This week we present the second installment of our inaugural SEC filing highlights blog, in which we cover some of the unique and unusual events from the past year. In this one we look at Auditor Changes, Out of Period Adjustments, Changes in Estimates, and D&O turnover. You can see Part 1 here.
Roughly 1,100 companies changed auditors last year, a number relatively unchanged compared to 2013. Of the departing auditors, the one with the longest tenure — 124 years — was PricewaterhouseCoopers at Unilever. In May 2014, the multinational consumer goods giant retained KPMG to audit its 2014 financial statements, having previously used PwC as its auditor since 1890. Based in Europe, this change was likely in anticipation of the imminent EU regulations limiting auditor tenure.
A number of companies switched auditors twice in the same year, going from auditor A to auditor B to auditor C. You might think that’s the upper limit, but one company, Clone Algo, managed to change auditors three distinct times in 2014. The Las Vegas technology company reported revenues of $2.1 million for fiscal 2014, and losses of $122 million due largely to an impairment of intangible assets to the tune of $123.4 million.
As disclosed in Clone Algo Inc.’s 10-K for fiscal year ending March 2014 (filed at the end of November), three auditors resigned within a few months of each other, resulting in four successive auditors for the Company in 2014.
In March 2014, De Joya Griffith resigned as Clone Algo’s auditor, and Seale & Beers were appointed. In April, Seale & Beers resigned, and the company proceeded to hire Hartley Moore. Amazingly, Hartley Moore then resigned in June, citing scope limitations as the reason for their resignation. Both Seale & Beers and Hartley Moore resigned before giving an audit opinion.
Finally, the company engaged Terry L Johnson in July, who issued an unqualified opinion for the fiscal 2014 financial statements. Considering the CPA’s recent troubles, Clone Algo will soon have to change auditors again.
In 2014, 276 companies disclosed a total of 311 errors that were corrected as out-of-period adjustments. Out-of-period adjustments are errors that are found to be immaterial to both prior and current financial statements, and therefore are corrected in the current period as a one-off adjustment. In 2014, the largest out-of-period adjustment was disclosed by Walmart. The correction was required to adjust store lease expenses in China and Mexico that did not conform to Walmart’s global accounting policies. The description of the error, contained in the annual report filed on March 21, 2014, was minimal:
In fiscal 2014, the Company corrected certain amounts pertaining to previous fiscal years as management determined they were not material, individually or in the aggregate, to any of the periods presented in the Company’s Consolidated Financial Statements.
As we noted in a recent post, an SEC comment letter provided additional insight into the materiality of the error. According to the materiality analysis provided by Walmart, the correction of the error increased SG&A expenses in 2014 by $277 million, and decreased Diluted EPS by 0.08 (or about 1.6%). They later indicated serious material weaknesses related to lease accounting. In their most recent 10-Q, Walmart disclosed another lease-related out-of-period adjustment, the impact of which is yet to be determined.
Changes in Accounting Estimates
The largest Change in Accounting Estimate (CAE) that had a positive impact on earnings in 2014 was made by GE. In its Fiscal 2014 10-K, the company disclosed that revisions in percentage-of-completion estimates during the year increased earnings by $1 billion:
REVENUE RECOGNITION ON LONG-TERM PRODUCT SERVICES AGREEMENTS
Revenue recognition on long-term product services agreements requires estimates of profits over the multiple-year terms of such agreements, considering factors such as the frequency and extent of future monitoring, maintenance and overhaul events; the amount of personnel, spare parts and other resources required to perform the services; and future billing rate, cost changes and customers’ utilization of assets. We routinely review estimates under product services agreements and regularly revise them to adjust for changes in outlook.
… Revisions may affect a product services agreement’s total estimated profitability resulting in an adjustment of earnings; such adjustments increased earnings by $1.0 billion, $0.3 billion and $0.4 billion in 2014, 2013 and 2012, respectively. We provide for probable losses when they become evident.
Percentage-of-completion estimate adjustments are frequently quite large. The largest positive CAE that wasn’t related to percentage-of-completion was made by Petrobras, the Brazilian behemoth. In its Q3 2014 results, the company indicated that it increased “the estimated useful life of equipment and other assets, decreasing the depreciation in R$ 1,688 million.” This boosted their operating income by approximately $740 million US dollars.
The largest negative impact CAE was made by General Motors. In their Q2 2014 filing, they disclosed a “historical catch-up adjustment” of $874 million “to adjust the estimate for recall costs for previously sold vehicles.”
Director and Officer Changes
The number of CEO and Chief Financial Officer departures continued their downward trend in 2014, off from the peak in 2008. Just under 1,000 companies disclosed a total of about 1,125 CEO departures and 1,150 CFO departures. This coincides, as a matter of fact, with an overall decrease in the number of companies subject to this reporting requirement. In 2014, there were 7,332 companies which were required to report such departures, a decrease of more than 1,200 since 2010.1
While the majority of registrants who reported a change during the last five years for these executive positions did so only once, Harsco Corporation reported a total of six CEO departures since 2010, and Exopack Holding Corp reported six CFO departures before their SEC registration was terminated in late 2013.2
Although the number of companies required to disclose a change has steadily declined, the percentage of companies reporting a CEO or CFO change fluctuated. The percentage of CEO departures rose from 13.6% in 2012, to 14.1% in 2013, and then dropped down to 13.2% in 2014. As we mentioned in our report CEO & CFO Departures – A Ten Year Review: “Since the overall shape of the CFO departure history appears similar to the CEO history, it seems that market climate and other outside forces can influence turnover.”
1. This SEC requirement applies to those registrants that file a 10-K type form (i.e., 10-K, 10-Q, 10KSB, 10QSB, etc.).↩
2. The total departure count includes departures from possible interim positions, business segments, and subsidiaries.↩