Navigating SEC and PCAOB regulatory matters - EY SEC and PCAOB regulatory matters Facilitators: ... AQIs could help audit committees in their discussions with auditors ... Affiliates

Navigating SEC and PCAOB regulatory matters Facilitators: Serena Wolfe, Ernst & Young LLP Dan Helwing, Ernst & Young LLP

Solution Set – Session A

Page 1 2015 REIT CFO and Tax Director Roundtable

► SEC staff focus areas ► S-X Rule 3-14 practice matters ► PCAOB regulatory update

Agenda


SEC staff focus areas Areas of frequent comment

Comment letter topic Ranking Frequency

2015 2014 2014 and 2015 MD&A 1 1 44% Fair value measurements 2 2 21% Revenue recognition 3 5 16% Non-GAAP financial measures 4 6 15% Signatures, exhibits and agreements 5 3 16% Income taxes 6 4 14% Segment reporting 7 9 12% Intangible assets and goodwill 8 7 12% Acquisitions and business combinations 9 10 11% Executive compensation 10 8 12%

Source: Audit Analytics – Comment letter taxonomy for SEC staff comment letters issued to registrants related to Forms 10-K from 1 July 2013 to 30 June 2015


► Staff is taking a “refreshed approach” to reviewing segment disclosures and challenges: ► Identification of chief decision maker (CODM)

► Registrant’s shouldn’t default to CEO ► Identification of operating segments

► No rebuttable presumption ► Reports provided to CODM are one factor to consider ► Focus on process to make decisions about resources and assess performance ► Staff requests detailed information on organizational structure, management processes and discrete

financial information used ► Economic similarity as support for aggregation

► Focusing on qualitative criteria ► High hurdle, all criteria need to be met

► Impact of changes in the business (e.g., acquisitions, economic characteristics)

SEC staff focus areas Segment reporting


► Tell us the title and describe to us the role of each of the individuals who report to the Chief Operating Decision Maker (CODM).

► Please identify and describe to us the role of each of your segment managers. ► Describe to us the information regularly provided to the CODM and how frequently it is

prepared. Similarly, describe to us the financial information provided to the Board and how frequently it is prepared.

► Explain to us how budgets are prepared, who approves the budget at each step of the process and describe the level of detail discussed at each step.

► Tell us how often the CODM meets with his staff to discuss variances between actual and budgeted results.

► Describe the level of detail communicated to the CODM when actual results differ from budgets and clarify who is involved in meetings with the CODM to discuss budget variances.

► Describe the basis for determining segment manager compensation.

SEC staff focus areas Example segment comment


► Focus on whether all material weaknesses are being identified and evaluated appropriately

► Is there a “reasonable possibility” that a material misstatement will not be prevented or detected? ► Does not require an actual material misstatement – the “could factor” ► Recent focus on immaterial error corrections

► Evaluating severity of control deficiency includes both quantitative and qualitative factors

► Properly describe material weakness – design or operational failure?

A material weakness is a deficiency, or combination of deficiencies, in ICFR such that there is a reasonable possibility that a material misstatement will not be

prevented or detected on a timely basis

SEC staff focus areas Internal control over real estate areas


► Property acquisitions ► Business vs. asset determinations ► Below market lease intangibles

► With respect to your below-market lease intangibles, please tell us how you considered any fixed rate renewal options in your estimate of the remaining term of the underlying leases and your basis for your determination.

► Funds from operations ► Consistency with NAREIT definition ► Adjusted FFO

► Appropriate labeling of reconciling items and measures ► Transparency into how measure is useful to investors

► Combined periodic reporting ► Parent owns substantially all of the subsidiary ► No more than nominal differences

SEC staff focus areas Real estate areas


► Capitalized overhead ► Please tell us the amount of personnel costs you have capitalized. To the extent material, in

future periodic filings, please separately quantify and disclose personnel costs capitalized to real estate under redevelopment and deferred leasing costs for all periods presented and discuss fluctuations in capitalized personnel costs for all periods presented within your MD&A. To the extent you do not believe these amounts are material, please tell us how you made that determination.

► Relationship of market to expiring rents ► To the extent you have material lease expirations in the next year, please include

discussion of the relationship of rents on expiring leases to market rents. In addition, please expand your disclosure of your leasing activities for the most recent period, including a discussion of the volume of new or renewed leases, average rents or yields on new and renewed leases…

SEC staff focus areas Real estate areas


► Rule 3-14 requirements differ from Rule 3-05: ► Rule 3-14 applies only to real estate operations ► Different significance threshold – 10% versus 20% ► Abbreviated financial statement presentation – revenues and direct expenses

► Significance is calculated by comparing the investment in the property with the registrant’s total assets as of latest audited balance sheet

► Financial statements for significant acquisitions required in: ► Form 8-K ► Registration statements (includes individually significant acquisitions and probable acquisitions,

individually insignificant properties that are significant in aggregate) ► Financial statements required for individually significant acquisitions made during each year presented, even if

reflected in audited results for entire year

► Number of periods required depends on purchase from related or third party ► SEC recently issued a Request for Comment to seek input on S-X requirements for other

entity financial statements

S-X Rule 3-14 Background


► Real estate operations – have continuity and predictability of cash flow ► Examples of real estate operations:

► Commercial property leasing ► Apartment leasing

► Not real estate operations: ► Hotels/motels ► Nursing homes ► Golf courses, auto dealerships, equipment rental operations

► Rule 3-14 vs. 3-05 when acquisition that is between 10% and 20% has operations other than leasing

S-X Rule 3-14 Defining real estate operations


► Properties subject to triple net lease ► Tenant financial statements required if such properties represent a significant portion (e.g.,

20%) of registrant’s assets ► Significance measured based on most recent balance sheet, whether audited or unaudited ► Ongoing reporting may be necessary ► Property financial statements required if between 10% and 20%

► Owner-occupied properties ► REIT formation transactions ► Blind pool offerings

S-X Rule 3-14 Other practice matters

PCAOB regulatory update


► Review controls, including Electronic Audit Evidence ► Information Technology General Controls ► Financial Statement Close Process ► Cybersecurity ► Revenue recognition ► Business combinations ► Income taxes ► FV of investments ► Statement of cashflows (controls on classification on the SOCF)

PCAOB Current areas of focus


Internal controls SEC focus on management review controls

Review control: a control designed to review financial statements, account balances and other data for

completeness and accuracy, proper accounting, potential errors or effective performance of other controls

PCAOB findings on review controls

► Accounting estimates ► Infrequent, complex or unusual

transactions ► Entity-level controls ► Areas where there are no/few

other controls

Why are findings recurring? (SEC staff considerations)

► Auditors not communicating importance of testing

► Management unaware ► Insufficient precision or operation

Possible additional guidance for management


When designing review controls, consider: ► Importance of control (risk of material misstatement) ► Documentation of policies and procedures, particularly design ► Evidence of operating effectiveness ► Dependence on other controls that verify the completeness, accuracy and integrity of data and

reports used ► Precision of control

Internal controls SEC focus on management review controls (cont.)

Factors for designing precision of review control Purpose of control Correlation to relevant assertions Predictability of expectations

Level of aggregation Consistency of performance Criteria for investigation


Selected PCAOB projects Current status

Project Status Transparency – disclosures of engagement partner and others in audits Considering feedback on proposal

Audit quality indicators Concept release comment period Auditor’s reporting model Drafting reproposal Auditing estimates including fair value measurements and related disclosures Considering feedback on

consultation papers Use of specialists Supervision of other auditors and multilocation audits Drafting proposal

Going concern Drafting consultation paper


Asks for feedback on whether more disclosures would benefit investors: ► Explain how audit committees perform their responsibilities ► Inform investment and voting decisions on ratification of auditor and re-

election of audit committee members

Explores possible changes to audit committee disclosures related to: ► Oversight of the auditor ► Process for appointing or retaining auditor ► Evaluation of audit firm and engagement team qualifications

Audit transparency initiatives SEC concept release – audit committee disclosures

Comments period ended on 8 September 2015


Seeks comment on 28 possible AQIs ► How could they be used by audit committees, audit firms, investors and

regulators? ► Would other information be more useful? ► How could they be distributed? ► Should providing AQIs be voluntary?

AQIs could help audit committees in their discussions with auditors to improve audit quality ► Also could increase focus on quality in competition for audit services

Audit transparency initiatives PCAOB concept release – audit quality indicators (AQIs)

Comments period ended 29 September 2015


Audit transparency initiatives PCAOB concept release – audit quality indicators (continued)

Category Example Pr

ofes

s-io

nals

► Availability ► Competence ► Focus

Workload (e.g., chargeable hours and number of clients)

Proc

ess

► Tone at the top ► Incentives ► Independence ► Infrastructure ► Monitoring and remediation

Results of monitoring and remediating quality issues (e.g., percentage of audits subject to internal inspections and nature of findings)

Res

ults

► Financial statements ► Internal control ► Going concern reporting ► Communications with audit

committee ► Enforcement and litigation

Restatements for errors (e.g., annual number, percentage, and magnitude of those restatements)


Disclose in new form:

► Name of engagement partner ► Names, locations and extent of participation of firms that individually

performed ≥ 5% of total audit hours

File form with PCAOB within 30 days after issuing auditor’s report

► Publicly available and searchable on PCAOB website

Would alleviate some concerns raised by earlier proposals to disclose information in auditor’s report

Audit transparency initiatives PCAOB proposal – disclosure of certain audit participants

Proposal: effective for audit reports issued or reissued on or after 30 June 2016


Related party auditing standard (AS 18) Practice issues

Management Auditor ► Have controls to identify,

authorize/approve, account for and disclose all related party relationships and transactions

► Provide auditor with list of all related parties and transactions identified

► Make representations on completeness and accuracy

► Provide support for any assertions of arm’s length

► Understand controls ► Assess completeness and accuracy of

list ► Perform procedures to evaluate certain

transactions ► Perform additional procedures if

undisclosed items identified ► Why was information not

communicated? ► Is this a control deficiency?

Required for all companies subject to PCAOB audits


Related party auditing standard (AS 18) Practice issues (cont.)

Use applicable accounting definition (e.g., ASC 850) Affiliates and equity method investments Trusts for the benefit of employees Management and principal owners, including immediate family ► Individuals responsible for achieving entity’s objectives and have authority to establish

policies and make decisions ► Normally includes board of directors, CEO, COO, VPs in charge of principal business functions

and others performing similar functions ► May differ from SEC Section 16 officers and named officers in proxy Certain other parties (e.g., those that can significantly influence management or operating policies of transacting parties if one might be prevented from fully pursuing its separate interests)

Related party definition not changed by standard; determination of related parties may require judgment

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Navigating SEC and PCAOB regulatory matters - EY SEC and PCAOB regulatory matters Facilitators: ... AQIs could help audit committees in their discussions with auditors ... Affiliates