SEC comment letter trends for Consumer market companies

The SEC Division of Corporation Finance's filing review process is a key function utilized by the SEC staff to monitor the critical accounting and disclosure decisions applied by registrants. Our analysis of SEC comment letters identifies the frequency of topical areas addressed by the SEC staff and how their focus areas changed over time. In addition to providing our insights on the nature of the SEC staff comments, we provide sample text from the SEC staff’s comments and links to where you can learn more about the accounting and disclosure requirements addressed in each topical area.

Revenue recognition

The new revenue standard (ASC 606) requires more quantitative and qualitative disclosure than prior guidance. The following areas have been addressed in the SEC staff's comments:

  • Performance obligations – the nature of performance obligations, why goods or services are distinct, and disclosure of remaining performance obligations. Also, comments related to information provided in other parts of the filing that appear inconsistent with the number of performance obligations in a contract.
  • Variable consideration – the determination of the transaction price and how a company estimates variable consideration.
  • Recognizing revenue – the timing of when control transfers, the method of recognizing revenue over time, and accounting for licensing arrangements.
  • Costs to obtain a contract – the determination of the appropriate costs to capitalize, the amortization period, and related disclosures (including election of practical expedients).
  • Gross versus net presentation – judgments related to gross versus net presentation of revenue, including an assessment of whether the company controls the good or service being provided to the end customer.
  • Disaggregated revenue – disaggregation disclosures that appear inconsistent with information provided in other parts of the filing or in other forums, such as investor presentations.

  • Please provide us with your analysis regarding how you determined you had one performance obligation in your revenue arrangements.
  • Please tell us how you considered the requirements in ASC 606-10-50-13 through 50-15 to disclose information about remaining performance obligations or application of optional exemptions.
  • We note that you have concluded that your three performance obligations under your franchise agreements are not distinct and therefore are not separate performance obligations given your conclusion that they are highly interrelated. Please revise your disclosure to clarify your conclusions. Reference 606-10-25-22.
  • Please tell us, and revise to disclose how you account for returns, if different from other variable consideration. For example, please tell us and revise to disclose if you record a refund liability and asset for the right to recover goods from the customer at the time of sale. See guidance in ASC 606-10-32-10 and 606-10-55- 23.
  • We note that you offer consulting and trainings as part of your services offerings. Please tell us over what period of time you typically provide these services and how you determined that point in time revenue recognition was appropriate. Refer to ASC 606-10-25-23 through 25-30.
  • We note that you utilized the practical expedient to avoid capitalizing incremental costs of obtaining the contract. Given your disclosure that you sell product to your largest customer under a long term contract and other customers under contracts that could be one to two years in duration, please further tell us how you considered the guidance under ASC 340-40-25-4.
  • Please explain to us your consideration of the guidance in ASC 606-10-55-36 through 55-40 when determining whether you are acting as a principal or as an agent when providing your products / services.
  • We note your disclosure of sales disaggregated by each reportable segment. How did you consider your discussions of sales by end market within your investor presentation and earnings call.

Non-GAAP measures

Non-GAAP financial measures result in frequent comments regarding compliance with Item 10(e) of Regulation S-K and the related compliance and disclosure interpretations, sometimes resulting in requests to remove or substantially modify non-GAAP metrics. Focus areas have included:

  • Presentation with equal or greater prominence of the most directly comparable GAAP financial measure;
  • Reconciliation to the most comparable GAAP financial measure;
  • Appropriateness of adjustments to eliminate or smooth items identified as non-recurring, infrequent or unusual; and
  • Disclosure of why management believes the non-GAAP presentation provides useful information to investors regarding the financial condition or results of operations of the registrant.

  • You disclose non-GAAP measures without presenting the comparable GAAP measures with equal or greater prominence. Please ensure any discussion regarding non-GAAP measures is preceded by an equal or more prominent discussion of the comparable GAAP measure.
  • Please include a reconciliation of core earnings that begins with the most directly comparable GAAP measure. Your revised reconciliation should provide disaggregated disclosure of all the adjustments necessary to arrive at core earnings from the most directly comparable GAAP measure.
  • The disclosure characterizes restructuring charges and impact of foreign currency translation as unusual, though these items appear to be recurring. Please revise your disclosures as appropriate as Item 10(e) prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as unusual when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years.
  • Your current disclosure discusses management’s use, but not how the presentation of the measure is useful to investors. Please revise your disclosure to include a discussion of investor's use of these measures.

Fair value measurement

Fair value measurements often require the application of significant judgment. The SEC staff has focused on the quality of disclosure around those significant judgments and estimates, frequently commenting on:

  • The valuation techniques and key inputs used to determine the fair value for each significant class of asset or liability, whether determined by management or a third party (e.g., independent pricing service).
  • The quantitative information provided for significant unobservable inputs used in Level 3 fair value measurements, including the sensitivity of the fair value measurement to changes in those significant unobservable inputs.
  • The sufficiency of disclosure related to non-recurring fair value measurements, such as impairments.

Certain of the fair value disclosure requirements, and consequently the nature of the SEC staff’s comments may be impacted by ASU 2018-13, Changes to the Disclosure Requirements for Fair Value Measurements, which can be early adopted.

  • You indicate the securities included in Level 2 of the fair value hierarchy are valued utilizing inputs obtained from an independent pricing service. Please tell us what consideration was given to disclosing a description of the valuation techniques and inputs used in the fair value measurements. In addition, tell us what consideration you gave to separately disclosing the valuation techniques and inputs for each class of assets. We refer you to ASC 820-10-50-2 and ASC 820-10-50-2(bbb).
  • Please disclose quantitative information about the significant unobservable inputs used in developing the fair value of your Level 3 assets and liabilities. Also, tell us what consideration was given to providing a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs. Please refer to ASC 820-10-50-2(bbb) and (g).
  • Please tell us how you complied with the non-recurring fair value measurement disclosures related to the impairment charge, as required by ASC 820-10-50-2(a). Also refer to the example of these disclosures at ASC 820-10-55-100.

Management's discussion and analysis

The SEC staff's comments on management’s discussion and analysis have emphasized the requirements in Item 303 of Regulation S-K and the related disclosure objectives, including a focus on:

  • The discussion and analysis of results of operations, including the description and quantification of unusual or infrequent events or any significant economic changes;
  • Critical accounting estimates, including the judgments made in the application of significant accounting policies, and the likelihood of materially different reported results if different assumptions or conditions were to prevail; and
  • Liquidity and capital resources, including clear discussion of drivers of cash flows and the trends and uncertainties related to meeting known or reasonably likely future cash requirements.

  • In future filings, please provide additional information about the components of operating expenses, such as quantifying the components and the factors driving the increase and the extent to which you expect this trend to continue.
  • To the extent any of your reporting units have estimated fair values that are not substantially in excess of their carrying values, please provide the following:
    • Amount of goodwill allocated to the reporting unit;
    • Description of the methods and key assumptions used;
    • Discussion of the degree of uncertainty associated with the key assumptions; and
    • Description of events or changes in circumstances that could reasonably be expected to negatively affect the assumptions.
  • Revise future filings to disclose the amount of cash and cash equivalents held by foreign subsidiaries and quantify any amounts that would not be available for use in the United States without incurring US income taxes. Provide a discussion of any known trends, demands or uncertainties relating to your liquidity as a result of your policies of indefinitely reinvesting earnings outside the United States.

Business combinations

Business combinations are a consistent area of focus for the SEC staff, with frequent comments related to:

  • Purchase price allocations, including questions about how fair value was determined and the key assumptions used; 
  • The completeness of disclosures when the purchase price allocation is preliminary; 
  • Why the registrant omitted the pro forma financial information required by ASC 805; and 
  • Compliance with the Regulation S-X Article 11 pro forma financial information requirements for significant business combinations disclosed on Form 8-K and in certain registration statements.

  • Tell us how you determined the fair value of the significant intangible assets acquired, including the significant assumptions utilized. 
  • You disclose that the purchase price allocation for the acquisition is preliminary. Please disclose the information required by ASC 805-20-50-4A. 
  • Please tell us why you did not include pro forma financial information reflecting the acquisition, as required by ASC 805-10-50-2(h). 
  • It does not appear to us that the pro forma adjustment is directly attributable to the transaction. Please revise your pro forma financial statements to remove this adjustment or tell us how this adjustment complies with Article 11-02(b)(6).

Goodwill and other intangibles

The SEC staff has focused on the quality of the disclosure around significant judgments and estimates associated with goodwill and intangible assets, including impairment assessments, frequently commenting on:

  • The identification of reporting units, including factors considered when multiple components have been combined into a single reporting unit due to economic similarities;
  • At risk reporting units, including information about the amount of goodwill and headroom at the reporting unit, discussion of the key assumptions used to determine the reporting unit’s fair value and their associated degrees of uncertainty, and a description of potential events or changes in circumstances that could negatively affect the key assumptions; and
  • The timing of goodwill and intangible asset impairment charges.

  • Please clarify for us if you aggregate multiple components into your reporting units. If so, tell us the components you have aggregated and provide us with your analysis that supports aggregation is appropriate pursuant to ASC 350-20-35-35. 
  • Please tell us whether you have any reporting units with material goodwill at risk of failing your goodwill impairment test. For each such reporting unit, please provide the following disclosures: 
    • Percentage by which fair value exceeded carrying value as of the date of the most recent test; 
    • Amount of goodwill allocated to the reporting unit; 
    • Description of the methods and key assumptions used and how the key assumptions were determined; 
    • Discussion of the degree of uncertainty associated with the key assumptions.  The discussion regarding uncertainty should provide specifics to the extent possible (e.g., the valuation model assumes recovery in a particular business from a downturn within a defined period of time); and 
    • Description of the potential events and/or changes in circumstances that could reasonably be expected to negatively affect the key assumptions. 
  • In light of the current year interim period results of your reportable segment, which appear to be negatively impacted by the referenced business unit, management changes, and a shift in the primary focus of the business unit, please help us further understand how you determined that none of the impairment indicators outlined in ASC 350-20-35-3 existed in the current year interim period.  


Debt, quasi-debt, warrants and equity

Debt, quasi-debt, warrants and equity securities continue to be a source of restatements and revisions due to errors in the application of the relevant guidance. The accounting for such items often include critical accounting estimates that require significant judgment. The SEC staff has focused on the transparency and quality of the disclosures around these judgments and estimates, frequently requesting: 

  • The registrant's consideration of conversion and redemption options in determining debt or equity classification; 
  • Support for the classification of financing transactions as extinguishments or modifications of debt; and 
  • Expanded disclosures of the material terms of debt agreements, including an indication of compliance with financial covenants and the sensitivity associated with such measures.

  • We are unable to agree with your conclusion that the amounts under the agreement were appropriately classified as equity. We believe that since the agreement is not legal form equity, is titled as a loan agreement and contains some debt-like features, liability classification of the instrument is required. Further, we note that the instrument has no features that would indicate that it is indexed to the Company’s equity. As a result, please advise how you evaluated the identification and correction of the apparent error in the previously-issued financial statements in accordance with ASC 250-10-05. 
  • You note that you may be required to repurchase your convertible notes for cash if you undergo a fundamental change, and that the convertible notes may become due and payable under certain events of bankruptcy, insolvency or reorganization. Please provide us with your analysis of the applicable accounting guidance supporting your classification of the equity component of the notes as equity. Explain your consideration of ASC 815 and ASC 480 in this analysis. 
  • Please explain to us why a portion of the refinancing transaction was accounted for as an extinguishment and a portion accounted for as a modification. In your response, please discuss the guidance in ASC 470-50-40. 
  • We note that you are subject to negative and project-specific covenants. Summarize for us the nature and computation of the covenants you are subject to. Please tell whether any of such covenants could impact your ability to obtain additional debt financing to a material extent. If so, please discuss the covenants in question and the consequences of any limitations to the company's financial condition and operating performance. See Sections I.D and IV.C of the SEC Interpretive Release No. 33-8350.

Disclosure controls and ICFR

The focus of the SEC staff’s comments on Internal Control over Financial Reporting (ICFR) has not changed significantly from prior years. They continue to focus on:

  • The identification and disclosure of material weaknesses. Specifically, the SEC staff continues to question why a restatement or revision did not result in the reporting of a material weakness;
  • Management’s disclosure around the effectiveness of ICFR and disclosure controls and procedures (DC&P).The SEC staff has questioned registrants when there is no explicit conclusion about the effectiveness of DC&P or when management has concluded that ICFR is ineffective while DC&P is effective; and
  • Management’s documentation of the changes in ICFR that have materially affected, or are reasonably likely to materially affect the registrant’s ICFR as required by Item 308 of Regulation S-K. Such changes may include updates to internal controls made in the process of (a) remediating previously identified material weaknesses, (b) as a result of the integration of significant acquisitions, (c) due to the implementation of new information technology systems, or (d) implementation of a new accounting standard.

  • Please provide us with a detailed explanation of how you considered the identification and correction of the error in your evaluation of internal control over financial reporting and disclosure controls and procedures. In doing so, please tell us how you evaluated the control deficiency(s) that led to this error, whether this control deficiency(s) posed a substantial risk of a material restatement, and the reason(s) for your conclusion.
  • Tell us whether you made any changes to your internal control over financial reporting in response to the correction described under this note. If so, explain to us how you considered disclosing this change under Controls and Procedures of your filing. If not, explain to us your basis for concluding no change was necessary.
  • Please tell us how you determined that the material weakness identified did not impact your conclusion regarding the effectiveness of your disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Please refer to SEC Release No. 33-8238, Final Rule: Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports.
  • Please file an amended Form 10-K to specifically state your assessment of internal control over financial reporting as either effective or not effective. Refer to the guidance in Item 308(a)(3) of Regulation S-K. 
  • Please revise future filings to clarify which version, 1992 or 2013, of the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission's Internal Control -- Integrated Framework you utilized when performing your assessment of internal control over financial reporting.

Inventory and cost of sales

The SEC staff comments for inventory focused on inventory reserves, including subsequent recoveries. To a lesser extent, the SEC staff inquired regarding management’s estimates for inventory reserves.

For cost of sales, the SEC staff focused on the components of cost of sales, ensuring non-cash items, like depreciation, were allocated to cost of sales, and questioning the calculation of gross margin when it was not.

  • Please tell us how your inventory recoveries are consistent with the guidance in SAB Topic 5.BB and ASC 330-10-35-14 which states when goods have been written down below cost at the close of a fiscal year such reduced amount is viewed as creating a new cost basis for the item.

  • Please disclose, if true, that you allocate a portion of your payroll costs and depreciation and amortization to cost of sales. If such an allocation is not made, please tell us why not. Refer to ASC 330-10-30-1 through 30-8.

  • Please tell us your basis for presenting gross margin on the face of the statement of operations. In this regard, we note you exclude depreciation and amortization from gross margin. To avoid placing undue emphasis on cash flow, depreciation and amortization should not be positioned in the income statement in a manner which results in reporting a figure for income before depreciation. Refer to ASC 225-10-S99-8. See also Item 302(a) of Regulation S-K.

Accounting changes and error corrections

Disclosures relating to a change in accounting principle, a change in estimate, and a correction of an error often receive attention in SEC staff comment letters. Comments request further quantitative and qualitative analysis on the accounting and disclosure judgments applied by management in these areas.

The SEC staff comments relating to accounting changes and errors asked registrants to provide:

  • Additional information regarding management’s evaluation of materiality in accordance with SAB Topics 1.M and 1.N;
  • Clarification regarding whether adjustments relate to a change in estimate or correction of an error; and
  • For corrections of errors, additional information regarding management’s evaluation of the related impact on the design and operating effectiveness of internal control over financial reporting.

  • Your disclosure indicates that you have concluded the effects of the correction of errors were not material individually or in the aggregate to your previously reported annual periods; however, it appears that the corrections had a material impact. Please provide a comprehensive analysis explaining how you determined these corrections were not material.

  • We note that your discussion references an "accounting adjustment." Please tell us the nature of these accounting adjustments including whether you changed accounting policies or corrected errors in accordance with ASC 250.

  • Regarding the accounting error you disclose in the notes to your consolidated financial statements, please provide us with a detailed explanation of how you considered the identification and correction of this error in your evaluation of internal control over financial reporting and disclosure controls and procedures. In doing so, please tell us how you evaluated the control deficiency(s) that led to this error, whether this control deficiency(s) posed a substantial risk of a material restatement, and the reason(s) for your conclusion.

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Melissa Palmer

Consumer Markets Assurance Leader, PwC US

Chris Hardt

Partner, National Professional Services Group, PwC US

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