The “2010 SEC Staff Review of Common Financial Reporting Issues Facing Small Issuers” is a great reference. Our staff saw it presented at the 2010 PCAOB Small Auditor conference in Dallas, and thought the section on reverse merger accounting was particularly well constructed. We frequently see issuers have trouble with the tricky accounting that follows a reverse merger.
Pages 18 – 21 cover the accounting for reverse mergers.
Cash Flow Woes Slows Post-Recession Recovery
Posted February 24th, 2011
Cash flow tight? It’s not just you.
Bloomberg Businessweek says it’s a trend of the times, and may have some unfortunate sticking power.
San Diego Investment Conference
Posted February 4th, 2011
Tomorrow is the San Diego Investment Conference, which Seale and Beers helps sponsor. We got here just in time to catch the sunset from the Torrey Pines State Beach…
Cut Debt Burden With an Audit
Posted January 19th, 2011
The Wall Street Journal got ahold of a University of Chicago Booth School of Business study showing that lenders tend to charge less to loan money to companies that have audited financial statements – the result is compelling reading for smart business executives.
Development vs. Exploration Stage Companies
Posted January 18th, 2011
When is a development stage company not a development stage company? When it’s public!
Accounting standards (ASC 915) state that a “development stage company” has certain reporting requirements that differ from the rest of the world and define such companies as:
typically be devoting most of its efforts to activities such as the following:
a. Financial planning
b. Raising capital
c. Exploring for natural resources
d. Developing natural resources
e. Research and development
f. Establishing sources of supply
g. Acquiring property, plant, equipment, or other operating assets, such as mineral rights
h. Recruiting and training personnel
i. Developing markets
j. Starting up production.
However, it would confuse investors for start-up companies in the extractive industries to use the same GAAP used by start-up companies in all other industries, so the SEC has published Industry Guide 7 for miners, online here…
It says, for public companies engaged in mining, that a development stage company company is “engaged in the preparation of an established commercially minable deposit” but is not yet in production. All other mining companies not producing revenue are in “exploration stage” – in the search for mineral deposits.
This is why you see companies that clearly fall within ASC 915’s definition of “Development Stage” labeled instead: “Exploration Stage.”
FINRA Rules Carry Heavy Enforcement Stick
Posted October 6th, 2010
FINRA rule 6490 went into effect last week, requiring all OTC companies to notify FINRA of corporate actions at least 10 days before the record date. Late notification can result in fines up to $5,000. Actions covered under the new rule include:
Dividends (of cash or stock)
FINRA expects to have online reporting forms built and mandated sometime in 2011. Until then, filers should use these paper forms:
Making the sale is the result of an operating decision, while bearing the risk of fluctuating spot rates is the result of a financing decision… because the risk of a foreign exchange transaction loss can be avoided by (1) making immediate payment… or (2) fixing the price of the purchase in US dollars instead of in the foreign currency, or (3) by entering into a forward exchange contract to hedge the exposed asset (cash). The fact that “US Company” did not take any of these actions is reflected by recognizing foreign currency transaction gains or losses in its income statement (reported as financial or nonoperating items) in the period during which the exchange rates changed. This treatment has been criticized, however, because earnings will fluctuate because of changes in exchange rates and not because of changes in the economic activities of the enterprise. The counterargument, however, is that economic reality is that earnings are fluctuating because the management chose to commit the reporting entity to a transaction that exposes it to economic risks and, therefore, the case can be made that the volatility in earnings faithfully represents the results of management’s business decision.
We think Wiley’s analysis of recognizing all forex gain/loss on the current income statement misses half of the controversy.
Let’s consider “Other Comprehensive Income,” that strange classification of things that are not included in net income. There is a list of things that must be included in OCI at ASC 220-10-55-2.
The list elements share a common theme – they are all things whose impact on net income cannot be determined because their impact has not stopped changing yet. They are transactions whose profit or loss wanders with the passage of time, until the company takes some future action that will allow the transaction to be determinable. Until then, any impact on net income could be reversed in a matter of weeks. Reporting such items in net income would be deceptive.
Temporary (unrealized) gain/loss on securities
Temporary (unrealized) gain/loss on hedging
These are transactions that take longer than our accounting principle of periodicity can handle. Their start time took place before the balance sheet date, and the end time has not yet happened. When the transaction is concluded, a realized gain/loss will be calculated and included in net income… but until then, all we can do is estimate what that actual gain/loss might someday be, by pretending the transaction was concluded at the balance sheet date – and treating that temporary estimate as OCI excluded from Net Income.
Forex gain/loss associated with unpaid bills that must eventually be settled in CAD, but which have not been settled as of the balance sheet date, would seem to fall squarely into this category. The forex gain/loss associated with a 10% change in the forex rate between incurring the expense and period end may well be reversed by a 15% swing the other way between period end and when the bill is paid.
GAAP, however, suggests any temporary gain/loss calculated at period end belongs in Net Income.
ASC 830-20-35-1 says:
A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes.
Note that we’ve highlighted the word “generally” – because there are plenty of exceptions, caveats and gotchas sunk into the more obscure sections of ASC 830. We’ll tackle those in our next post.
Direct Offering Costs
Posted August 15th, 2010
ASC 720-15-15-4(m) lists “Costs of Raising Capital” as excluded from the ASC 720 “Start-up Costs” topic. But what is the GAAP authority for netting “direct offering costs” against the proceeds that a company raises from selling stock rather than reporting them as an expense?
It’s a frequent flier in Intermediate Accounting textbooks – this is from Nikolai, Bazley and Jones’ eleventh edition (2009):
A corporation may incur miscellaneous costs that are related directly to issuing its capital stock. They include items such as legal fees, accounting fees, stock certificate costs, underwriter’s fees, promotional costs, and postage. When related to the initial issuance of stock at incorporation,. the corporation records these costs as an expense. On the other hand, the costs related to later issuances of stock are considered to be normal financing expenditures and reduce the proceeds from the issuances. When a corporation incurs these costs, it reduces additional paid-in capital for the amount of the costs.
Page 5.04 of CCH’s GAAP 2007 Handbook of Policies and Procedures offers:
The costs to issue stock include accounting and legal fees, printing charges, SEC filing fees, and promoting costs for the issue. The prevalent accounting treatment is to harge such costs against paid-in-capital as incurred.
SAB Topic 5A notes that it is okay to defer such costs until the proceeds from the offering are received, but otherwise the SEC seems silent on the issue.
Forex Gain/Loss and You – Part 1
Posted August 14th, 2010
Recording foreign currency exchange gains and losses (“forex gain/loss”) seems mysterious to many. The treatment prescribed by GAAP seems even more mysterious.
Money issued by different countries can be exchanged at a bank. But it would be easier to understand if you imagined a car dealer straddling the US-Canadian border. Let’s pretend all of her cars cost her $10,000 each.
Depending on the weather, the day of the week, how busy she is, or how nice you are to her, she might sell you a car for $20,000, plus or minus.
One of the factors she considers is the relative “worth” of the currency she is receiving from her customers. If, say, one side of the border (let’s call it the South side) had a federal government wildly spending money it doesn’t have, just printing the stuff up out of cheap ink and paper, she might decide that she would start charging 10% more for her car, if her customer was paying with that country’s currency.
Soon, moneychangers all along the border would demand $1.10 of the southern country’s money to pay off each $1 of bills denominated in the northern country’s money.
Such transactions, by themselves, don’t give rise to foreign currency conversion gain/loss – for that, you have to mix in the accountants.
Accrual accounting requires that expenses be recognized when they are incurred, rather than when they are paid. It is the timing difference between those two events that gives rise to forex gain/loss.
Here’s how it works:
If the “reporting currency” in which you present your financial statements are US Dollars (USD), and the exchange rate between Canadian Dollars (CAD) is 1.1 (where we left things along that imaginary border four paragraphs ago), and you get a legal bill of $909 denominated in Canadian dollars (CAD) , then you record an expense of $1,000 USD. [$909 x 1.1 = $1,000].
Three months later, you want to pay that bill. However, over the intervening three months, the exchange rate has gone from 1.1 to 1.2. That means you will have to come up with $1,091 USD in order to pay your lawyer $909 CAD [$909 x 1.2 = $1,091]. The $91 USD required to pay your bill today, over the $1,000 USD legal expense you recorded three months ago, is your forex loss.
Another way to look at it: forex gain loss is the difference in exchange rates between when you incur an expense and when you pay it [(1.1 – 1.2) * $909 = <$91>].
Auditors sanctioned by the PCAOB may appeal their sanction to the Securities and Exchange Commission. Today, the SEC decided the first such sanction – and upheld the PCAOB.
As a result, Florida auditor James Gately has been banned for life from participating in public company audits. The Commission found Gately had failed to cooperate with the Board’s attempted examination of his audit practice.