The challenge of Management Discussion & Analysis.

• Author: Hay, Laura A.

"No surprises" may be today's mantra for financial reporting, especially in the public company environment. Following a period of high-profile bankruptcies and financial restatements, increased attention to, and scrutiny of the most subjective portion of annual and quarterly reports is an understandable development. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD & A) has received significant attention recently from the Securities and Exchange Commission (SEC) as users of financial statements call for an increase in the qualitative information included in financial statements. Recent additions to Item 303 of the SEC's Regulation S-K and a large amount of interpretative guidance has been issued as the SEC seeks to continue the evolution of MD & A into a more meaningful disclosure, especially of forward-looking information, from the perspective of the company's executive management.

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Recent guidance from the SEC emphasizes an executive overview of the most important matters in the MD & A disclosure, key trends and performance measures, quality and variability of earnings and cash flow requirements, critical accounting policies, and materiality. But is the recent guidance on improving this written communication sufficiently understood by those preparing the disclosure? How can this disclosure be enhanced to improve its usefulness to readers of financial statements? We spoke to CPAs who work with MD & A disclosures on some of the challenges in the recent SEC guidance.

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MD & A Challenges

"One of the most confusing elements of MD & A disclosure requirements for CPAs is the use of words that look a lot like words found in Statements on Financial Accounting Standards," notes Dr. Ray Stephens, CPA, a professor at Ohio University who teaches an eight-hour MD & A program. "For example, in identifying contingencies for MD & A disclosures, the words 'possibility' and 'probability' mean very different things in the SEC interpretative guidance than in SFAS No. 5."

Stephens notes that under financial accounting standards, a contingency is not disclosed unless its occurrence can be affirmatively answered as being possible and the amount can be estimated to be material. For MD & A, however, disclosure may be required if the amount cannot be reasonably estimated or materiality cannot be estimated (that is, the contingency must be discussed unless the future event is either not possible and/or not...