Judgments, Estimates and Uncertainties – Oh My!
By George Wilson
Financial accounting and SEC reporting involve more judgments, estimates and uncertainties every quarter and year-end. Challenges such as making the principles-based judgments for disclosing disaggregated revenues under ASC 606, estimating the appropriate discount rates to use for lease accounting in ASC 842, and determining the necessity of an MD&A know-trend disclosure about an uncertainty, are inescapable.
One of the scariest “oh my” moments we have as SEC reporting professionals is when actual results differ materially from our estimates and judgments.
Unfortunately, in the realm of SEC reporting, we are sometimes – perhaps all the time – aware that when we deal with these challenges, we are subject to SEC scrutiny. The SEC Enforcement Division’s leadership has emphasized that they are “incredibly focused” on company disclosures. Sometimes we are concerned that we are “darned if we do and darned if we don’t” when making challenging decisions about judgments, estimates and uncertainties.
At an October 2020 securities enforcement conference, Enforcement Division Associate Director Melissa Hodgman discussed how the Division approaches situations where companies miss an estimate or judgment. In her remarks, Associate Director Hodgman told the audience that the Division will not assume wrongdoing if a company misses an estimate or judgment in an uncertain situation. She stated that the staff will “trust good faith estimates” and does not view this as a “gotcha” game when a company misses an estimate or judgment. Instead, the Division will focus on process and documentation. They will try to ascertain that we have made reasoned and good faith judgments using a consistently applied process. The staff has also repeatedly emphasized the importance of robust and clear documentation about why we did what we did.
These remarks are consistent with those of Chief Accountant Sagar Teotia who has said on a number of occasions that well-thought-out applications of principles will not be second guessed. This is an excerpt from a speech by Mr. Teotia on June 23, 2020:
Significant Estimates and Judgments; Reasonable Judgments
As we noted in our April 2020 statement, in connection with their financial reporting responsibilities, many companies have been required to make significant judgments and estimates to address a variety of accounting and financial reporting matters. As those who engage with us well know, OCA has consistently not objected to well-reasoned judgments that entities have made, and we will continue to apply this perspective. Companies should ensure that significant judgments and estimates are disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects and is consistent with the company’s specific facts and circumstances.
What both the Enforcement Division and the Chief Accountant are telling us is that when we miss on a challenging estimate or judgment we may be questioned by the staff. To put ourselves in the best position possible to answer the staff’s questions we must be able to show that we consistently followed a well-thought-out process with complete and robust documentation.
As always, your thoughts and comments are welcome.