Summary by the Division of Corporation Finance of
Significant Issues Addressed in the Review of the Periodic Reports of
the Fortune 500 Companies
Monitor of the Fortune 500 by the Division of Corporation Finance
In December 2001, the Division of Corporation Finance determined it
would monitor the annual reports filed by all Fortune 500 companies with
the Commission in 2002 as part of its process of reviewing financial and
non-financial disclosures made by public companies. This summary
discusses the principal subjects of comment by the Division on these
2002 reports. It is not intended to be an evaluation of the quality of
disclosure, and the fact that an area of disclosure is not addressed
should not be taken as an indication that we do not see issues or
potential for improvement in other areas. As indicated in December 2001,
the Division focused on disclosure that appeared to be critical to an
understanding of each company's financial position and results, but
which, at least on its face, seemed to conflict significantly with
generally accepted accounting principles or SEC rules, or to be
materially deficient in explanation or clarity. As a result of this
focus, comments substantially concentrated on financial reporting,
including financial statements and management's discussion and analysis.
Report of the Division of Corporation Finance
All annual reports on Form 10-K filed by Fortune 500 companies
received a preliminary review, which we have sometimes referred to as a
screening. Based on that process, we selected a substantial number of
companies for some level of further review. Comment letters have been
sent to more than 350 of the Fortune 500 companies. As in the past, we
asked companies to amend their filing where appropriate; in many cases,
we asked companies to respond to our comments in future filings. We
expect to selectively review future filings of these companies to ensure
continued compliance with our comments and with the federal securities
laws. It is important to note that our work on this project is not yet
complete - we continue to work with many companies as they respond to
our comments, and we continue to send comments to companies who filed
their annual reports in the later part of 2002.
Many of the comments we provided to companies were fact specific to
individual companies. While we addressed a variety of issues in our
comments, we have identified certain general areas of comment where we
believe disclosure could be significantly enhanced. We also discovered
that the comments raised on the Fortune 500 companies are consistent
with the comments we issue generally in our review of periodic filings.
We are providing in this document a summary of the most common areas of
comment addressed in our Fortune 500 project. While all of the comments
discussed in this report were issued frequently, they are not discussed
in any particular order. We put them forth to assist all companies as
they prepare documents that they will file with the Commission.
We found that we issued comments on the MD&A discussions of the
Fortune 500 companies more than any other topic. Item 303 of Regulation
S-K requires a company to discuss its financial condition, changes in
financial condition and results of operations. A company must include in
this section a discussion of its liquidity, capital resources and
results of operations. In particular, forward looking information is
required where there are known trends, uncertainties or other factors
enumerated in the rules that will result in, or that are reasonably
likely to result in, a material impact on the company's liquidity,
capital resources, revenues and results of operations, including income
from continuing operations. A company must focus on known material
events and uncertainties that would cause reported financial information
not to be necessarily indicative of future operating results or of
future financial condition.
We issued a significant number of comments generally seeking greater
analysis of the company's financial condition and results of operations.
Our comments addressed situations where companies simply recited
financial statement information without analysis or presented
boilerplate analyses that did not provide any insight into the
companies' past performance or business prospects as understood by
management. In this vein, we sought information regarding the existence
of known trends, uncertainties or other factors that required disclosure
that was not included. We issued comments discouraging companies from
providing rote calculations of percentage changes of financial statement
items and boilerplate explanations of immaterial changes to these
figures, encouraging them to include instead, a detailed analysis of
material year-to-year changes and trends. In addition, we issued
comments addressing key areas, in particular the related topics of
liquidity, cash flow and capital resources, which were given
insufficient attention. We will continue to focus on this section of
disclosure documents in our review efforts and encourage all companies
to present useful and meaningful disclosure of their financial condition
and results of operations.
In addition to these general areas, we issued a significant number of
comments regarding company or industry-specific MD&A disclosure, in
particular comments posing specific questions relating to information
presented in the financial statements that we believed warranted more
discussion in the MD&A.
We asked a number of companies to present, or expand a current
presentation of, a discussion of their critical accounting policies in
their MD&A. In December 2001, the Commission released FR-60 and
indicated that companies should provide more discussion in MD&A about
their critical accounting policies. Under an appropriate heading,
companies are encouraged to disclose their most difficult and judgmental
estimates, the most important and pervasive accounting policies they
use, and the areas most sensitive to material change from external
factors, and to provide a sensitivity analysis to facilitate an
investor's understanding of the impact on the bottom line.
In our review of the Fortune 500 companies, we noted a substantial
number of companies did not provide any critical accounting policy
disclosure in circumstances where FR-60 could fairly be read as calling
for this disclosure. We also found that the critical accounting policy
disclosure of many companies did not adequately respond to the guidance
provided in FR-60. We also found that many companies failed to provide
the sensitivity analysis the Commission encouraged in FR-60.
Many of the areas identified below could have been made more
transparent as a result of a more thoughtful discussion of assumptions
and estimates. We found that we asked many companies to enhance their
disclosure of critical accounting policies in one or more of the
following areas:
- Revenue recognition;
- Restructuring charges;
- Impairments of long-lived assets, investments and goodwill;
- Depreciation and amortization expenses;
- Income tax liabilities;
- Retirement and post retirement liabilities;
- Pension income and expense;
- Environmental liabilities;
- Repurchase obligations under repurchase commitments;
- Stock based compensation;
- Insurance loss reserves; and
- Inventory reserves and allowance for doubtful accounts.
In a large number of comments, we addressed the use of non-GAAP
financial information. In general, we asked companies either to remove
non-GAAP financial measures, because we believed they were misleading or
susceptible to misinterpretation, or to present them less prominently
with better explanation and disclosure that is more balanced. We found
that we directed many of these comments to financial services companies
since they often presented "managed basis" or "normalized" financial
information and related discussions in the MD&A. "Managed basis"
information is GAAP-based information adjusted to reverse the sale of
loans and other assets under securitization arrangements. Many companies
often gave limited prominence to GAAP financial information and provided
limited discussions of GAAP-based results of operations and changes in
assets and liabilities. Companies that presented alternative or
pro-forma statements of operations were asked to remove them. We also
issued comments advising companies that GAAP-based financial information
was required in MD&A and that they should provide GAAP-based performance
discussions with equal or greater prominence than those based on
non-GAAP measures.
In January 2003, the Commission adopted rules implementing Section
401(b) of the Sarbanes-Oxley Act of 2002 (Release No.
33-8176).
Generally, the new rules require that where non-GAAP financial
information is presented in periodic reports filed with the Commission,
the company must also include:
- a presentation with equal or greater prominence of the most
directly comparable financial measure presented in GAAP;
- a reconciliation to the comparable GAAP measure;
- a statement of the reasons why management believes that the
non-GAAP presentation is useful; and
- a statement disclosing the additional purposes, if any, for
which management uses the non-GAAP financial measure that are not
otherwise disclosed.
The Commission's rules also amended Regulation S-K to codify certain
staff positions regarding filings. Companies' 2002 filings, of course,
pre-dated these requirements. We believe that comments we issued on 2002
filings have been generally consistent with the new rules. We recognize
that the new disclosure requirements may affect how companies respond to
comments we have issued in this area. We will continue to monitor
disclosure in this area, especially in light of these new rules that
will be in effect beginning March 28, 2003.
We frequently requested clarification of how companies recognize
revenue, including how their revenue recognition specifically complies
with Staff Accounting Bulletin 101, which provides guidance on how to
apply general accepted accounting principles to revenue recognition
issues. We also asked companies to expand significantly their revenue
recognition accounting policy disclosures. In response to our comments,
many companies agreed to provide additional company-specific disclosure
about the nature, terms and activities from which revenue is generated
and the accounting policies for each material revenue generating
activity.
In certain industries, we noted common disclosure and comment themes,
including the following:
- Computer software, computer services, computer hardware and
communications equipment. We issued comments requiring
expanded disclosure regarding the revenue recognition accounting
policy for software and multiple element arrangements (providing
software, hardware and services under the same agreement) to a
number of companies in these industries.
- Capital goods, semiconductor, and electronic instruments and
controls. Our comments demonstrated that the accounting policy
disclosure for deferred revenue, revenue recognition for products
with return or price protection features, requirements for
installation of equipment and other customer acceptance provisions
could be improved in the filings of a number of companies in these
industries.
- Energy. We found that many companies in this industry
did not adequately disclose the material terms of energy contracts.
- Pharmaceutical and retail. We found that many
pharmaceutical companies did not adequately disclose the revenue
recognition policy in respect of product returns, discounts and
rebates. In addition, we issued comments requiring improved
disclosure of their arrangements for co-op advertising arrangements
with retail companies.
We asked many companies to justify or explain more fully their
accounting for restructuring charges. We also issued a significant
number of comments asking companies to expand their disclosure of
restructuring charges in their financial statements and in their MD&A.
We commented on this topic throughout many of the industries represented
in the Fortune 500. Set forth below is a summary of some of the more
common types of comments we issued on this topic.
- We asked companies to include a period-by-period analysis of
restructuring charges. We asked that this analysis include the
original restructuring charge, cash payments made, non-cash charges
used, reversals or adjustments to the charges and non-cash
write-downs (impairments, etc.), and disclosure of the adjustment or
reversal for each material component of the total restructuring
charges.
- We asked companies to describe the facts and circumstances
leading to the restructuring plan. We asked companies to provide a
complete description of each component of total restructuring
charges.
- We asked companies to more fully describe the timing of cash
payments to be made under the restructuring plan and to disclose
when they expected the restructuring plan to be complete.
- In several instances, we asked companies to highlight the nature
and reasons for adjustments or reversals of restructuring charges.
- We asked companies to expand their MD&A to include a reasonably
detailed discussion of the events and decisions that gave rise to
restructuring plans, and the reasonably likely material effects of
management's plans on financial position, future operating results
and liquidity.
- We asked companies to provide a discussion of the nature, amount
and description for each material component of total restructuring
charges. We also asked companies to identify the periods in which
material cash outlays are anticipated, to identify the expected
source of their funding, and to discuss material revisions to the
plans, and the timing of the plan's execution, including the nature
and reasons for any revisions.
- We asked companies to discuss the reasonably likely material
effects on future earnings and cash flows resulting from the plans
(for example, reduced depreciation, reduced employee expense, etc.).
We asked companies to quantify and disclose these effects and to
disclose when they expected those effects to be realized.
We issued a significant number of comments on impairment charges,
focused in significant part on three distinct areas - long-lived assets,
securities held for investment, and goodwill and other intangible
assets.
Many of our comments related to the timing, measurement and
disclosure of impairment charges recognized for long-lived assets. We
asked companies why impairment charges were not recognized in prior
periods or not yet recognized at all. We also asked companies to
identify in their MD&A material assets analyzed for impairment for which
an impairment charge had not yet been recorded. This could be related to
a discussion of critical accounting policies and estimates discussed
above. In addition, we asked these companies to expand their disclosures
in their financial statements and MD&A to describe:
- The specific assets that were impaired, including whether those
assets were held for use or held for sale;
- The facts and circumstances (specific events and decisions) that
led to the impairment charge; and
- The assumptions or estimates they used to determine the amount
of the impairment charge.
Treatment of investment securities with other-than-temporary losses
was another frequent area of comment. SFAS No. 115 provides guidance on
accounting for equity securities with readily determinable fair values
and for all investments in debt securities. According to SFAS No. 115,
companies may classify securities as held to maturity or available for
sale. For these classifications of securities, unrealized losses (the
difference between the current market price of the security and the
carrying amount) are not recognized in net income until the loss is
determined to be other-than-temporary. We noticed that many companies
held investments that had significant unrealized losses for an extended
period of time. We asked these companies to explain or justify how they
determined that these losses were still considered temporary, referring
them to Staff Accounting Bulletin 59 for additional guidance. We also
asked companies to expand their MD&A to describe the specific factors
they used to determine whether unrealized losses were considered to be
temporary and when they were considered other-than-temporary.
Another prominent impairment issue dealt with the adoption of SFAS
No. 142. This standard was first applied in fiscal years beginning after
December 15, 2001, and requires that the carrying amount of goodwill and
intangibles with indefinite lives no longer be amortized into expense,
but instead be tested at least annually for impairment. We asked
companies questions about their goodwill impairment tests and their
determination that intangible assets had indefinite lives. We asked
companies to revise their financial statements to reflect impairments,
to more clearly describe their accounting policy for measuring
impairment, including how reporting units are determined and how
goodwill is allocated to those reporting units, and/or to provide
missing disclosures required by SFAS No. 142. We also asked companies to
expand their MD&A to describe the methodology and assumptions or
estimates used to test goodwill and other intangible assets for
impairment, and to highlight any reporting units for which goodwill
impairment charges were reasonably likely to occur.
Another significant area of comment related to the assumptions
companies use in determining the amount of pension income or expense to
recognize. The majority of our comments dealt with the long-term
expected return assumption for plan assets. SFAS Nos. 87 and 106 provide
guidance on accounting and disclosure for post-retirement plans. The
majority of companies use an estimated return, and therefore must
amortize the difference from the actual return, the unrecognized
gain/loss, into income in future periods. The negative stock market
returns of the last three years caused many companies to have
significant unrecognized losses related to their pension plans, which
are often not transparent to investors. We asked companies about the
basis for and the reasonableness of their expected return assumption. We
also asked many companies to expand their MD&A to clearly describe:
- The significant assumptions and estimates used to account for
pension plans and how those assumptions and estimates are
determined, for example the method (arithmetic/simple averaging, or
geometric/compound averaging) and source of return data used to
determine the expected return assumption and the assumptions,
estimates and data source used to determine the discount rate;
- The effect that pension plans had on results of operations, cash
flow and liquidity, including the amount of expected pension returns
included in earnings and the amount of cash outflows used to fund
the pension plan;
- Any expected change in pension trends, including known changes
in the expected return assumption and discount rate to be used
during the next year and the reasonably likely impact of the known
change in assumption on future results of operation and cash flows;
- The amount of current unrecognized losses on pension assets and
the estimated effect of those losses on future pension expense; and
- A sensitivity analysis that expresses the potential change in
expected pension returns that would result from hypothetical changes
to pension assumptions and estimates.
We issued a significant number of comments dealing with how companies
determine their operating segments in their financial statements and
MD&A. Under SFAS No. 131 and our rules, an operating segment is a
component of a business, for which separate financial information is
available that management regularly evaluates in deciding how to
allocate resources and assess performance. SFAS No. 131 and our rules
specify when a company must report separate financial information about
an operating segment. We asked companies questions about their segment
reporting disclosure. A number of companies inappropriately aggregated
multiple segments, or did not adequately explain the basis for
aggregating information. We also asked questions about the various
aspects of SFAS No. 131 that specify specific disclosure requirements
once the operating segments are identified.
We raised questions about how some companies described their sale of
financial assets (such as accounts receivable, loans, and investment
securities) through securitizations. While the newly created securities
are sold to outside investors, companies often retain a portion of the
securities or interests in obligations regarding the securitized assets.
SFAS No. 140 provides guidance to companies to determine when a sale has
occurred, how to account for that sale, and when to disclose information
about the sale. Pursuant to that guidance, a transfer of financial
assets is not considered a sale unless the company has surrendered
control over those assets. We asked companies questions about how they
determined that they had surrendered control of the assets transferred,
especially when there appeared to be substantial continuing involvement
with the transferred assets. We asked companies to expand their MD&A to
describe the structure, business purpose and accounting for these
transactions. We also asked companies to highlight in their MD&A the
significant assumptions they used to determine a gain or loss from the
sale of these assets, and the potential risk of loss they retained in
these assets. In addition, we requested some companies, most commonly
financial institutions, to expand their financial statements to provide
all of the disclosures required by paragraph 17 of SFAS 140, separately
for each type of asset sold in a securitization.
Although the technical literature governing special purpose or
variable interest entities is different, we found the disclosure issues
and our general areas of comment to be similar. In FR 61, we encouraged
companies to include expanded, as well as tabular, disclosure of
off-balance sheet arrangements. We asked many companies to explain more
fully in their MD&A the nature and accounting for off-balance sheet
arrangements and to expand their footnote disclosure to specify the
accounting for those arrangements. With the Commission's recent adoption
of new disclosure requirements in this area and new financial
interpretations by the Financial Accounting Standards Board regarding
both accounting for and disclosure regarding guarantees and variable
interest entities, we will continue to monitor accounting and disclosure
in these areas.
We issued comments relating to environmental and product liability
disclosure to a number of oil and gas and mining companies, as well as
to several manufacturing companies. In these comments, we pointed the
companies to the guidance in SFAS 5, FIN 14, SOP 96-1 and SAB 92, which
generally provide that companies with environmental and product
liabilities must disclose:
- The nature of a loss contingency;
- The amount accrued;
- An estimate of the range of reasonably possible loss;
- Significant assumptions underlying the accrual; and The cost of
litigation.
In addition to finding that many companies did not provide adequate
disclosure relating to those items, we also found that companies could
improve their disclosures required by SAB 92. SAB 92 provides
interpretations of SFAS 5, but also includes additional specific
disclosure requirements. We urged companies with material contingent
liabilities to carefully review their disclosures and ensure that they
include all required information. We also urged companies to provide in
their MD&A a meaningful analysis as to why the amounts charged in each
period were recorded and how the amounts were determined.
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