Christensen 12e Chap14 SM PDF

Preview

Summary

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent14- 1CHAPTER 14SEC REPORTINGANSWERS TO QUESTIONSQ14-1 The basis of the SEC's legal authority to regulate accounting principles stems from the Securities Exchange Act of 1934....

Description

Chapter 14 - SEC Reporting

CHAPTER 14 SEC REPORTING ANSWERS TO QUESTIONS Q14-1 The basis of the SEC's legal authority to regulate accounting principles stems from the Securities Exchange Act of 1934. In the 1934 Act, the SEC was given the legal responsibility to regulate trades of securities and to determine the types of financial disclosures that a publicly held company must make. Q14-2 The Securities Act of 1933 regulates the initial registration of securities. The Securities Exchange Act of 1934 regulates the periodic reporting of publicly traded companies. Q14-3 The Division of Corporation Finance receives the registration statements of companies wishing to make public offerings of securities. The Division of Enforcement investigates individuals or firms who may be in violation of a security act. Q14-4 The Foreign Corrupt Practice Act of 1977 requires that companies maintain accurate accounting records and an adequate system of internal control. An adequate system of internal control should contain the following: a. b. c. d.

Strong budgetary controls An objective internal audit function that helps develop, document, and then monitor the control system An active audit committee comprised of nonmanagement members from the company's board of directors A review of the internal control system by the independent auditors *The FCPA indicated that the cost of an internal control procedure should not outweigh its benefit to the firm

Q14-5 Regulation S-X covers the form and content of financial disclosures; specifically, this Reg. covers the form and content of financial statements, schedules, footnotes, reports of accountants, and pro forma disclosures. Items included in Regulation S-K are articles specifying disclosure rules of nonfinancial items to be included in registration statements. Examples include a description of the business, management's discussion and analysis, disagreements with accountants, and required information about new stock issues. Q14-6 Under Regulation A and Regulation D, certain public offerings of securities are exempted from the comprehensive registration requirements of the SEC.

Regulation A provides for two exemptions from full registration requirements as follows: 1. "Tier 1" issuances of up to $20,000,000 within a 12-month period can be exempt if the entity files a notice with the SEC and an “offering circular” containing financial and other information provided to the persons to whom the offer is made (the financial statements in the offering circular do not have to be audited). There is no ongoing reporting requirement for a Tier 1 issuance other than a final report on the results of the offering. 14-1 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

2. "Tier 2" issuances of up to $50,000,000 within a 12-month period can be exempt if the entity files an offering circular and the financial statements are audited. Tier 2 issuances are subject to ongoing reporting, however only semiannual reports (not quarterly reports) are required. Regulation D provides three exemptions from full registration requirements as follows: 1. Rule 504 of Regulation D exempts small issuances up to $1,000,000 within a 12-month period to any number of investors. No specific disclosures are required, but the offerer must send a notice of the offering to the SEC within 15 days of the first sale of the securities. 2. Rule 505 of Regulation D exempts issuances up to $5,000,000 within a 12-month period. The sales can be made to up to 35 “unaccredited investors” and to an unlimited number of “accredited investors.” Accredited investors include banks, credit unions, insurance companies, partnerships and corporations, and individuals having a net worth exceeding $1,000,000 or individual income of $200,000 for the two most recent years. Unaccredited investors are persons who do not meet the income or net worth requirements. An unaccredited investor who purchases the securities must be supplied audited balance sheets along with other financial statements. If the sales are only to accredited investors, no disclosures are required. Under Rule 505, the SEC must be notified within 15 days of the first sale, and the issuer must restrict the purchasers’ rights to resell the securities, generally for a period of two years. The securities typically state the nature of their restriction and the fact that they have not been registered with the SEC. 3. Rule 506 of Regulation D allows private placements of an unlimited amount of securities and applies, in general, the same rules as Rule 505 except that the maximum of 35 unaccredited investors must be sophisticated investors who have knowledge and experience in financial affairs. Q14-7 A company uses a Form S-1 registration form when the general registration is for a first-time offering and no other publicly traded stock has been issued by that company. A company may use a Form S-3 registration form for a new stock issuance when the registrant is large and established, possessing stock that has been trading for several years. Q14-8 (a) A customary review is a thorough examination by the SEC and may result in acceptance of the registration or a comment letter from the SEC. (b) A comment letter is issued by the SEC specifying the deficiencies that must be corrected before the securities may be offered for sale. (c) A red herring prospectus is a preliminary prospectus providing information to investors about an upcoming issue. This type of prospectus has a cover printed in red ink indicating it is not an offering statement and the securities being discussed are not yet available for sale. (d) Shelf registration allows large, established companies with other issues of stock already actively traded to file a registration statement with the SEC for a stock issue which

14-2 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

may be brought off the shelf and updated within a very short time when the company wants to actually issue the stock. Q14-9 Form 10-K is the annual filing to the SEC, and is broken into four parts. Parts I, II, and III contain the basic financial information including the audited financial statements, the management discussion and analysis, the report by management on internal control, and the auditor’s opinion. Part IV contains additional schedules and exhibits. For “accelerated filers” (those companies having at least $75 million in aggregate market value and been subject to the periodic and annual reporting requirements for at least one year), the Form 10-K must be filed with the SEC within 60 days after the end of the company's fiscal year-end. Other companies, such as small businesses, have 90 days in which to file their 10-Ks. Q14-10 Interim reports submitted to the SEC are not required to be audited. The public accountant is expected to review, on an ex post basis, the information provided in the company's Form 10-Qs as part of the annual, year-end audit. Q14-11 In 2004, the SEC enlarged the list of items that must be reported on the Form 8K. The entire list is presented in the chapter. Although the registrant’s accounting function would be involved with almost of the specific items, those items for which the particular involvement of the accounting function would be the greatest are: 1.03. 2.01. 2.02. 2.03.

The bankruptcy or receivership of the company Completion of the acquisition or disposition of assets Public announcement of material financial results Creation of a direct financial obligation under an off -balance sheet arrangement 2.04. An event that accelerates or increases an obligation under an off -balance sheet arrangement 2.05. Costs associated with exit or disposal activities 2.06 Material impairments of assets 4.01 Changes in the registrant’s certifying accountant 4.02 Non-reliance on previously issued financial statements or audit report 5.03 Changes in the registrant’s fiscal year Q14-12 A proxy is a request by the company, or by a stockholder, for a security holder's vote on a corporate matter. Proxy solicitations must include a full discussion of the matters to be voted on, and must also include the most recent annual shareholders' report if the present management is making the solicitation for a meeting at which directors will be elected. Q14-13 Part I of the Foreign Corrupt Practices Act (FCPA) prohibits individuals associated with United States companies from giving bribes to foreign governmental or political officials for the purpose of securing a contract or otherwise increasing the company's business. Part II of the FCPA requires all public companies, whether operating internationally or not, to keep detailed records that accurately and fairly reflect the company's financial transactions, and to develop and maintain an adequate internal control system. The impact of this act is to require companies to establish and maintain an adequate internal control system, to require public accountants to evaluate the company's internal controls, and to communicate any material weaknesses in those controls to the company's top management and board of directors. Q14-14 The MD&A must include a discussion of trends and expected changes on the company’s financial condition, changes in financial condition, and its results from 14-3 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

operations for the last three-year period. SEC rules require management to discuss the following items in the MD&A: a. Liquidity b. Capital resources c. Results of operations (a line -item analysis of material changes) d. Off-balance sheet arrangements e. Tabular disclosure of contractual obligations Q14-15 The Sarbanes-Oxley Act of 2002 placed a number of requirements on both companies and their auditors. A Public Company Accounting Oversight Board (PCAOB) was created with the authority to regulate registered public accounting firms and establish standards for audit firm quality controls. A second major requirement was that the CEO and CFO had to file with the SEC a notarized statement attesting to the accuracy of their financial filings. After the initial filing, management must periodically assess and report on the effectiveness of their company’s internal control over financial reporting structure and processes. A third major requirement is that an accounting firm can provide a client company with either auditing or consulting services, but not both! And the auditing firm must rotate the partners who work on each client at least every five years. A fourth major requirement is the enhanced responsibilities assigned to a public company’s audit committee of the Board of Directors. This group of nonmanagement directors is charged with the appointment, compensation and oversight of the work of the public accounting firm employed by the company. Furthermore, the audit committee must approve all services provided by the auditor. And fifth, the criminal penalties for destroying audit records in a federal or bankruptcy investigation, or committing securities fraud, were increased substantially.

14-4 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

SOLUTIONS TO CASES C14-1 Objectives of Securities Acts [CMA Adapted] a.

Investment practices of the 1920s that contributed to the erosion of the stock market include the following: – The prices of securities were manipulated through the use of "wash sales" or "matched orders." Brokers or dealers engaged in prearranged buy and sell orders that created the impression of activity and drove up prices. When the public began buying, driving prices up even higher, the brokers and dealers would sell, making huge profits before prices fell back to market level. – False or misleading financial statements were issued to lure unwary investors. – The excessive use of credit to finance speculative activities served to undermine the market. There was no limit to the amount of credit or "margin" that a broker could extend to a customer. As a result, a slight decline in market prices often caused overextended customers to sell when margins could not be covered, thus further reducing prices. – Corporate officials and other "insiders" misused information about corporate activities to take advantage of fluctuations in stock prices.

b. 1. The objectives of the Securities Act of 1933 are to: – provide investors with financial and other information concerning the initial offering of securities for sale, thus ensuring full and fair disclosure. Companies were required to file a registration statement and prospectus for review. – prohibit misrepresentation, deceit, and other fraudulent acts and practices in the sale of securities. 2. The objectives of the Securities Exchange Act of 1934 are to: – regulate the trading of securities on secondary markets by requiring the registration of securities traded on any national exchange. – create a regulatory agency, the Securities and Exchange Commission, to administer the requirements of both the 1933 and 1934 acts. c. The provisions of the Foreign Corrupt Practices Act of 1977 include the requirement for public companies to devise and maintain a system of internal accounting controls to provide reasonable assurance that transactions are properly authorized, recorded, and accounted for. The Dodd-Frank Act created (1) the Financial Stability Oversight Council and Orderly Liquidation Authority to oversee the financial stability of firms that have a significant influence on the economy (i.e., companies described as being “too big to fail”), (2) the Consumer Financial Protection Bureau (CFPB) to prevent predatory mortgage lending and ensure that consumers understand the mortgage terms prior to finalizing their paperwork and (3) the SEC Office of Credit Ratings to ensure that agencies provide meaningful and reliable credit ratings of the entities they evaluate.

14-5 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

C14-2 Roles of SEC and FASB [CMA Adapted] a.

The Securities and Exchange Commission (SEC) was created through the Securities Exchange Act of 1934. As a result of this Act, the SEC has legal authority over accounting practices. The U.S. Congress has given the SEC broad regulatory power to control accounting principles and procedures in order to fulfil its goal of full and fair disclosure. Specific responsibilities of the SEC include: – – – –

b.

Regulating the sale of securities on secondary markets Regulating the initial offerings and actual sales of stock in interstate commerce Prescribing the forms and reports to be filed and be made publicly available (Students may include a number of other responsibilities. The important learning objective is that students understand that the SEC is very important in the U.S.’s capital formation process.)

The SEC was created by Congress, and the FASB was created by the private sector; therefore, no direct relationship exists. However, the SEC historically has followed a policy of relying on the private sector to establish financial accounting and reporting standards. The SEC recognized the FASB as authoritative in one of its Accounting Series Releases (ASR 150: Dec. 20, 1973). There has been cooperation between the SEC and FASB, but at times the relations between these bodies have become strained. In cases of unresolved differences, the SEC rules take precedence over FASB rules for the companies within SEC jurisdiction. The Sarbanes-Oxley Act of 2002 gave the PCAOB the responsibility for establishing auditing standards and also renewed the SEC’s ultimate responsibility for establishing accounting and financial reporting standards.

14-6 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

C14-3 Information Content of Proxy The information presented in the company’s proxy is expected to change from year to year. Some instructors will select a local company or other one of interest to their students as an exemplar for their discussions during the semester. There are strong learning advantages to using one company for applications of the concepts presented in your advanced financial accounting course. This case can be applied to any publicly traded company. a. The proxy includes the proposals placed before the shareholders. Common examples of such proposals include: 1. Election of Directors. The company lists the Directors up for election this year The Board of Directors normally unanimously recommends a vote “For” the nominees. 2. Ratification of Independent Registered Public Accounting Firm. The Board’s Audit Committee appoints the independent registered public accounting firm (auditors) for the year. The Board of Directors normally unanimously recommends a vote “For” this proposal. 3. Stockholder Proposals. Sometimes groups of stockholders will make proposals they wish to have placed for vote by the shareholders. These resolutions may include provisions regarding shareholders’ rights, establishment of specific committees by the Board of Directors to issue reports on issues of concern to corporate governance by the management of the company, and proposals to revise specific sections of the company’s By-Laws. Management typically makes a recommendation either in favor of, or in opposition to, each of the stockholder proposals. b. The Board of Directors of most registrants have four standing committees, as follows: 1. Audit Committee. This committee has a number of oversight responsibilities for financial matters, as defined in the Sarbanes-Oxley Act of 2002. Included is the responsibility to appoint, retain, compensate, evaluate, and if appropriate, to replace the auditors. The members of the Audit Committee must be nonmanagement members of the Board of Directors. 2. Compensation Committee. The Compensation Committee approves and recommends standards for the company’s compensation program and plans, including incentive compensation, retirement, and other benefit plans. The Committee reviews the performance of the Chief Executive Officer and fixes his compensation. In addition, the Committee reviews the company’s compensation practices for employees and officer workers, and fixes the salary and other compensation of all officers of the company. 3. Governance Committee. This committee reviews the company’s Shareholder Rights Plan, makes recommendations regarding the appropriate size and composition of the board, recommends a slate of nominees for the board, and makes recommendations for candidates for election as officers of the company. 4. Public Policy Committee. The Public Policy Committee assists in the board’s oversight responsibilities for company matters related to public and social policy, including investor, consumer and community relations issues and employee safety programs, policies and procedures, and labor relations issues. The committee also oversees the company’s business conduct code. c. The total annual compensation received by the chairman and CEO of the company is presented in the proxy. The compensation typically includes a salary, a bonus, and selected stock options in addition to other incentive plan payments.

14-7 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 14 - SEC Reporting

C14-4 Form 10-K Disclosures a. The Management’s Discussion and Analysis must contain information ...