Remarks before the 2015 AICPA National Conference on Current SEC and PCAOB Developments

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Introduction

Good morning. It is an honor to be here with you. Today, I would like to discuss observations regarding the presentation of discontinued operations and the impact of post-vesting restrictions on the measurement of share-based payments.

Presentation of Discontinued Operations

A high quality accounting standard results in financial statements that provide transparent financial information that accurately depicts the economics of the underlying transactions. High quality accounting standards increase the usefulness of financial statements to investors and the capital markets. The FASB issued new guidance on reporting discontinued operations with one of its objectives being to make financial statements more meaningful by addressing concerns that too many disposals were qualifying for discontinued operations presentation. I believe that this new guidance, which allows for the use of judgment, results in more useful and transparent reporting of discontinued operations and has characteristics of a high quality standard. The guidance introduced new terminology into the judgment of determining whether the presentation of discontinued operations is appropriate, such as strategic shift and major effect. Under the new guidance, to present a disposal as a discontinued operation, a component (or group of components) that is disposed of or classified as held for sale must represent “a strategic shift that has (or will have) a major effect on an entity’s operations and financial results”. [1]

So how does one determine what represents a strategic shift that has or will have a major effect? I would observe that the standard requires judgment to determine whether a disposal meets the revised definition for a discontinued operation. ASC 205-20 provides several examples of what may constitute a strategic shift that will have a major effect on operations and financial results. The examples include a sale of a product line that represents 15% of total revenue; the sale of a geographic area that represents 20% of total assets; and the sale of all stores in one of two types of store formats that historically provided 30-40% of net income and 15% of current net income. We have heard suggestions that the quantitative factors included in the examples are meant to create thresholds by which to determine whether a disposal represents a strategic shift that has a major effect on the entity’s operations and financial results. In my view, the thresholds are illustrative and do not establish bright lines or safe harbors.

A question also arises as to what constitutes a financial result? I believe that judgment is required to determine which financial results are indicative of a strategic shift that has a major effect. I think there are certain “primary” metrics that are prominently presented in the financial statements and communicated to investors. For example, revenue, total assets and net income are items that I would clearly consider to be relevant metrics. However, the identification of other financial results may require judgment, with an eye toward what is relevant from an investor’s perspective. It also may be helpful to understand alternative measures, as certain operating metrics may also be relevant, particularly where the Company has used the measure on a consistent basis for communicating operating and financial results. I also believe that it is prudent to consider the effect of the relevant financial metric on the entity from the perspective of current, historical and forecasted results. In my view, the guidance indicates a need to evaluate the totality of the evidence, and there is no single financial metric that is determinative in concluding that a disposal had a major effect on the entity’s operations and financial results.

While the guidance does not provide quantitative bright lines in determining whether a disposal is a strategic shift that has a major effect, the less significant a financial impact the disposal has on an entity, the stronger the qualitative evidence would need to be. In evaluating whether the qualitative evidence supports a strategic shift that has a major effect, I think it is important to consider the prominence and consistency with which the disposed component and related qualitative factors have been discussed within periodic filings.

Post-vesting restrictions                

I would now like to turn to an observation regarding the impact of post-vesting restrictions on the measurement of share-based awards. The measurement of share-based awards impacts compensation expense. Post-vesting restrictions, such as transfer or sale restrictions, are a common feature of many share-based payment arrangements.

ASC 718 provides guidance on the accounting for share-based awards when the sale of the underlying shares is prohibited for a period of time subsequent to the awards vesting date. The post-vesting restrictions should be considered when estimating the grant-date fair value of the award.[2] I would expect that a post-vesting restriction may result in a discount relative to the market value of common stock to reflect that the market shares can be freely traded while restricted shares cannot. The assumptions used in determining the value of the share-based award should be attributes that a market participant would consider related to the underlying award, rather than an attribute related to the individual holding the award.

Some market participants have indicated that post-vesting holding restrictions on share-based payment awards can result in significantly lower stock compensation expense. While post-vesting restrictions should be considered in estimating the fair value of share-based payments[3], when evaluating the appropriateness of measurement in this area, we continue to look to the guidance in ASC 718-10-55-5, which states that “…if shares are traded in an active market, post-vesting restrictions may have little, if any, effect on the amount at which the shares being valued would be exchanged”. With that being said, I would encourage you to consult with the Staff if you believe that you have a fact pattern in which a post-vesting restriction results in a significant discount being applied to the grant-date fair value of a share-based award.

Thank you for your time and attention.