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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the 2008 AICPA National Conference on Current SEC and PCAOB Developments


Robert G. Fox III

Professional Accounting Fellow, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 8, 2008

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.


Good afternoon. It is a pleasure to be here. Today, I would like to talk about judgment regarding accounting matters, push down of debt and goodwill impairment.

Judgment regarding Accounting Matters

The SEC’s Advisory Committee on Improvements to Financial Reporting, commonly referred to as “CIFiR” recommended that the SEC issue a statement of policy articulating how the SEC evaluates the reasonableness of accounting judgments, including factors that the SEC considers when making this evaluation.1

The issue of judgment regarding accounting matters is not new or unique, but recent events, such as the debate over fair value reporting, have re-emphasized the importance of judgment. In today’s complex world, there are many accounting issues where a reasonable range of acceptable practice may exist. In CIFiR’s report, one of their main observations was that when such an issue arose, a registrant might demand specific guidance to ensure that their conclusion was not “second-guessed”. CIFiR’s point was that repeated demands for additional guidance, if fulfilled, can result in unnecessary complexity. CIFiR also addressed the perception that the SEC staff’s evaluation of judgments was not as clear or as transparent as it could be.

As to CIFiR’s observation related to demands for additional guidance causing unnecessary complexity, I will leave the debate on “rules” vs. “principles” for others. However, I believe that CIFiR had many good ideas worthy of consideration. This is not to say that in every situation where a registrant follows certain factors, a reasonable application of accounting standards necessarily results that the staff would not question. However, before you conclude that additional detailed guidance is necessary because of a concern about the staff “second guessing” your judgment, please take a step back and consider your conclusion. Have you accounted for your transaction or issue in a transparent manner, after careful application of GAAP and after involving individuals with the appropriate knowledge and expertise? If you aren’t comfortable with your conclusion after consideration of these factors, you might want to reconsider whether your judgment was reasonable.

I believe that the staff does recognize that there may be a range of reasonable accounting judgments. The staff has attempted to highlight this many times in the past, for example in staff guidance such as SAB Topic 14.2, dealing with share-based payment transactions. I would like to emphasize once again that the staff does respect reasonable judgments made in good faith. As the staff noted in Topic 14, “different conduct, conclusions or methodologies by different issuers in a given situation does not of itself raise an inference that any of those issuers is acting unreasonably”. Of course, the staff’s evaluation of the appropriateness of the registrant’s judgment would be assisted by full and transparent disclosure surrounding the transaction.

One last item related to judgment. While I believe that the staff is more than willing to consider the reasonableness of your conclusion when you attempt to report in a transparent manner that is consistent with the substance of a transaction, it is difficult for the staff to accept judgment supporting the accounting for a transaction that is structured to be potentially misleading, to circumvent the objective of a standard or in a way that is opaque to investors. Therefore, if you attempt to structure a transaction to obtain a potentially misleading accounting result and do not fully comply with applicable GAAP, do not expect that a simple invocation of “respect my judgment” will serve as a defense for your accounting conclusion.

Push Down of Debt under SAB Topic 5J

One area that the staff has dealt with in the past year that has required the use of judgment relates to push down accounting discussed in SAB Topic 5J,3 specifically as it relates to situations where there is more than one subsidiary that was acquired in an acquisition. The example in Question 3 of SAB Topic 5J describes a situation where only one subsidiary is acquired, and assuming the other criteria of the SAB Topic are met, the debt related to the acquisition is pushed down to the financial statements of that subsidiary. Some have asserted a view that since the example in Question 3 only describes a situation where there is a single subsidiary, the requirements to push down acquisition related debt do not apply to situations where there is more than one subsidiary acquired.

Supporters of this view point out that SAB Topic 5J does not answer how to actually push down acquisition related debt to more than one subsidiary. For example, if one concluded that push down of debt was required, should 100% of the acquisition debt be reflected in the financial statements of each separate subsidiary, or should the debt be allocated on some pro-rata basis to each separate subsidiary? Further, if the debt is allocated on a pro-rata basis, should the debt be reflected on a net basis, or should acquisition debt be recorded at its full amount and a receivable from the other subsidiaries be recorded as well? The potential uncertainty related to these unanswered questions leads some to conclude that acquisition debt should not be pushed down when more than one subsidiary is acquired.

We do not believe that SAB Topic 5J should be interpreted to only apply to situations where one subsidiary is acquired. When a subsidiary, whether directly owned by the parent or not, is to assume the parent’s debt, the proceeds will be used to retire all or a part of the parent’s debt, or if the subsidiary guarantees or pledges its assets as collateral for the parent’s debt, acquisition related debt should be pushed down to all acquired subsidiaries. While the unanswered question pertaining to how the acquisition related debt would be recorded on the financial statements of the subsidiaries is significant, I do not believe that this should serve as an impediment to the application of push down accounting. Rather, I believe that there are merits to all of the approaches noted above, and there may be other approaches that have merit as well. A registrant should carefully consider the facts and circumstances of their particular transaction, and reach a conclusion to record the acquisition related debt in a manner that portrays the risks and the nature of the transaction that meets the information needs of investors.

Goodwill impairment

Goodwill impairment under the provisions of Statement 1424 is another area that requires the use of judgment. For many registrants, this judgment may be more challenging in the current environment due to recent market declines that indicate that a potential impairment exists. While we would expect more goodwill impairments than in prior years given the current environment, the requirements of Statement 142 do not require that goodwill be marked-to-market (or marked to market capitalization); however Statement 142 does requires a measurement of goodwill impairment when the fair value of the reporting unit falls below the carrying value of that reporting unit. For example, paragraph 23 of Statement 142 points out, an entity might derive “substantial value” from the ability to obtain control. Accordingly, the market capitalization of an entity may not fully capture the fair value of the reporting units as a whole. However, the amount of a control premium in excess of a registrant’s market capitalization can require a great deal of judgment. Contrary to some rumors I have heard, the staff does not have “bright line” tests that we use in determining the reasonableness of a control premium. Instead, we believe that a registrant needs to carefully analyze the facts and circumstances of their particular situation when determining an appropriate control premium and that there is normally a range of reasonable judgments a registrant might reach. While it would be prudent to reconcile the combined fair value of your reporting units to your market capitalization, I believe that this should not be viewed as the only factor to consider in assessing goodwill for impairment.

When a registrant is evaluating an appropriate control premium, I believe that an important factor to consider is their recent trends in market capitalization. Note that I said recent trends in their market capitalization. Especially in volatile markets, and other unique circumstances, it may not always be reasonable to look at a single day’s market capitalization. In some cases, I believe it would be more reasonable to look at market capitalization over a reasonable period of time leading up to the date at which you are testing for potential impairment. However, I would also note that it would not be reasonable for a registrant to simply ignore recent declines in their stock price, as the declines are likely indicative of factors the registrant should consider in their determination of fair value, such as a more than temporary repricing of the risk inherent in any company’s equity that results in a higher required rate of return or a decline in the market’s estimated future cash flows of the company.

If a registrant concludes that their current market capitalization does not reflect fair value then they should understand that the staff may ask them to support the propriety of their control premium or other reasons for such a conclusion. For example, I believe that this support should be based on factors such as an evaluation of control premium identifiable in comparable transactions or the cash flows associated with obtaining control of a reporting unit. A percentage selected because it allows the registrant to avoid an impairment or one based on an arbitrary percentage determined by a “rule-of-thumb” would not appear to be well reasoned. Nor do I believe it is appropriate to support a control premium based on the quantitative percentage that the control premium is in excess of the market capitalization. I would also note that the amount of supporting evidence supporting your judgment would likely be expected to increase as any control premium increases.


That concludes my prepared remarks. Thank you for your attention.




Modified: 12/08/2008