Critical Accounting Policies and How They Differ From Significant Accounting Policies

Critical AccountingIn an effort to help improve my client’s filings, and of course avoid SEC Comment Letters,  I am constantly reminding them that the disclosures required by SEC Rules Release 33-8098, contained in the MD&A, are considerably different than the significant accounting policies disclosed in the footnotes. Too frequently issuers simply cut and paste their summary of significant accounting policies into this section, which I believe will result in comments from the SEC if selected for a full review by Corp Fin.

I believe the intent of the critical accounting policies disclosures is for issuers to identify and disclose only those accounting policies that require significant judgment and estimation with a degree of uncertainty. Further, simply narrating the assumptions used in a Black-Scholes model for valuing stock options does not provide the appropriate information contained in the rules release. Disclosures related an issuers critical accounting policies (estimates) should include the methodology used in developing assumptions and the corresponding estimates, how the estimates impact the financial statements, and the effect of a change in the estimates and / or underlying assumptions.

The SEC provides two questions issuers need ask in making the “critical” determination:

  1. Did the estimate require making assumptions about matters that are highly uncertain?
  2. Would reasonably developed, different estimates / assumptions, at the time or in future periods, have a material impact on our financial statements?

When both questions are answered yes, it should be included in this section of the MD&A.

The included disclosures should not simply be boilerplate (like significant accounting policies tend to be) or be overly accounting technical (as “plain English” as possible). Further, the SEC expects varying numbers of critical accounting policies amongst issuers, but they have indicated three to five as a reasonable range.

The rules release provides several examples of disclosures that can help issuers develop the approach and content for appropriate inclusion in future filings.

Does anybody know what an accounting policy is?

Until FAS 154 came along I thought I understood what an accounting policy was.  They were the things that went into note 1 to the financial statements for situations where there was an accounting choice between two alternatives.  Rather curiously whatever choice you made ended up providing a fair presentation as long as you were consistent and disclosed it in Note 1.

Until FAS 154 came along I thought I understood what an accounting policy was.  They were the things that went into note 1 to the financial statements for situations where there was an accounting choice between two alternatives.  Rather curiously whatever choice you made ended up providing a fair presentation as long as you were consistent and disclosed it in Note 1. Continue reading “Does anybody know what an accounting policy is?”