The U.S. Securities and Exchange Commission has issued final rules adopting amendments to certain financial disclosure requirements and to the disclosure required in Management’s Discussion and Analysis (MD&A). We previously discussed the proposed rules in a January 2020 client alert, and the final rules are substantially consistent with the proposal.
The final rules, issued on November 19, 2020, address Items 301 (Selected Financial Data), 302 (Supplementary Financial Data) and 303 (MD&A) of Regulation S-K. We discuss the most significant of these changes in the following alert.
Amendments to Item 301 (Selected Financial Data)
Current Item 301 requires companies to provide selected financial information for each of the five most recent fiscal years. It does not apply to smaller reporting companies, and emerging growth companies are not required to provide selective financial information for any year for which audited financial statements were not included in the company’s initial registration statement. The final rules eliminate Item 301. Notwithstanding the elimination, the adopting release encourages companies to consider whether trend information for periods earlier than those presented in the financial statements included in the report or registration statement may be helpful to investors in light of the objectives of MD&A disclosure (as further discussed below).
Amendments to Item 302 (Supplementary Financial Data)
Current Item 302 requires reporting companies, other than smaller reporting companies, to include selected financial information for each fiscal quarter in the two most recent fiscal years. Under new Item 302, companies will no longer be required to provide two years of tabular selected quarterly financial data. Companies will now be required to provide a principles-based discussion of any material retrospective changes for any quarter within the two most recent fiscal years, and any subsequent interim period that is presented. Companies must explain the reasons for such material changes and disclose summarized financial information related to the statements of comprehensive income and earnings per share reflecting such changes.
Amendments to Item 303 (MD&A)
Item 303(a) (Objective)
The final rules add a new subsection (a) to Item 303 stating that the objective of the MD&A section is to provide material information relevant to an assessment of the financial condition and results of operations of the registrant including an evaluation of the amounts and certainty of cash flows from operations and from outside sources. New Item 303(a) also includes elements of current instructions 1, 2 and 3 to current Item 303(a) and incorporates past SEC guidance on the purpose of MD&A. The SEC noted that the requirements of new subsection (a) are intended to “better allow investors to view the registrant from management’s perspective.”
With the creation of new Item 303(a), current Items 303(a) (Full Fiscal Years) and 303(b) (Interim Periods) have been re-captioned as Items 303(b) and 303(c).
Current Item 303(a) included subsections (1) and (2) addressing liquidity and capital resources, subsection (3) addressing results of operations and subsections (4) and (5) requiring disclosure of off-balance sheet arrangements and a table of contractual obligations. The final rules amend several sections of new Item 303(b) to streamline disclosure and remove duplicative requirements.
- Reasons underlying material changes. Instruction 4 to current Item 303(a) includes a requirement that companies discuss the “causes” for material period over period changes and provides additional guidance on this requirement. The substance of Instruction 4 is now included in new Item 303(b), with a slightly revised requirement to discuss the “underlying reasons” for material changes, in place of the “causes.”
- Cash requirements. Current Item 303(a)(2) requires, in the discussion of capital resources, a description of material commitments for “capital expenditures.” This will be replaced in new Item 303(b)(2) by a description of “cash requirements,” including capital expenditures.
- Trend impact. Current Item 303(a)(3)(ii) requires a description of trends or uncertainties that have had or that the company “reasonably expects will have” a material impact on revenues. New Item 303(b)(3)(ii) replaces the “reasonably expects will have” analysis with a requirement to disclose known trends or uncertainties that have had or that “are reasonably likely to have” a material impact on revenues.
- Price and volume impact on revenues. Current Item 303(a)(3)(iii) states that, to the extent the financial statements disclose material increases in revenues, a discussion should be provided of the extent to which such increases are attributable to increases in prices or to increases in the volume of goods or services being sold or to the introduction of new products or services. New Item 303(b)(3)(iii) requires such discussion if the statement of comprehensive income, as opposed to the financial statements, disclose such an increase.
- Impact of inflation. The final rules eliminate current Item 303(a)(3)(iv), which required discussion of the impact of inflation and price changes on revenue and income from continuing operations. Per the objective provided in new Item 303(a), companies will now be expected to discuss the impact of inflation or changing prices if they are part of a known trend or uncertainty that had, or is reasonably likely to have, a material impact on revenue or income from continuing operations.
- Off-balance sheet arrangements. Current Item 303(a)(4) requires a discussion of off-balance sheet arrangements. This item has been replaced by a new instruction to Item 303(b) requiring companies to discuss material commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons even when the arrangement results in no obligation being reported in the registrant’s consolidated balance sheets.
- Contractual obligations. Current Item 303(a)(5) requires that companies provide a table of their contractual obligations. This requirement has been removed from new Item 303(b), with the expectation that the principles-based approach of MD&A would elicit a discussion of the matters previously covered by the table if material to an understanding of the company’s cash requirements. A new instruction to new Item 303(b) further makes this point.
- Critical accounting estimates. In 2003, the SEC provided guidance that companies should include in their MD&A a discussion of their critical accounting estimates and certain information about such estimates. While such guidance was never included in Item 303, it became widely followed. New Item 303(b) now incorporates the substance of this guidance into the item itself. Among other things, it requires quantitative as well as qualitative information necessary to understand the critical estimate and the impact the estimate had or is reasonably likely to have on the company’s financial condition or results of operations, to the extent the information is reasonably available and material. The SEC noted in the adopting release that companies frequently just repeat the information in the financial statement footnotes about significant accounting policies. Therefore, the final rules are intended to eliminate duplicative disclosures and promote enhanced analysis to supplement the disclosure in the financial statements.
Item 303(c) (Interim Periods)
Amended Item 303(c) provides for interim period disclosure requirements and will allow for more flexibility than current Item 303(b) by permitting companies to compare their most recently completed quarter to either the corresponding quarter of the prior year or to the immediately preceding quarter. In any period when the company elects to compare the current quarter to the immediately preceding quarter, it must provide summary financial information that is the subject of the discussion for that quarter or identify the prior EDGAR filing that presents such information so that a reader may have ready access to the prior quarter financial information being discussed. In addition, if in a subsequent Form 10-Q, a company changes the comparison from the comparison presented in the immediately preceding Form 10-Q, it would be required to explain the reason for the change and present both comparisons in the filing in which the change is announced.
Reporting companies are required to comply with the final rules beginning with their first fiscal year ending on or after the date that is 210 days after publication of the final rules in the Federal Register (the "mandatory compliance date"). Companies will be required to comply with the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. For example, for companies with a fiscal year ending on December 31, mandatory compliance will begin with their Annual Report on Form 10-K for the 2021 fiscal year that’s filed in 2022. Voluntary early compliance is permitted, but any early compliance must comply with the amendments in their entirety.