TheCorporateCounsel.net

March 3, 2005

Internal Controls and Lease Accounting

Following up on my blog of February 24th, I have been hearing from various members that the SEC, PCAOB and Big 4 are still kicking around how to treat the restatements caused recently by the SEC Chief Accountant’s letter on lease accounting for purposes of internal controls (i.e. whether it should be deemed to be a “material weakness” or simply a “significant deficiency.”) The magnitude of the impact of this letter was explored in yesterday’s article in the WSJ regarding the high number of restatements (carried on page B2A in the East Coast edition, but not available online for some reason).

With only a few weeks to go until 10-Ks are due for calendar-year companies, the stakes are high and time is short. Here are examples of the arguments being made by companies as to why their restatements for lease accounting shouldn’t be considered material weaknesses:

- There is no change in net cash flow. Although the balance sheet/income statement impacts of the correction of the “error” frequently aren’t material, auditors have told companies that they should consider the impact on their cash flow statements of the correction of the errors – as cash flow is shifted from one category to another – to be material if it would exceed the imaginary 5% threshold for material (which for a lease-intensive company it readily could).

- This is precisely the type of situation that PCAOB had in mind when it drafted PCAOB Auditing Std. No.2, ¶ 140 to provide that a restatement is only a “strong indicator” of a material weakness rather than an irrefutable presumption. The commentary allows some judgment here – see ¶¶ E95-E98 – but auditors are so intensely risk adverse that they are not exercising their judgments in this (or similar) situations.

- Companies do not think certain aspects of the SEC Chief Accountant’s letter have clear support in SFAS 13 and its progeny, particularly the concept that pre-occupancy leasehold build-outs always constitute “rent.” A number of companies also were not thrilled with the tone of the WSJ article or the quotes from the SEC. There were so many companies that were accounting for leases inconsistently with the SEC’s interpretation – and all of the Big Four were signing off on that accounting – that clearly they were not doing it intentionally wrong.

Some companies are preparing their draft 404 disclosure both ways in the hope that the SEC/PCAOB will say before the 10-K due date that it is okay for the Big Four to take the position that a “miss” on this issue is not a material weakness.

New 404 Deadline for Non-Accelerated and Non-US Filers

Yesterday, the SEC announced that it is extending the deadline for non- US and non-accelerated filers regarding 404 reports and auditor attestations. The SEC pushed out the deadline by one year, so that these filers now will have to include these documents in their first annual reports filed on – or after – July 15, 2006. For these types of companies, the year-long extension also applies to the rules requiring maintainance of internal control over financial reporting, periodic evaluation of changes in internal controls, and related changes to 302 certifications.

FYI, nearly 200 members have responded to our survey on the location, format and content of 404 reports – see the running results.

Analysis of Latest Compensation Proxy Disclosures

With so many of our members in the thick of drafting and reviewing proxy statement compensation disclosures – particularly compensation committee reports – we have posted this “Special Proxy Disclosures Supplement” on CompensationStandards.com. As can be seen from the table of contents of the special supplement below, members should not miss Mark Borge’s daily commentaries and pointers on good/bad disclosures and practices in “The Compensation Disclosure Blog.”

· The Morgan Stanley Compensation Committee Report – A Reprise
· Goldman Sach’s Aircraft Policy
· Intel’s 10-K Equity Disclosure
· A Model SERP Disclosure
· Do You 162(m)?
· American Express’ Fulsome Disclosure
· Tally Sheets Makes an Appearance
· Disclosing Option Grant Values