FINANCIAL REPORTING DOSSIER

SEC: Accounting Guidance on ‘Spring-Loaded’ Compensation Awards to Executives
On 29th November, 2021, the US Securities and Exchange Commission (SEC) released guidance (Staff Accounting Bulletin No. 120) for companies to properly recognize and disclose compensation costs for ‘spring-loaded awards’ made to executives. Spring-loaded awards are share-based compensation arrangements where a company grants stock options or other awards shortly before it announces market-moving information (such as an earnings release with better-than-expected results or the disclosure of a significant transaction). The Bulletin provides additional guidance to companies estimating the fair value of share-based payment transactions regarding the determination of the current price of the underlying share and the estimation of the expected volatility of the price of the underlying share for the expected term when the company is in possession of material non-public information. [https://www.sec.gov/news/press-release/2021-246]

PCAOB: Updated Guidance on Disclosures Related to Audit Participant Reporting in Form AP
On 17th December, 2021, the Public Company Accounting Oversight Board (PCAOB) released updates to its Staff Guidance: Form AP, Auditor Reporting of Certain Audit Participants, and Related Voluntary Audit Report Disclosure Under AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. Extant PCAOB Rules require each registered public accounting firm to provide information about engagement partners and accounting firms that participate in audits of issuers by filing a Form AP for each audit report issued by the firm for an issuer. The current updates to the guidance include a revised description of secondment arrangements to address both in-person and remote work and a revised illustrative example of disclosure in the audit report. [https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/standards/documents/2021-12-17-form-ap-staff-guidance.pdf?sfvrsn=52d4323d_4]

FASB: Exposure Draft Proposing Enhanced Transparency around Supplier Finance Programs
And on 20th December, 2021, the Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED): Liabilities – Supplier Finance Programs (Subtopic 405-50), Disclosure of Supplier Finance Program Obligations. The proposed Accounting Standards Update affects buyers that use supplier finance programs (commonly known as reverse factoring, payables finance, or structured payables arrangements) to purchase goods and services. The ED requires buyers in a supplier finance program to disclose sufficient information to allow an investor to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. [https://www.fasb.org/cs/Satellite?c=Document_C&cid=1176179161221&pagename=FASB%2FDocument_C%2FDocumentPage]

International Financial Reporting Material
1. UK FRC: Developments in Audit 2021. [18th November, 2021.]
2. IAASB: Non-Authoritative Support Material Related to Technology: Frequently Asked Questions (FAQ) on Audit Planning. [7th December, 2021.]
3. IASB: Issue 25 of Investor Update. [16th December, 2021.]

2. EVOLUTION AND ANALYSIS OF ACCOUNTING CONCEPTS – EXTRAORDINARY ITEMS

Setting the Context
Financial statement analysis and exercises in valuation involve inter-alia, a process of normalizing GAAP reported figures for the effects of items of income/expense that are non-recurring, not related to the core business operations and the like. The isolation of such items could involve labelling them separately on the face of the income statement or providing a narrative in the accompanying management commentary. In this context, broadly, accounting has had two presentation categories: namely 1) extraordinary items and 2) exceptional items (also labelled in practice globally as ‘special items’, ‘one-time items’, ‘unusual items’, ‘infrequent items’, etc.).

Items of income or expense were considered Extraordinary in accounting when they arose from events or transactions that were distinct from the ordinary activities of the enterprise and, therefore, not expected to recur frequently or regularly.

The concept of ‘extraordinary items’ prevails under the AS accounting framework in India. US GAAP, IFRS and little GAAPs like IFRS for SMEs have eliminated the same. According to global standard setters, eliminating extraordinary items dispensed the need for arbitrary segregation of the effects of related external events – some recurring and others not – on the profit or loss of an entity for a period. For example, arbitrary allocations would have been necessary to estimate the financial effect of an earthquake on an entity’s profit or loss if it occurs during a significant cyclical downturn in economic activity. Companies could continue to communicate the impact of such events/transactions using the guidance available for ‘exceptional’/ ‘unusual or non-recurring items.’

The Position under prominent GAAPs

US GAAP

Historical Developments
The Committee on Accounting Procedure (CAP) issued Accounting Research Bulletin (ARB) No. 321 in December 1947, the first Bulletin that covered the concept of extraordinary items. It contained the viewpoint that only ‘extraordinary items’ may be excluded from determining net income (when their inclusion would impair the significance of net income leading to misleading inferences). This accounting literature contained a general presumption that all items of profit and loss recognized during a period should be used in determining net income, with the only possible exception being material items that are not identifiable with or do not result from usual or typical business operations.

The Bulletin discussed two conflicting viewpoints: ‘current operating performance’; and ‘all-inclusive’. The principal emphasis in the ‘current operating performance’ concept is upon an entity’s ordinary, normal, recurring operations during the period under report. If extraordinary transactions have occurred, their inclusion could impair the significance of net income leading to misleading inferences by users of financial statements. Under the ‘all inclusive’ viewpoint, it is a presumption that net income includes all transactions affecting the net increase/decrease in Equity, excluding dividend distributions and capital transactions.

In 1966, the Accounting Principles Board (APB) of AICPA issued APB Opinion No. 9, Reporting the Results of Operations, which concluded that net income should reflect all profit and loss items recognized during the period (with the sole exception of prior period adjustments). However, it stated that ‘extraordinary items’ should be segregated from the results of ordinary operations and shown separately in the income statement, with disclosure of the nature and amounts thereof, thereby providing meaningful information to users. In the document, the Board acknowledged that this approach could involve difficulty in segregating extraordinary items.

In later years, the financial reporting practices indicated that interpreting the criteria in APB Opinion No. 9 had been difficult for stakeholders and significant differences of opinion existed concerning certain of its provisions.

Accordingly, APB Opinion No. 30, Reporting the Results of Operations (issued in 1973), superseded APB Opinion No.9. It provided more definitive criteria for extraordinary items as follows:

‘Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria should be met to classify an event or transaction as an extraordinary item:

1. Unusual nature—the underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.

2. Infrequency of occurrence—the underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

The Board concluded that an event or transaction should be presumed to be an ordinary and usual activity of the reporting entity, the effects of which should be included in income from operations unless the evidence supports its classification as an extraordinary item. This Opinion formed Codified US GAAP. [Sub Topic 225-20.]

In this context, it is pertinent to note the Emerging Issues Task Force (EITF) had, post the September 11 US Terror Attack decided against extraordinary treatment for terrorist attack costs (EITF 01-10.) It stated that while the events of 9/11 were indeed extraordinary, the financial reporting treatment that uses that label would not be an effective way to communicate the financial effects of those events. The EITF observed that the economic effects of the events were so pervasive that it would be impossible to capture them in any one financial statement line item. Any approach to extraordinary item accounting would include only a part—and perhaps a relatively small part—of the actual effect of those tragic events. Readers of financial reports will be intensely interested in understanding the complete impact of the events on each company. The EITF concluded that showing part of the effect as an extraordinary item would hinder, rather than help, effective communication.

In 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-01, Income Statement: Extraordinary and Unusual Items – Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The ASU eliminated the Concept of Extraordinary Items in response to stakeholders’ feedback that the concept causes uncertainty since it was unclear when an item should be considered both unusual and infrequent. The FASB noted that it was extremely rare in practice for a transaction or event to meet the requirements to be presented as an extraordinary item.

The Board issued the Accounting Standards Update as part of its initiative to reduce complexity in accounting standards. (Effective for fiscal years commencing after 15th December, 2015.)

In reaching its conclusion, the FASB concluded that the elimination of the concept would not result in a loss of information since the presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and would be expanded to include items that are both unusual in nature and infrequently occurring.

Current Position
Extant US GAAP, ASC Subtopic 225-20 does not contain the concept of extraordinary items.

IFRS

Historical Developments

IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies (issued in 1993), required extraordinary items to be disclosed in the income statement separately from the profit or loss from ordinary activities. ‘Extraordinary items’ was defined as ‘income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and therefore are not expected to recur frequently or regularly’.

In 2002, the Board decided to eliminate the concept of extraordinary items from IAS 8. Accordingly, as per IAS 1, Presentation of Financial Statements no items of income and expense are to be presented as arising from outside the entity’s ordinary activities. The Board decided that items treated as extraordinary result from the normal business risks faced by an entity and do not warrant presentation in a separate component of the income statement. The nature or function of a transaction or other event, rather than its frequency, should determine its presentation within the income statement. Items currently classified as ‘extraordinary’ are only a subset of the items of income and expense that may warrant disclosure to assist users in predicting an entity’s future performance. [IAS 1. BC 63.]

Current Position
Paragraph 87 of IAS 1 states, ‘An entity shall not present any items of income or expense as extraordinary items, in the statement(s) presenting profit or loss and other comprehensive income or in the notes.’

AS

Current Position
AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies (Revised 1997), defines extraordinary items as income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.

AS 5 states that whether an event or transaction is clearly distinct from the ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than by the frequency with which such events are expected to occur. [AS 5. 10.]

Extraordinary items require disclosure in the P&L Statement as a part of net profit or loss for the period.

The Little GAAPs

US FRF for SMEs
AICPA’s US Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs), a self-contained framework not based on US GAAP in Chapter 7, Statement of Operations, contains no reference to extraordinary items.

IFRS for SMEs
International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), Section 5, Statement of Comprehensive Income and Income Statement prohibits the presentation or description of any items of income and expense as ‘extraordinary items’. [Section 5.10.]

Conclusion
The prevailing pandemic situation might not have qualified as extraordinary under accounting. Regulators/accounting bodies worldwide had stepped in to provide advisories/guidance to preparers of financial statements of publicly accountable companies to provide disclosures related to the effects of the pandemic.

3. GLOBAL ANNUAL REPORT EXTRACTS: “SHAREHOLDER ENGAGEMENT”
Background
The UK Companies (Miscellaneous Reporting) Regulations 2018 require Directors to explain how they considered the interests of key stakeholders and the broader matters set out in Section 172(1) (A) to (F) of the Companies Act 2006 when performing their duty to promote the success of the Company. This includes considering the interest of other stakeholders which will have an impact on the long-term success of the Company. Herein below is provided an extract from an Annual Report with respect to reporting on Shareholder Engagement.

Extracts from an Annual Report

Company: 4imprint Group PLC, listed on London Stock Exchange (YE 2nd January, 2021 Revenue – $ 560 million).

Stakeholder Engagement – Shareholders

4. FROM THE PAST – “OUR STARTING POINT IN DEVELOPING A STANDARD IS UNDERSTANDING AND EVALUATING THE INVESTOR’s PERSPECTIVE”

Extracts from a speech by Leslie F. Seidman (then Chairman of FASB) at the 12th Annual Baruch College Financial Reporting Conference held in 2013:

“Our starting point in developing a standard is understanding and evaluating the investor’s perspective – how can we make financial reports more decision-useful for them?

But financial information comes at a cost – the cost of preparing and using that information. When the FASB says it won’t issue a standard unless the benefits justify the costs, we mean the following: We issue standards if the expected improvements in the quality of reporting, from the perspective of investors and other users, are expected to justify the costs of preparing and using the information. Until investors have experience using that new information, our understanding of benefits is based on what they tell us they need and how they will use the information. Likewise, until a company has actually adopted a new standard, our understanding of costs is based on imprecise estimates, even in a well-constructed and broad-based field test.

The process I have described is designed to identify the most faithful way to present the information; we do not try to control how others will interpret or act on the information.

It is observable that when market participants perceive an improvement in the quality and credibility of the information they are receiving, the efficiency of the market improves, and investors are better able to price stocks and other capital investments.”