Most public companies in the United States have a reporting year that ends on December 31. Such companies must report their financial results with the Securities and Exchange Commission (SEC) within 90 days (by April 1 this year since the 90th day is a Sunday), or sooner if they are an “accelerated filer” as defined by the SEC.
While the SEC requires its Form 10-K to be used for annual financial reports filed with the SEC, some companies incorporate this form into their glossy annual report to shareholders. Other companies use their glossy annual report, together with other information needed to meet SEC requirements, for their Form 10-K reporting. This blog article provides what I hope is helpful guidance for those in “corporate America” who are preparing the required annual report, whether the “glossy version” or the Form 10-K itself.
Start Fresh with Brainstorming about Changes
Some companies begin the preparation process by starting with last year’s report and doing a “cut-and-paste job” from it. While that may seem like a reasonable approach, it would be better to start by having the company’s accounting staff responsible for external reporting meet with appropriate personnel from the company’s legal group. They should brainstorm about what happened in the last year that affected the financial statements and (or) that could give rise to a need for explanation or disclosure.
Likely brainstorming questions to be asked include:
Did a major acquisition or disposition of assets occur?
Are the financial results of the company better than or comparable to what existed a year ago, and if not, why not?
Have company margins changed, and if so, why?
Were there any changes in financing that require explanation?
Have there been any changes in the economic environment in which the company operates, and if so, has there been any effect on company financial statements?
Is it likely or possible that changes in the economic environment will have an effect on future financial statements?
Has the Financial Accounting Standards Board (FASB) or the SEC issued any new guidance that requires new disclosures or changes in how the financial statements are presented or discussed?
These are just ideas. Other questions, depending on company-specific circumstances, may be just as or even more important.
Obtain Legal and Accounting Consensus on Messages
The accountants in the financial reporting group as well as the legal team should agree on the messages to be conveyed in the annual report. It may also be appropriate to get the external auditors onboard to ensure they do not disagree with the message intended to be conveyed in the annual report. Agreement on such messages is desirable before they are shared with a company’s investor relations department or corporate communications group—collectively, the “spin group.” While the accountants and legal team should certainly consider and respect the views of the “spinners,” at the end of the day, it is the accountants and legal group who are typically held responsible for SEC compliance.
Once the themes or messages have been agreed to by all the parties, what next? In many companies, the legal team drafts the material outside the financial statements. The accountants work on the financial statements as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)—arguably, the most important part of the annual report since the SEC believes that MD&A should be “written from the eyes of management.” Once the accounting records for the year have been finalized and the results have been announced to the public, the drafting process can begin. Although actually, if properly planned, the process should be well under way before the books are closed.
Pay Attention to SEC “Hot-Button” Issues
Accountants are keenly aware of the reporting and disclosure requirements in the SEC’s Regulations S-K and S-X and the views documented in various Staff Accounting Bulletins (SABs) that are reflected in the FASB’s Accounting Standards Codification. However, as discussed in my prior blog article, “FASB Codification Turns Three Years Old,” the FASB Codification is not updated in a timely manner for recent changes in the SABs, so users should use the most recent SABs available on the SEC website and elsewhere.
However, many accountants don’t realize that areas of “soft” disclosure guidance exist in other SEC literature that is not contained in the FASB Codification at all. For example, there are recent speeches and presentations made by members of the SEC staff, particularly those made at the annual SEC conference held in Washington D.C. each December. Like most important staff speeches, these are made available by the SEC shortly after the conference or whenever they are given during a year. These presentations can help preparers understand the current “hot button” issues or areas of focus at the SEC. A company’s audit firm is likely keenly aware of views expressed in such presentations when performing its audit duties.
In addition, the most recent edition of the Financial Reporting Manual (FRM), which is published and updated quarterly (typically one quarter in arrears) by the SEC’s Division of Corporation Finance (Corp Fin), is a valuable tool. This manual is used by staff members in Corp Fin when they review the adequacy of a company’s SEC filings—a review process that has always been in place and is now mandated by the Sarbanes-Oxley Act of 2002 to be performed on each registrant at least every three years. Yes, the FRM is over 350 pages long and is not “light reading,” but it is certainly worth reviewing to see if anything in it might be relevant to determining exactly what should be disclosed or reported in a company’s annual report. For example, in Topic 9 of the FRM, there is very useful discussion of the requirements for MD&A. And Topic 8 in the FRM documents the views of the SEC staff when a company discloses or uses a non-GAAP financial measure in its financial reports, including in press releases.
Other SEC interpretive documents have been developed and are also available on the SEC website.
Review Thoroughly before Issuing
Once the financial reporting group has assembled the financial statement and MD&A portion of the annual report, it should share these with the legal group, and the legal group should share with the accountants the portion of the annual report it has drafted. Consistency of theme and message should be a primary focus of such reviews. Of course, the company’s outside auditors should be involved in the process along the way so that there are no surprises. In the end, an auditor will not render the required opinion on the fairness of these financial statements without being extremely comfortable with the numbers, presentation and disclosures.
Keeping track of all of the requirements in SEC filings may be time-consuming, but it is also necessary. A company’s outside auditors can be extremely useful, but company management is ultimately responsible for the financial statements, not the auditors. Developing a checklist of all potentially relevant FASB and SEC requirements, whether they are formal rules or “soft” guidelines, will help management meet its legal responsibility and avoid SEC sanctions—which could include jail time for those not following the rules and possible delisting of a company’s stock from trading!
The arduous effort of preparing a company’s annual report properly does bring rewards. It forces company lawyers and accountants together with the external auditors to think about what investors need to or may want to know about a company. If the annual report provides clear insight into how the company is performing in the marketplace and relative to its peers and discloses possible “bumps in the road,” investors will likely remain happy. And all parties involved in the process will sleep better at night.
About the Author
Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis as well as accounting consultation on a variety of topics.