich and Use the Money to…
A new Morning Consult-Politico poll found that Americans largely support proposals to tax the rich. Fifty-one percent strongly agree and 23% somewhat agree, that “the wealthiest Americans should pay higher taxes.”
Those surveyed said that the generated funds should be used for the following goals: Improving health care system (92%), Infrastructure (91%), U.S. Poverty (89%), Entitlement programs (88%) Reducing federal budget deficit (84%) Cutting taxes (70%), Free Child Care (61%), Global poverty (59%), Increase defense spending (56%), U.S.-Mexico border wall (34%).
As for how to tax the rich, an earlier Morning Consult survey found 61% support for a wealth tax on households that have a net worth of at least $50 million, proposed by Senator Elizabeth Warren (D-MA). That compares with 45% support for a plan to raise the marginal tax rate to 70% on income over $10 million, proposed by Representative Ocasio-Cortez (D-NY).
Simply Stated Thoughts
LIFE AFTER REGULATORY ONSLAUGHT
By Corey Fischer, CPA
Firm Managing Partner
Weinberg & Company
Financial reporting executives, audit committees, and independent auditors have been wrestling with a number of developments in the U.S. recently, including new accounting standards, technological impacts on financial reporting, tax reform and other regulatory developments.
Implementation of new accounting standards has been burdensome for many companies, including new standards for equity linked derivatives, credit losses, nonemployee stock compensation, the definition of a business in business combinations, and, the two most significant changes, the new revenue and leasing standards. But these are all effective now, so the accounting onslaught is over for the foreseeable future. So what is on the horizon?
Simplification Not So Simple
Effective November 5, 2018, the SEC issued its final rule that eliminates or revises a number of disclosure requirements that are redundant or outdated in light of changes in US GAAP, or the business or technological environment.
The simplification rules are 308 pages long, and actually add a new requirement to disclose interim changes in stockholders’ equity. This results in a new equity statement format to replace a single statement of changes in stockholders’ equity with up to four equity statements for interim and year to date periods for two comparable years.
Introducing Critical Audit Matters
Under the newly-revised PCAOB standard, auditors must augment their traditional audit opinion with a discussion of “critical audit matters” (CAMs), essentially matters that “kept the auditor up at night.”
A CAM is defined as any matter that is required to be communicated to the audit committee that relates to accounts or disclosures that are material to the financial statements and involve especially challenging, subjective or complex auditor judgment. Disclosure of CAMs will be effective for large accelerated filers for fiscal years ending after June 30, 2019 (and all other filers for fiscal years ending after December 15, 2020).
A CAM could include matters related to revenue recognition, management override of controls, receivables, inventories, intangibles, covenants, investment valuations, derivatives, fixed assets, lease accounting, pension accounting, expenses, reserves, and related parties, just to name a few. The PCAOB has said it expects that, in most audits, the auditor will identify at least one CAM.
Ineffective Internal Controls
In January 2019, the SEC settled charges against four public companies for failing to maintain internal control over financial reporting (ICFR) for seven to 10 consecutive annual reporting periods. According to the SEC’s orders, year after year, the four companies disclosed material weaknesses in ICFR involving certain high-risk areas of their financial statement presentation.
Each of the four companies took months, or years, to remediate their material weaknesses after being contacted by the SEC staff. The companies involved three accelerated filers and one smaller reporting company that all had audits of their ICFR.Three of these companies had clean ICFR audit reports in their most recent fiscal year, but the SEC still charged them for continually having ineffective controls in prior years.
Changes to Employee Benefit Plan Audits
A new standard for employee benefit plan audits is coming soon that primarily focuses on expanded reporting and disclosures. It follows a collaborative effort by the Department of Labor (DOL) and Auditing Standards Board (ASB), in response to weaknesses found in a number of benefit plan audits.
A new report format will replace what is currently known as a limited-scope audit. The new standard will require new procedures for engagement acceptance; audit risk assessment and response; and communications with those charged with governance.The standard is expected to be issued in the first half of 2019 and for audits of financial statements for periods ending on or after Dec. 15, 2020 (i.e. December 31, 2020 audits).
Audit Committee Responsibilities
Both the SEC and the PCAOB continue to focus on the responsibility of the audit committee to understand financial reporting requirements fully, and to challenge senior management on major, complex decisions if necessary.
The audit committee should review all financial communications to satisfy itself that all information is presented fairly and in a transparent and consistent manner. Also, as part of their oversight of the external audit, audit committees need to ask probing questions of external auditors related to audits and any significant deficiencies or material weaknesses that were identified.
An Audited Legacy of Quality
It’s become a lot easier to choose the best audit firm. That’s because the Public Accounting Oversight Board (PCAOB) conducts periodic inspections of all audit firms and publishes its reports online. For all to see.
Yes, we get audited too.
Weinberg & Company is consistently at the very top when it comes to the quality of our work– just check our legacy of stellar inspection reports.
We thought we were building a leading, international accounting firm by providing Big 4 expertise, delivered with personal service.
Turns out we were also building “An Audited Legacy of Quality.”