(A) Describe, identify and explain how the accounting estimates would affect the company's reported financial results, condition and changes in financial condition and, where material identify the affected line item. The disclosure would also have to describe the methodology underlying each critical accounting estimate, the assumptions regarding highly uncertain matters and other material assumptions; 

 

(B) For each critical accounting estimate, the company must discuss changes that would result either from (i) making reasonably possible near-term changes in the most material assumption(s) underlying the estimate or (ii) using in place of the recorded estimate the ends of the range of reasonably possible amounts which the company likely determined when formulating its recorded estimate.  The company would then have to describe the impact of those changes on its overall financial performance, as well as a qualitative and quantitative discussion of management's history of changing its critical accounting estimates in recent years.

 

(C) The disclosure must discuss whether or not management discussed the development, selection and disclosure of these estimates with the company's audit committee. This latter element reflects the SEC's new policy of increasing the importance of the audit committee, as explained in last month's column.

 

If there is a new accounting estimate which becomes relevant, the MD&A discussion must disclose the following about this first-time disclosure: (i) the events or transactions that gave rise to the initial adoption; (ii) the accounting principle adopted and the method of applying the principle; and (iii) the impact, discussed qualitatively on the company's financial presentation. In addition, if upon the initial adoption the company had a choice between two acceptable generally accepted accounting principles, the company should discuss why it made the choice and explain its methodology.

 

Because of the importance, lack of precedence and complexity of this proposal, which is designed to greatly enhance the transparency of financial statements, the SEC staff is soliciting and encouraging comments from financial professionals and others directly affected by this new proposal. What is especially unique is that the SEC is not only specifying the general areas in which it seeks comments, but is requesting comments on specific items within each of those areas.  Each financial professional should read this release to analyze the specific comments sought by the SEC within each general comment area, especially as it may affect your particular company. 

 

Set forth below are the general areas in which the SEC is requesting specific comments. Each general area includes a number of specific issues for comment:

 

1.  Whether or not the SEC should broaden the scope of these proposals to achieve a broader objective of even better disclosure. 

 

2.  The proposed definition of critical accounting estimates. 

 

3.  The proposed identification and analysis of the changes in these estimates.

 

4.  Proposed disclosure of past material changes in critical accounting
estimates. 

 

5.  Proposed disclosures about discussions between senior management and the audit committee regarding the development, selection and disclosure of critical accounting estimates. 

 

6.  Identification of the segments affected and the proposed additional disclosure of the critical accounting estimates on a segment basis.

 

Because of the complexity and lack of precedence of these proposed new disclosures in the MD&A, the SEC staff has provided three examples of the application and proposed new MD&A disclosures to assist companies, its financial and legal professionals and other affected persons or entities to understand the complex new disclosures required by this proposal. These disclosures would apply to all companies, except small business issuers that have not had revenues from operations during the last two fiscal years. The proposed new MD&A disclosure requirements would cover the most recent fiscal year and any subsequent interim period for which financial statements are required to be presented. 

 

The SEC estimates that the average additional cost, both for internal staff and external professionals, relating to these new disclosures, exclusive of additional costs in any registration statements filed under the 1933 Act, will be approximately $14,000 per annum.  It is the author's belief that initially these costs may be greater, because defining which accounting estimates are critical to a particular company and how to handle these issues under the new SEC rule, will require substantial additional work.  This is especially so, since the impact of this MD&A disclosure is probably one of the most significant changes in the last 70 years.  The proposal is extremely complex and I urge each financial professional to read this proposal a number of times in order to be in a position to discuss all of the issues and long term implications of these new disclosures with the senior management, the audit committee and outside accountants for the company. 

 

The SEC has requested that comments be received by it on or before July 19, 2002.  Because of the importance of the proposed new disclosures, and the SEC's desire to have input from those most directly affected by this major change, I urge each company to not only carefully review these proposed changes, but be in a position to provide meaningful analysis and discussion to the SEC on additional issues and concerns which are raised by this broad-ranging and important proposed change. 

 

If you need a copy of this SEC release or a further explanation of its potential impact, please feel free to contact me at hechtlawoffice@aol.com or at (212) 490-3232.