[Federal Register Volume 68, Number 248 (Monday, December 29, 2003)]
[Rules and Regulations]
[Pages 75056-75065]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-31802]



[[Page 75055]]

-----------------------------------------------------------------------

Part IV





Securities and Exchange Commission





-----------------------------------------------------------------------



17 CFR Parts 211, 231, and 241



Commission Guidance Regarding Management's Discussion and Analysis of 
Financial Condition and Results of Operations; Interpretation; Rule

  Federal Register / Vol. 68, No. 248 / Monday, December 29, 2003 / 
Rules and Regulations  

[[Page 75056]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 211, 231 and 241

[Release Nos. 33-8350; 34-48960; FR-72]


Commission Guidance Regarding Management's Discussion and 
Analysis of Financial Condition and Results of Operations

AGENCY: Securities and Exchange Commission.

ACTION: Interpretation.

-----------------------------------------------------------------------

SUMMARY: The Commission is publishing interpretive guidance regarding 
the disclosure commonly known as Management's Discussion and Analysis 
of Financial Condition and Results of Operations, or MD&A, which is 
required by Item 303 of Regulation S-K, Items 303(b) and (c) of 
Regulation S-B, Item 5 of Form 20-F and Paragraph 11 of General 
Instruction B of Form 40-F. This guidance is intended to elicit more 
meaningful disclosure in MD&A in a number of areas, including the 
overall presentation and focus of MD&A, with general emphasis on the 
discussion and analysis of known trends, demands, commitments, events 
and uncertainties, and specific guidance on disclosures about 
liquidity, capital resources and critical accounting estimates.

EFFECTIVE DATE: December 29, 2003.

FOR FURTHER INFORMATION CONTACT: Questions about specific filings 
should be directed to staff members responsible for reviewing the 
documents the registrant files with the Commission. General questions 
about this release should be referred to Todd Hardiman, Karl Hiller, 
Nina Mojiri-Azad, Mara Ransom, or Sondra Stokes, Division of 
Corporation Finance, at (202) 824-5300, Securities and Exchange 
Commission, 450 5th Street NW., Washington, DC 20549-0401.

SUPPLEMENTARY INFORMATION:

I. Overview

A. Purpose

    This release interprets requirements for Management's Discussion 
and Analysis of Financial Condition and Results of Operations 
(``MD&A'').\1\ It provides guidance to assist companies:
---------------------------------------------------------------------------

    \1\ The requirements are set forth in Item 303 of Regulation S-K 
(Management's Discussion & Analysis of Financial Condition and 
Results of Operations) [17 CFR 229.303], Items 303(b) and (c) of 
Regulation S-B (Management's Discussion & Analysis of Financial 
Condition and Results of Operations, and Off-balance sheet 
arrangements) [17 CFR 228.303(b) and (c)], Item 5 of Form 20-F 
(Operating and Financial Review and Prospects) [17 CFR 249.220f], 
and General Instruction B.(11) of Form 40-F (Off-balance sheet 
arrangements) [17 CFR 249.240f].
    Although the wording of the MD&A requirement in Form 20-F was 
revised in 1999, the Commission's adopting release noted that we 
interpret that Item as calling for the same disclosure as Item 303 
of Regulation S-K. See Release No. 33-7745 (Sept. 28, 1999) [64 FR 
53900 at 59304]. In addition, Instruction 1 to Item 5 in Form 20-F 
provides that issuers should refer to the Commission's 1989 
interpretive release on MD&A disclosure under Item 303 of Regulation 
S-K (Interpretive Release: Management's Discussion and Analysis of 
Financial Condition and Results of Operations; Certain Investment 
Company Disclosures, Release No. 33-6835 (May 18, 1989) [54 FR 
22427] (the ``1989 Release'')) for guidance in preparing the 
discussion and analysis by management of the company's financial 
condition and results of operations required in Form 20-F. 
Therefore, although this release refers primarily to Item 303 of 
Regulation S-K, it also is intended to apply to MD&A drafted 
pursuant to Item 5 of Form 20-F.
    In addition, the guidance in this release applies to small 
business issuers that are subject to the disclosure requirements of 
Items 303(b) and (c) of Regulation S-B. Small business issuers, like 
all other companies subject to SEC reporting obligations, should 
consider the interpretive guidance based on their own particular 
facts and circumstances.
---------------------------------------------------------------------------

    [sbull] In preparing MD&A disclosure that is easier to follow and 
understand; and
    [sbull] In providing information that more completely satisfies our 
previously enunciated principal objectives of MD&A.
    We believe that management's most important responsibilities 
include communicating with investors in a clear and straightforward 
manner. MD&A is a critical component of that communication. The 
Commission has long sought through its rules, enforcement actions and 
interpretive processes to elicit MD&A that not only meets technical 
disclosure requirements but generally is informative and transparent. 
We believe and expect that when companies follow the guidance in this 
release, the overall quality of their MD&A will improve. The Division 
of Corporation Finance will continue to review MD&A submitted after 
this guidance is released and take action as appropriate. In addition, 
we have instructed the Division to keep us apprised of whether this 
guidance has produced improved disclosure, and to suggest additional 
Commission action related to MD&A as appropriate.

B. Approach to MD&A

    The purpose of MD&A is not complicated. It is to provide readers 
information ``necessary to an understanding of [a company's] financial 
condition, changes in financial condition and results of 
operations.''\2\ The MD&A requirements are intended to satisfy three 
principal objectives:
---------------------------------------------------------------------------

    \2\ Item 303(a) of Regulation S-K [17 CFR 229.303(a)].
---------------------------------------------------------------------------

    [sbull] To provide a narrative explanation of a company's financial 
statements that enables investors to see the company through the eyes 
of management;
    [sbull] To enhance the overall financial disclosure and provide the 
context within which financial information should be analyzed; and
    [sbull] To provide information about the quality of, and potential 
variability of, a company's earnings and cash flow, so that investors 
can ascertain the likelihood that past performance is indicative of 
future performance.\3\
---------------------------------------------------------------------------

    \3\ See Commission Statement About Management's Discussion and 
Analysis of Financial Condition and Results of Operations, Release 
No. 33-8056 (Jan. 22, 2002) [67 FR 3746] (``January 2002 Release'').
---------------------------------------------------------------------------

    MD&A should be a discussion and analysis of a company's business as 
seen through the eyes of those who manage that business. Management has 
a unique perspective on its business that only it can present. As such, 
MD&A should not be a recitation of financial statements in narrative 
form or an otherwise uninformative series of technical responses to 
MD&A requirements, neither of which provides this important management 
perspective. Through this release we encourage each company and its 
management to take a fresh look at MD&A with a view to enhancing its 
quality. We also encourage early top-level involvement by a company's 
management in identifying the key disclosure themes and items that 
should be included in a company's MD&A.
    Based on our experience with many companies' current disclosures in 
MD&A, we believe there are a number of general ways for companies to 
enhance their MD&A consistent with its purpose. The recent review 
experiences of the staff of the Division of Corporation Finance, 
including its Fortune 500 review,\4\ have led us to conclude that 
additional guidance would be especially useful in the following areas:
---------------------------------------------------------------------------

    \4\ See Summary by the Division of Corporation Finance of 
Significant Issues Addressed in the Review of the Periodic Reports 
of the Fortune 500 Companies (Feb. 27, 2003) (``Fortune 500 
Summary'') available at www.sec.gov/divisions/corpfin/fortune500rep.htm.
---------------------------------------------------------------------------

    [sbull] The overall presentation of MD&A
    [sbull] The focus and content of MD&A (including materiality, 
analysis, key performance measures and known material trends and 
uncertainties);
    [sbull] Disclosure regarding liquidity and capital resources; and
    [sbull] Disclosure regarding critical accounting estimates.
    Therefore, in this release, we emphasize the following points 
regarding overall presentation:
    [sbull] Within the universe of material information, companies 
should present

[[Page 75057]]

their disclosure so that the most important information is most 
prominent;
    [sbull] Companies should avoid unnecessary duplicative disclosure 
that can tend to overwhelm readers and act as an obstacle to 
identifying and understanding material matters; and
    [sbull] Many companies would benefit from starting their MD&A with 
a section that provides an executive-level overview that provides 
context for the remainder of the discussion.
    We also emphasize the following points regarding focus and content:
    [sbull] In deciding on the content of MD&A, companies should focus 
on material information and eliminate immaterial information that does 
not promote understanding of companies' financial condition, liquidity 
and capital resources, changes in financial condition and results of 
operations (both in the context of profit and loss and cash flows); \5\
---------------------------------------------------------------------------

    \5\ In this release we sometimes use the term ``financial 
condition and operating performance'' to refer to the required 
subjects of MD&A of financial condition, liquidity and capital 
resources, changes in financial condition and results of operations 
(both in the context of profit and loss and cash flows).
---------------------------------------------------------------------------

    [sbull] Companies should identify and discuss key performance 
indicators, including non-financial performance indicators, that their 
management uses to manage the business and that would be material to 
investors;
    [sbull] Companies must identify and disclose known trends, events, 
demands, commitments and uncertainties that are reasonably likely to 
have a material effect on financial condition or operating performance; 
\6\ and
---------------------------------------------------------------------------

    \6\ Note 27 to the 1989 Release states, ``MD&A mandates 
disclosure of specified forward-looking information, and specifies 
its own standards for disclosure--i.e., reasonably likely to have a 
material effect. The specific standard governs the circumstances in 
which Item 303 requires disclosure. The probability/magnitude test 
for materiality approved by the Supreme Court in Basic v. Levinson, 
108 S.Ct. 978 (1988), is inapposite to Item 303 disclosure.''
---------------------------------------------------------------------------

    [sbull] Companies should provide not only disclosure of information 
responsive to MD&A's requirements, but also an analysis that is 
responsive to those requirements that explains management's view of the 
implications and significance of that information and that satisfies 
the objectives of MD&A.

C. Impact of Increased Amounts of Information Available to Companies

    Companies have access to and use substantially more detailed and 
timely information about their financial condition and operating 
performance than they did when our MD&A requirements initially were 
introduced or when we last provided general interpretive guidance.\7\ 
Some of this information is itself non-financial in nature, but bears 
on companies' financial condition and operating performance. The 
increased availability of information is relevant to companies in 
preparing MD&A for the following reasons:
---------------------------------------------------------------------------

    \7\ See, e.g., Improving Business Reporting--A Customer Focus; 
Meeting the Information Needs of Investors and Creditors, 
Comprehensive Report of the Special Committee on Financial 
Reporting, American Institute of Certified Public Accountants 
(AICPA) (1994) (``Jenkins Report'').
---------------------------------------------------------------------------

    [sbull] First, companies must evaluate an increased amount of 
information to determine which information they must disclose. In doing 
so, companies should avoid the unnecessary information overload for 
investors that can result from disclosure of information that is not 
required, is immaterial, and does not promote understanding.
    [sbull] Second, in identifying, discussing and analyzing known 
material trends and uncertainties, companies are expected to consider 
all relevant information, even if that information is not required to 
be disclosed.

D. Liquidity and Capital Resources

    We devote a separate section of this release to disclosure in MD&A 
regarding liquidity and capital resources. In that section, we 
emphasize the need for attention to disclosure of cash requirements and 
sources of cash. We believe that:
    [sbull] Companies should consider enhanced analysis and explanation 
of the sources and uses of cash and material changes in particular 
items underlying the major captions reported in their financial 
statements, rather than recitation of the items in the cash flow 
statements;
    [sbull] Companies using the indirect method \8\ in preparing their 
cash flow statements should pay particular attention to disclosure and 
analysis of matters that are not readily apparent from their cash flow 
statements; and
---------------------------------------------------------------------------

    \8\ In Financial Accounting Standards Board (FASB) Statement of 
Financial Accounting Standards (SFAS) No. 95, Statement of Cash 
Flows (Nov. 1987), the FASB allowed the indirect method of reporting 
net cash flow from operating activities by adjusting net income to 
reconcile it to net cash flow from operating activities. Under that 
method, the major classes of operating cash receipts and payments 
are determined indirectly by determining the change in asset and 
liability accounts that relate to operating income. However, in SFAS 
95, the FASB encouraged companies to use the direct method of 
reporting net cash flow from operating activities rather than the 
indirect method. The direct method reports net cash flow from 
operations by summing major classes of gross cash receipts, such as 
customer payments, and gross cash payments, such as cash paid to 
employees. The direct method also requires a reconciliation of net 
income to net cash flow from operating activities. The FASB gave its 
opinion that the direct method is ``the more comprehensive and 
presumably more useful approach.''
    While this release refers primarily to U.S. GAAP, the underlying 
events and circumstances described in the release ordinarily will be 
applicable to foreign private issuers and should be discussed to the 
extent material. Consistent with the Instructions to Form 20-F, 
however, companies using that form should focus on the primary 
financial statements in their discussion and analysis in Item 5 
(Operative and Financial Review Prospects). Also, companies are 
required to discuss in Item 5 of Form 20-F any aspects of the 
differences between foreign and U.S. GAAP that they believe are 
necessary for an understanding of the financial statements as a 
whole. See Instruction 2 to Item 5 of Form 20-F [17 CFR 249.220f].
---------------------------------------------------------------------------

    [sbull] Companies also should consider whether their MD&A should 
include enhanced disclosure regarding debt instruments, guarantees and 
related covenants.

E. Critical Accounting Estimates

    Finally, we have included a separate section in this release 
regarding accounting estimates and assumptions that may be material due 
to the levels of subjectivity and judgment necessary to account for 
highly uncertain matters or the susceptibility of such matters to 
change, and that have a material impact on financial condition or 
operating performance. Companies should consider enhanced discussion 
and analysis of these critical accounting estimates and assumptions 
that:
    [sbull] Supplements, but does not duplicate, the description of 
accounting policies in the notes to the financial statements; and
    [sbull] Provides greater insight into the quality and variability 
of information regarding financial condition and operating performance.

F. Effect on Prior Commission Statements

    This release does not modify existing legal requirements or create 
new legal requirements. Rather, we intend this release to assist 
companies in preparing MD&A by providing interpretive guidance and, in 
some cases, providing additional guidance in areas that the Commission 
has addressed previously. We do not believe that the guidance in this 
release conflicts with prior Commission guidance, nor is it our 
intention to alter any prior Commission guidance.

II. Background

    The following is a chronology of certain prior Commission action 
regarding MD&A:

[[Page 75058]]

    1980--We adopted the present form of the disclosure requirements 
for MD&A.\9\
---------------------------------------------------------------------------

    \9\ Final Rule: Amendments to Annual Report Form, Related Forms, 
Rules, Regulations, and Guides; Integration of Securities Acts 
Disclosure Systems, Release No. 33-6231 (Sept. 2, 1980) [45 FR 
63630].
---------------------------------------------------------------------------

    1981--We published the staff's interpretive guidance for MD&A after 
its review of disclosures that were prepared in accordance with the 
then-recently adopted disclosure requirements.\10\
---------------------------------------------------------------------------

    \10\ Management's Discussion and Analysis of Financial Condition 
and Results of Operations, Release No. 33-6349 (Sept. 28, 1981) 23 
SEC Docket 962 [Release not published in the Federal Register].
---------------------------------------------------------------------------

    1987--We sought public comment on the adequacy of MD&A and on 
proposed revisions submitted by members of the professional accounting 
community.\11\
---------------------------------------------------------------------------

    \11\ Concept Release on Management's Discussion and Analysis of 
Financial Condition and Operations, Release No. 33-6711 (April 24, 
1987) [52 FR 13715].
---------------------------------------------------------------------------

    1989--We published an interpretive release that addressed a number 
of disclosure matters that should be considered by companies in 
preparing MD&A.\12\ The 1989 Release provided guidance in various 
areas, including required prospective information, analysis of long- 
and short-term liquidity and capital resources, material changes in 
financial statement line items, required interim period disclosure, 
segment analysis, participation in high-yield financings, highly 
leveraged transactions or non-investment grade loans and investments, 
the effects of federal financial assistance upon the operations of 
financial institutions and the disclosure of preliminary merger 
negotiations.
---------------------------------------------------------------------------

    \12\ 1989 Release.
---------------------------------------------------------------------------

    December 2001--As part of its process of reviewing financial and 
non-financial disclosures made by public companies, the Division of 
Corporation Finance announced that it would preliminarily review the 
annual reports filed in 2002 by the Fortune 500 companies, and 
undertake further review as appropriate, consistent with its selective 
review program. The focus of the project was to identify ``disclosure 
that appeared to be critical to an understanding of each company's 
financial position and results, but which, at least on its face, seemed 
to conflict significantly with generally accepted accounting principles 
[GAAP] or SEC rules, or to be materially deficient in explanation or 
clarity.''\13\ As a result of this review, comment letters, many of 
which commented on companies' MD&A, were sent to more than 350 of the 
Fortune 500 companies. Earlier this year, the Division published a 
summary of the most frequent general areas of comment resulting from 
this review.\14\
---------------------------------------------------------------------------

    \13\ Fortune 500 Summary.
    \14\ Id.
---------------------------------------------------------------------------

    December 2001--The Commission issued cautionary advice to companies 
regarding the need for greater investor awareness of the sensitivity of 
financial statements to the methods, assumptions, and estimates 
underlying their preparation. This cautionary advice encouraged public 
companies to include in their MD&A full explanations of their 
``critical accounting policies,'' the judgments and uncertainties 
affecting the application of those policies, and the likelihood that 
materially different amounts would be reported under different 
conditions or using different assumptions.\15\
---------------------------------------------------------------------------

    \15\ Cautionary Advice Regarding Disclosure About Critical 
Accounting Policies, Release No. 33-8040 (Dec. 12, 2001) [66 FR 
65013] (``December 2001 Release'').
---------------------------------------------------------------------------

    January 2002--After receiving a petition requesting additional MD&A 
interpretive guidance,\16\ we issued a statement ``to suggest steps 
that issuers should consider in meeting their current disclosure 
obligations with respect to the topics described.''\17\ The statement 
provided explicit interpretive guidance on certain MD&A topics 
considered material to an understanding of companies' operations. The 
topics addressed by the release were liquidity and capital resources 
(including off-balance sheet arrangements), trading activities 
involving non-exchange traded contracts accounted for at fair value, 
and relationships and transactions with persons or entities that derive 
benefits from their non-independent relationships with the company or 
the company's related parties.\18\
---------------------------------------------------------------------------

    \16\ On December 31, 2001 the Commission received a petition 
from Arthur Andersen LLP, Deloitte and Touche, LLP, Ernst & Young 
LLP, KPMG LLP and PricewaterhouseCoopers LLP. The American Institute 
of Certified Public Accountants endorsed the petition. A copy of the 
petition is available at www.sec.gov/rules/petitions/petndiscl_12312001.htm.
    \17\ See January 2002 Release.
    \18\ Id.
---------------------------------------------------------------------------

    May 2002--We proposed additional MD&A disclosure requirements, 
which remain under consideration, regarding the application of 
companies' critical accounting estimates.\19\
---------------------------------------------------------------------------

    \19\ Proposed Rule: Disclosure in Management's Discussion and 
Analysis About the Application of Critical Accounting Policies, 
Release No. 33-8098 (May 10, 2002) [67 FR 35620] (``2002 Critical 
Accounting Policies Proposal'').
---------------------------------------------------------------------------

    January 2003--We adopted additional disclosure requirements 
regarding off-balance sheet arrangements and aggregate contractual 
obligations.\20\ The new rules require the disclosure of off-balance 
sheet arrangements in a designated section of MD&A and an overview of 
certain known contractual obligations in a tabular format.\21\
---------------------------------------------------------------------------

    \20\ Final Rule: Disclosure in Management's Discussion and 
Analysis About Off-Balance Sheet Arrangements and Aggregate 
Contractual Obligations, Release No. 33-8182 (Jan. 28, 2003) [68 FR 
5982] (``2003 Off-Balance Sheet Release'').
    The overall guidance in this Interpretive Release is applicable 
to all MD&A discussions, including those related to off-balance 
sheet arrangements. As such, it should be applied to General 
Instruction B.(11) of Form 40-F and Item 303(c) of Regulation S-B, 
in addition to the other sections set out in note 1, above. We are 
not addressing specifically disclosures of off-balance sheet 
arrangements in this release, however, because we have little 
experience with companies' application of the new rules, which are 
effective for companies' registration statements, annual reports and 
proxy or information statements that are required to include 
financial statements for their fiscal years ending on or after June 
15, 2003. Companies (other than small business issuers) must include 
the table of contractual obligations in registration statements, 
annual reports, and proxy or information statements that are 
required to include financial statements for the fiscal years ending 
on or after December 15, 2003. In addition, Section 401(c) of the 
Sarbanes-Oxley Act requires us to complete a study and report to the 
President and Congress next year on these types of disclosures.
    \21\ The tabular disclosure is not required for small business 
issuers by Item 303 of Regulation S-B.
---------------------------------------------------------------------------

    We also have brought numerous enforcement actions based on alleged 
violations of MD&A requirements and will continue to bring such actions 
under appropriate circumstances.\22\
---------------------------------------------------------------------------

    \22\ See, e.g., In the Matter of Edison Schools, Inc., Release 
No. 34-45925 (May 14, 2002); In the Matter of Sony Corporation and 
Sumio Sano, Release No. 34-40305 (Aug. 5, 1998); In the Matter of 
Bank of Boston Corp., Initial Decision Release No. 81 (Dec. 22, 
1995); In the Matter of Gibson Greetings, Inc., Ward A. Cavanaugh, 
and James H. Johnsen, Release No. 34-36357 (Oct. 11, 1995); In the 
Matter of America West Airlines, Inc., Release No. 34-34047 (May 12, 
1994); In the Matter of Salant Corporation and Martin F. Tynan, 
Release No. 34-34046 (May 12, 1994); In the Matter of Shared Medical 
Systems Corporation, Release No. 34-33632 (Feb. 17, 1994); In the 
Matter of Caterpillar Inc., Release No. 34-30532 (Mar. 31, 1992); In 
the Matter of American Express Company, Release No. 34-23332 (June 
17, 1986).
---------------------------------------------------------------------------

    Based on recent experiences, we have determined that additional 
interpretive guidance regarding the requirements of MD&A will be useful 
to companies in enhancing overall disclosure under MD&A requirements.

III. Overall Approach to MD&A

A. The Presentation of MD&A

    Since the introduction of our MD&A requirements, many companies 
have become larger, more global and more complex. At the same time, the 
combination of our rules and investors' demands have led to an increase 
in the number of subjects and matters addressed in MD&A. For these and 
other reasons, many companies' MD&A have become necessarily lengthy and 
complex. Unfortunately, the

[[Page 75059]]

presentation of the MD&A of too many companies also may have become 
unnecessarily lengthy, difficult to understand and confusing.
    MD&A, like other disclosure, should be presented in clear and 
understandable language. We understand that complex companies and 
situations require disclosure of complex matters and we are not in any 
way seeking over-simplification or ``dumbing down'' of MD&A. However, 
we believe that companies can improve the clarity and understandability 
of their MD&A by using language that is clearer and less convoluted. We 
believe that efforts by companies to provide clearer and better 
organized presentations of MD&A can result in more understandable 
disclosure that does not sacrifice the appropriate level of complexity 
or nuance. In order to engender better understanding, companies should 
prepare MD&A with a strong focus on the most important information, 
provided in a manner intended to address the objectives of MD&A. In 
particular:
    [sbull] Companies should consider whether a tabular presentation of 
relevant financial or other information may help a reader's 
understanding of MD&A. For example, a company's MD&A might be clearer 
and more concise if it provides a tabular comparison of its results in 
different periods, which could include line items and percentage 
changes as well as other information determined by a company to be 
useful, followed by a narrative discussion and analysis of known 
changes, events, trends, uncertainties and other matters. A reader's 
understanding of a company's fair value calculations or discounted cash 
flow figures also could, in some situations, be enhanced by providing a 
tabular summary of the company's various material interest and discount 
rate assumptions in one location.
    [sbull] Companies should consider whether the headings they use 
assist readers in following the flow of, or otherwise assist in 
understanding, MD&A, and whether additional headings would be helpful 
in this regard.
    [sbull] Many companies' MD&A could benefit from adding an 
introductory section or overview that would facilitate a reader's 
understanding. As with all disclosure, what companies would 
appropriately include in an introduction or overview will depend on the 
circumstances of the particular company. As a general matter, an 
introduction or overview should include the most important matters on 
which a company's executives focus in evaluating financial condition 
and operating performance and provide the context for the discussion 
and analysis of the financial statements. Therefore, an introduction or 
overview should not be a duplicative layer of disclosure that merely 
repeats the more detailed discussion and analysis that follows.
    [sbull] While all required information must of course be disclosed, 
companies should consider using a ``layered'' approach. Such an 
approach would present information in a manner that emphasizes, within 
the universe of material information that is disclosed, the information 
and analysis that is most important. This presentation would assist 
readers in identifying more readily the most important information. 
Using an overview or introduction is one example of a layered approach. 
Another is to begin a section containing detailed analysis, such as an 
analysis of period-to-period information, with a statement of the 
principal factors, trends or other matters that are the principal 
subjects covered in more detail in the section.
    We would expect a good introduction or overview to provide a 
balanced, executive-level discussion that identifies the most important 
themes or other significant matters with which management is concerned 
primarily in evaluating the company's financial condition and operating 
results. A good introduction or overview would:
    [sbull] Include economic or industry-wide factors relevant to the 
company;
    [sbull] Serve to inform the reader about how the company earns 
revenues and income and generates cash;
    [sbull] To the extent necessary or useful to convey this 
information, discuss the company's lines of business, location or 
locations of operations, and principal products and services (but an 
introduction should not merely duplicate disclosure in the Description 
of Business section); and
    [sbull] Provide insight into material opportunities, challenges and 
risks, such as those presented by known material trends and 
uncertainties, on which the company's executives are most focused for 
both the short and long term, as well as the actions they are taking to 
address these opportunities, challenges and risks.
    Because these matters do not generally remain static from period to 
period, we would expect the introduction to change over time to remain 
current. As is true with all sections of MD&A, boilerplate disclaimers 
and other generic language generally are not helpful in providing 
useful information or achieving balance, and would detract from the 
purpose of the introduction or overview.
    An introduction or overview, by its very nature, cannot disclose 
everything and should not be considered by itself in determining 
whether a company has made full disclosure. Further, the failure to 
include disclosure of every material item in an introduction or 
overview should not trigger automatically the application of the 
``buried facts'' doctrine, in which a court would consider disclosure 
to be false and misleading if its overall significance is obscured 
because material is ``buried,'' such as in a footnote or an 
appendix.\23\
---------------------------------------------------------------------------

    \23\ See, e.g., Final Rule: Plain English Disclosure, Release 
No. 33-7497 (Jan. 28, 1998) [63 FR 6370 at 6375] (citing Gould v. 
American Hawaiian Steamship Company, 331 F. Supp. 981 (D. Del. 
1971); Kohn v. American Metal Climax, Inc., 322 F. Supp. 1331 (E.D. 
Pa. 1970), modified, 458 F.2d 255 (3d Cir. 1972).)
---------------------------------------------------------------------------

    Throughout MD&A, including in an introduction or overview, 
discussion and analysis of financial condition and operating 
performance includes both past and prospective matters. In addressing 
prospective financial condition and operating performance, there are 
circumstances, particularly regarding known material trends and 
uncertainties, where forward-looking information is required to be 
disclosed. We also encourage companies to discuss prospective matters 
and include forward-looking information in circumstances where that 
information may not be required, but will provide useful material 
information for investors that promotes understanding.

B. The Content and Focus of MD&A

    In addition to enhancing MD&A through the use of clearer language 
and presentation, many companies could improve their MD&A by focusing 
on the most important information disclosed in MD&A. Disclosure should 
emphasize material information that is required or promotes 
understanding and de-emphasize (or, if appropriate, delete) immaterial 
information that is not required and does not promote understanding.
    Our MD&A requirements call for companies to provide investors and 
other users with material information that is necessary to an 
understanding of the company's financial condition and operating 
performance, as well as its prospects for the future.\24\ While the 
desired focus of MD&A for a particular company will depend on the facts 
and circumstances of the company, some guidance about the content and 
focus of MD&A is generally applicable.
---------------------------------------------------------------------------

    \24\ See 1989 Release, Part III.A.

---------------------------------------------------------------------------

[[Page 75060]]

1. Focus on Key Indicators of Financial Condition and Operating 
Performance
    As discussed, one of the principal objectives of MD&A is to give 
readers a view of the company through the eyes of management by 
providing both a short and long-term analysis of the business.\25\ To 
do this, companies should ``identify and address those key variables 
and other qualitative and quantitative factors which are peculiar to 
and necessary for an understanding and evaluation of the individual 
company.'' \26\
---------------------------------------------------------------------------

    \25\ See, e.g., Release No. 33-6711 (Apr. 24, 1987) [52 FR 13715 
at 13717] (``an opportunity to look at the company through the eyes 
of management by providing both a short and long-term analysis of 
the business of the company.'').
    \26\ 1989 Release, Part III.A (citing Release No. 33-6349 (Sept. 
28, 1981) 23 SEC Docket 962 at 964 [Release not published in the 
Federal Register]).
---------------------------------------------------------------------------

    Financial measures generally are the starting point in ascertaining 
these key variables and other factors. However, financial measures 
often tell only part of how a company manages its business. Therefore, 
when preparing MD&A, companies should consider whether disclosure of 
all key variables and other factors that management uses to manage the 
business would be material to investors, and therefore required.\27\ 
These key variables and other factors may be non-financial, and 
companies should consider whether that non-financial information should 
be disclosed.
---------------------------------------------------------------------------

    \27\ Examples of such other factors, depending on the 
circumstances of a particular company, can include manufacturing 
plant capacity and utilization, backlog, trends in bookings and 
employee turnover rates. See, e.g., Quality, Transparency, 
Accountability, Lynn E. Turner, Chief Accountant, Securities and 
Exchange Commission, Remarks before Financial Executives Institute 
(Apr. 26, 2001), available at www.sec.gov/news/speech/spch485.htm.
    Companies should also consider disclosing information that may 
be peripheral to the accounting function, but is integral to the 
business or operating activity. Examples of such measures, depending 
on the circumstances of a particular company, can include those 
based on units or volume, customer satisfaction, time-to-market, 
interest rates, product development, service offerings, throughput 
capacity, affiliations/joint undertakings, market demand, customer/
vendor relations, employee retention, business strategy, changes in 
the managerial approach or structure, regulatory actions or 
regulatory environment, and any other pertinent macroeconomic 
measures. Because these measures are generally non-financial in 
nature, we do not believe that their disclosure generally will raise 
issues under Item 10(e) of Regulation S-K [17 CFR 229.10(e)] or Item 
10(h) of Regulation S-B [17 CFR 228.10(h)].
---------------------------------------------------------------------------

    Many companies currently disclose non-financial business and 
operational data.\28\ Academics, authors, and consultants also have 
researched the types of information, outside of financial statement 
measures, that would be helpful to investors and other users.\29\ Such 
information may relate to external or macro-economic matters as well as 
those specific to a company or industry. For example, interest rates or 
economic growth rates and their anticipated trends can be important 
variables for many companies. Industry-specific measures can also be 
important for analysis, although common standards for the measures also 
are important. Some industries commonly use non-financial data, such as 
industry metrics and value drivers.\30\ Where a company discloses such 
information, and there is no commonly accepted method of calculating a 
particular non-financial metric, it should provide an explanation of 
its calculation to promote comparability across companies within the 
industry. Finally, companies may use non-financial performance measures 
that are company-specific.
---------------------------------------------------------------------------

    \28\ See Improving Business Reporting: Insights into Enhancing 
Voluntary Disclosures, Steering Committee Report of the Business 
Reporting Research Project of the FASB (2001) available at 
www.fasb.org; the Jenkins Report; Financial Accounting Series 
Special Report, Business and Financial Reporting, Challenges from 
the New Economy (FASB) (2001) (``Special Report on Improving 
Business Reporting'').
    \29\ See Special Report on Improving Business Reporting.
    \30\ See, e.g., the Jenkins Report; the Special Report on 
Improving Business Reporting.
---------------------------------------------------------------------------

    In addition, if companies disclose material information (historical 
or forward-looking) other than in their filed documents (such as in 
earnings releases or publicly accessible analysts' calls or companion 
website postings) they also should evaluate that material information 
to determine whether it is required to be included in MD&A, either 
because it falls within a specific disclosure requirement or because 
its omission would render misleading the filed document in which the 
MD&A appears. We are not seeking to sweep into MD&A all the information 
that a company communicates. Rather, companies should consider their 
communications and determine what information is material and is 
required in, or would promote understanding of, MD&A.
    Since we adopted the MD&A requirements, and even since the last 
comprehensive guidance on MD&A we released in 1989, there have been 
significant advancements in the ability to develop and access 
information quickly and effectively. Changes in business enterprise 
systems, communications and other aspects of information technology 
have significantly increased the amount of information available to 
management, as well as the speed with which they receive and are able 
to use information.\31\ There is therefore a larger and more up-to-date 
universe of information, financial and non-financial alike, that 
companies have and should evaluate in determining whether disclosure is 
required. This situation presents companies with the challenge of 
identifying information that is required to be disclosed or that 
promotes understanding, while avoiding unnecessary information overload 
for readers by not disclosing a greater body of information, just 
because it is available, where disclosure is not required and does not 
promote understanding. Further, with advances in technology 
contributing to increasing amounts and currency of information, the 
factors relied upon by companies to operate and analyze the business 
may change. As this occurs, the discussion in MD&A should change over 
time to maintain an appropriate focus on material factors.
---------------------------------------------------------------------------

    \31\ See the Jenkins Report.
---------------------------------------------------------------------------

    The focus on key performance indicators can be enhanced not only 
through the language and content of the discussion, but also through a 
format that will enhance the understanding of the discussion and 
analysis. The order of the information need not follow the order 
presented in Item 303 of Regulation S-K if another order of 
presentation would better facilitate readers' understanding. MD&A 
should provide a frame of reference that allows readers to understand 
the effects of material changes and events and known material trends 
and uncertainties arising during the periods being discussed, as well 
as their relative importance. To satisfy the objectives of MD&A, 
companies also should provide a balanced view of the underlying 
dynamics of the business, including not only a description of a 
company's successes, but also of instances when it failed to realize 
goals, if material. Good MD&A will focus readers' attention on these 
key matters.
2. Focus on Materiality
    Companies must provide specified material information in their 
MD&A,\32\ and they also must provide other material information that is 
necessary to make the required statements, in light of the 
circumstances in which they are

[[Page 75061]]

made, not misleading.\33\ MD&A must specifically focus on known 
material events and uncertainties that would cause reported financial 
information not to be necessarily indicative of future operating 
performance or of future financial condition.\34\ Companies must 
determine, based on their own particular facts and circumstances, 
whether disclosure of a particular matter is required in MD&A. However, 
the effectiveness of MD&A decreases with the accumulation of 
unnecessary detail or duplicative or uninformative disclosure that 
obscures material information.\35\ Companies should view this guidance 
as an opportunity to evaluate whether there is information in their 
MD&A that is no longer material or useful, and therefore should be 
deleted, for example where there has been a change in their business or 
the information has become stale.
---------------------------------------------------------------------------

    \32\ See, e.g., Item 303(a)(1) of Regulation S-K [17 CFR 
229.303(a)(1)] (requiring the identification of ``known trends or 
known demands, commitments, events or uncertainties that will result 
in or that are reasonably likely to result in the registrant's 
liquidity increasing or decreasing in any material way''). See also 
Item 303(a)(2)(i) of Regulation S-K [17 CFR 229.303(a)(2)(i)] 
(requiring a description of registrant's material commitments for 
capital expenditures).
    \33\ See Securities Act Rule 408 [17 CFR 230.408], Securities 
Exchange Act of 1934 Section 10(b) [15 U.S.C. 78j(b)], Exchange Act 
Rule 10b-5 [17 CFR 240.10b-5], and Exchange Act Rule 12b-20 [17 CFR 
240.12b-20]. See also, In the Matter of Edison Schools, Inc., 
Release No. 34-45925 (May 14, 2002) (finding, among other things, 
that the company failed to provide accurate and complete disclosure 
about its reported revenues); In the Matter of Sony Corporation and 
Sumio Sano, Release No. 34-40305 (Aug. 5, 1998) (finding that the 
company violated Section 13(a) of the Exchange Act by making 
inadequate disclosures about the nature and the extent of Sony 
Pictures' net losses and their impact on the consolidated results 
Sony was reporting); In the Matter of Caterpillar Inc., Release No. 
34-30532 (Mar. 31, 1992) (finding failure to disclose the impact of 
a subsidiary's foreign operations on the company's results of 
operations violated Section 13(a) of the Exchange Act).
    \34\ Instruction 3 to Item 303(a) of Regulation S-K [17 CFR 
229.303(a)].
    \35\ See, e.g., Instruction 4 to Item 303(a) of Regulation S-K 
(indicating that repetition and line-by-line analysis is not 
required nor is it appropriate when the causes for a change in one 
line item also relate to other line items and indicating that, to 
the extent the changes from year to year are readily computable from 
the financial statements, the changes need not be recited in the 
discussion). The 1989 Release also addressed these points directly. 
See 1989 Release, Part III.D.
    Where companies believe that information from the face of 
financial statements is helpful to readers in MD&A, they should 
consider using a tabular presentation that shows the decimal 
percentages of components or year-over-year percentage changes of 
the financial statement line items. An appropriate analysis of this 
data, to the extent that it is material, should accompany the 
tabular presentation consistent with the guidance in Section III.B.3 
of this Release.
---------------------------------------------------------------------------

    As the complexity of business structures and financial transactions 
increase, and as the activities undertaken by companies become more 
diverse, it is increasingly important for companies to focus their MD&A 
on material information. In preparing MD&A, companies should evaluate 
issues presented in previous periods and consider reducing or omitting 
discussion of those that may no longer be material or helpful, or 
revise discussions where a revision would make the continuing relevance 
of an issue more apparent.
    Companies also should focus on an analysis of the consolidated 
financial condition and operating performance, with segment data 
provided where material to an understanding of consolidated 
information. Segment discussion and analysis should be designed to 
avoid unnecessary duplication and immaterial detail that is not 
required and does not promote understanding of a company's overall 
financial condition and operating performance.
    Both Instruction 4 to Item 303 of Regulation S-K and the 1989 
Release address the requirement of discussion and analysis of changes 
in line items. A review of current MD&A provided by some companies, 
however, reveals that this is a portion of MD&A that can include an 
excessive amount of duplicative disclosure, as well as disclosure of 
immaterial items that do not promote understanding. The 1989 Release 
explicitly provides for the grouping of line items for purposes of 
discussion and analysis in a manner that avoids duplicative disclosure. 
In addition, Instruction 4 and the guidance in the 1989 Release do not 
require a discussion of every line item and its changes without regard 
to materiality. Discussion of a line item and its changes should be 
avoided where the information that would be disclosed is not material 
and would not promote understanding of MD&A.
    Companies also must assess the materiality of items in preparing 
disclosure in their quarterly reports. There may be different 
quantitative and qualitative factors to consider when deciding whether 
to include certain information in a specific quarterly or annual 
report. The 1989 Release addresses some aspects of MD&A disclosure in 
the context of quarterly filings. That release clarifies that material 
changes to items disclosed in MD&A in annual reports should be 
discussed in the quarter in which they occur.\36\ There also may be 
circumstances where an item may not be material in the context of a 
discussion of annual results of operations but is material in the 
context of interim results.
---------------------------------------------------------------------------

    \36\ See 1989 Release, Part III.E.
---------------------------------------------------------------------------

    Disclosure in MD&A in quarterly reports is complementary to that 
made in the most recent annual report and in any intervening quarterly 
reports. Therefore, there may be cases, particularly where adequate 
disclosure is included in the MD&A in those earlier reports, where 
further disclosure in a quarterly report is not necessary. If, however, 
disclosure in those earlier reports does not adequately foreshadow 
subsequent events, or if new information that impacts known trends and 
uncertainties becomes apparent in a quarterly period, additional 
disclosure should be considered and may be required.
3. Focus on Material Trends and Uncertainties
    One of the most important elements necessary to an understanding of 
a company's performance, and the extent to which reported financial 
information is indicative of future results, is the discussion and 
analysis of known trends, demands, commitments, events and 
uncertainties. Disclosure decisions concerning trends, demands, 
commitments, events, and uncertainties generally should involve the:
    [sbull] Consideration of financial, operational and other 
information known to the company;
    [sbull] Identification, based on this information, of known trends 
and uncertainties; and
    [sbull] Assessment of whether these trends and uncertainties will 
have, or are reasonably likely to have, a material impact on the 
company's liquidity, capital resources or results of operations.
    As we have explained in prior guidance, disclosure of a trend, 
demand, commitment, event or uncertainty is required unless a company 
is able to conclude either that it is not reasonably likely that the 
trend, uncertainty or other event will occur or come to fruition, or 
that a material effect on the company's liquidity, capital resources or 
results of operations is not reasonably likely to occur.\37\ (In this 
release we sometimes use the term ``known material trends and 
uncertainties'' to describe trends, demands, commitments, events or 
uncertainties as to which disclosure is required.)
---------------------------------------------------------------------------

    \37\ See January 2002 Release at 3748 (``two assessments 
management must make where a trend, demand, commitment, event or 
uncertainty is known: 1. Is the known trend, demand, commitment, 
event or uncertainty likely to come to fruition? If management 
determines that it is not reasonably likely to occur, no disclosure 
is required. 2. If management cannot make that determination, it 
must evaluate objectively the consequences of the known trend, 
demand, commitment, event or uncertainty, on the assumption that it 
will come to fruition. Disclosure is then required unless management 
determines that a material effect on the registrant's financial 
condition or results of operations is not reasonably likely to 
occur'' (citing the 1989 Release)).
---------------------------------------------------------------------------

    In identifying known material trends and uncertainties, companies 
should consider the substantial amount of

[[Page 75062]]

financial and non-financial information available to them, and whether 
or not the available information itself is required to be disclosed. 
This information, over time, may reveal a trend or general pattern in 
activity, a departure or isolated variance from an established trend, 
an uncertainty, or a reasonable likelihood of the occurrence of such an 
event that should be disclosed.
    One of the principal objectives of MD&A is to provide information 
about the quality and potential variability of a company's earnings and 
cash flow, so that readers can ascertain the likelihood that past 
performance is indicative of future performance. Ascertaining this 
indicative value depends to a significant degree on the quality of 
disclosure about the facts and circumstances surrounding known material 
trends and uncertainties in MD&A. Quantification of the material 
effects of known material trends and uncertainties can promote 
understanding. Quantitative disclosure should be considered and may be 
required to the extent material if quantitative information is 
reasonably available.
    As discussed in the 1989 Release, the disclosures required to 
address known material trends and uncertainties in the discussion and 
analysis should not be confused with optional forward-looking 
information. Not all forward-looking information falls within the realm 
of optional disclosure. In particular, material forward-looking 
information regarding known material trends and uncertainties is 
required to be disclosed as part of the required discussion of those 
matters and the analysis of their effects.\38\ In addition, forward-
looking information is required in connection with the disclosure in 
MD&A regarding off-balance sheet arrangements.\39\
---------------------------------------------------------------------------

    \38\ See 1989 Release, Part III.B.
    \39\ In connection with our adoption of the off-balance sheet 
arrangements disclosure requirements, we eliminated a portion of the 
instructions in Item 303 of Regulation S-K that stated that 
registrants were not required to provide forward-looking 
information. Deleting that portion of the instructions did not 
affect requirements to provide forward-looking information in other 
circumstances where required or reduce the availability of any safe 
harbor for forward-looking information. See also 2003 Off-Balance 
Sheet Release. See Securities Act Section 27A [15 U.S.C. 77z-2], 
Securities Act Rule 175 [17 CFR 230.175], Exchange Act Section 21E 
[17 U.S.C. 78u-5], and Exchange Act Rule 3b-6 [17 CFR 240.3b-6].
---------------------------------------------------------------------------

4. Focus on Analysis
    MD&A requires not only a ``discussion'' but also an ``analysis'' of 
known material trends, events, demands, commitments and uncertainties. 
MD&A should not be merely a restatement of financial statement 
information in a narrative form. When a description of known material 
trends, events, demands, commitments and uncertainties is set forth, 
companies should consider including, and may be required to include, an 
analysis explaining the underlying reasons or implications, 
interrelationships between constituent elements, or the relative 
significance of those matters.
    Identifying the intermediate effects of trends, events, demands, 
commitments and uncertainties alone, without describing the reasons 
underlying these effects, may not provide sufficient insight for a 
reader to see the business through the eyes of management. A thorough 
analysis often will involve discussing both the intermediate effects of 
those matters and the reasons underlying those intermediate effects. 
For example, if a company's financial statements reflect materially 
lower revenues resulting from a decline in the volume of products sold 
when compared to a prior period, MD&A should not only identify the 
decline in sales volume, but also should analyze the reasons underlying 
the decline in sales when the reasons are also material and 
determinable. The analysis should reveal underlying material causes of 
the matters described, including for example, if applicable, 
difficulties in the manufacturing process, a decline in the quality of 
a product, loss in competitive position and market share, or a 
combination of conditions.
    Similarly, where a company's financial statements reflect material 
restructuring or impairment charges, or a decline in the profitability 
of a plant or other business activity, MD&A should also, where 
material, analyze the reasons underlying these matters, such as an 
inability to realize previously projected economies of scale, a failure 
to renew or secure key customer contracts, or a failure to keep 
downtime at acceptable levels due to aging equipment. Whether favorable 
or unfavorable conditions constitute or give rise to the material 
trends, demands, commitments, events or uncertainties being discussed, 
the analysis should consist of material substantive information and 
present a balanced view of the underlying dynamics of the business.
    If there is a reasonable likelihood that reported financial 
information is not indicative of a company's future financial condition 
or future operating performance due, for example, to the levels of 
subjectivity and judgment necessary to account for highly uncertain 
matters and the susceptibility of such matters to change, appropriate 
disclosure in MD&A should be considered and may be required. For 
example, if a change in an estimate has a material favorable impact on 
earnings, the change and the underlying reasons should be disclosed so 
that readers do not incorrectly attribute the effect to operational 
improvements. In addition, if events and transactions reported in the 
financial statements reflect material unusual or non-recurring items, 
aberrations, or other significant fluctuations, companies should 
consider the extent of variability in earnings and cash flow, and 
provide disclosure where necessary for investors to ascertain the 
likelihood that past performance is indicative of future performance. 
Companies also should consider whether the economic characteristics of 
any of their business arrangements, or the methods used to account for 
them, materially impact their results of operations or liquidity in a 
structured or unusual fashion, where disclosure would be necessary to 
understand the amounts depicted in their financial statements.

IV. Liquidity and Capital Resources

    Our rules require companies to provide disclosure in the related 
categories of liquidity and capital resources.\40\ This information is 
critical to an assessment of a company's prospects for the future and 
even the likelihood of its survival.\41\ A company is required to 
include in MD&A the following information, to the extent material:
    [sbull] Historical information regarding sources of cash and 
capital expenditures;
---------------------------------------------------------------------------

    \40\ See Item 303(a)(1) and (2) of Regulation S-K [17 CFR 
229.303(a)(1) and (2)].
    \41\ See January 2002 Release; 2003 Off-Balance Sheet Release.
---------------------------------------------------------------------------

    [sbull] An evaluation of the amounts and certainty of cash flows;
    [sbull] The existence and timing of commitments for capital 
expenditures and other known and reasonably likely cash requirements;
    [sbull] Discussion and analysis of known trends and uncertainties;
    [sbull] A description of expected changes in the mix and relative 
cost of capital resources;
    [sbull] Indications of which balance sheet or income or cash flow 
items should be considered in assessing liquidity; and
    [sbull] A discussion of prospective information regarding 
companies' sources of and needs for capital, except where otherwise 
clear from the discussion.\42\
---------------------------------------------------------------------------

    \42\ See 1989 Release, Part III.C. See also Item 303(a)(1) and 
(2) of Regulation S-K [17 CFR 229.303(a)(1) and (2)], and 
Instructions 2 and 5 thereto.


[[Page 75063]]


---------------------------------------------------------------------------

Discussion and analysis of this information should be considered and 
may be required to provide a clear picture of the company's ability to 
generate cash and to meet existing and known or reasonably likely 
future cash requirements.
    In determining required or appropriate disclosure, companies should 
evaluate separately their ability to meet upcoming cash requirements 
over both the short and long term.\43\ Merely stating that a company 
has adequate resources to meet its short-term and/or long-term cash 
requirements is insufficient unless no additional more detailed or 
nuanced information is material. In particular, such a statement would 
be insufficient if there are any known material trends or uncertainties 
related to cash flow, capital resources, capital requirements, or 
liquidity.
---------------------------------------------------------------------------

    \43\ Short-term liquidity is defined as a period of twelve 
months or less and long-term is defined as a period in excess of 
twelve months. See 1989 Release, Part III.C. Note that the period of 
time over which a long-term discussion of liquidity is relevant is 
dependent upon the timing of the cash requirements of a company, as 
well as the period of time over which cash flows are managed. A 
vague reference to periods in excess of twelve months may not be 
sufficient.
---------------------------------------------------------------------------

A. Cash Requirements

    In order to identify known material cash requirements, companies 
should consider whether the following information would have a material 
impact on liquidity (discussion of immaterial matters, and especially 
generic disclosure or boilerplate, should be avoided):
    [sbull] Funds necessary to maintain current operations, complete 
projects underway and achieve stated objectives or plans;
    [sbull] Commitments for capital or other expenditures; \44\ and
---------------------------------------------------------------------------

    \44\ See Item 303(a)(2)(i) of Regulation S-K [17 CFR 
229.303(a)(2)(i)].
---------------------------------------------------------------------------

    [sbull] The reasonably likely exposure to future cash requirements 
associated with known trends or uncertainties, and an indication of the 
time periods in which resolution of the uncertainties is anticipated.
    One starting point for a company's discussion and analysis of cash 
requirements is the tabular disclosure of contractual obligations,\45\ 
supplemented with additional information that is material to an 
understanding of the company's cash requirements.\46\
---------------------------------------------------------------------------

    \45\ See Item 303(a)(5) of Regulation S-K [17 CFR 
229.303(a)(5)].
    \46\ For example, the cash requirements for items such as 
interest, taxes or amounts to be funded to cover post-employment 
(including retirement) benefits may not be included in the tabular 
disclosure, but should be discussed if material.
---------------------------------------------------------------------------

    For example, if a company has incurred debt in material amounts, it 
should explain the reasons for incurring that debt and the use of the 
proceeds, and analyze how the incurrence of that debt fits into the 
overall business plan, in each case to the extent material.\47\ Where 
debt has been incurred for general working capital purposes, the 
anticipated amount and timing of working capital needs should be 
discussed, to the extent material.\48\
---------------------------------------------------------------------------

    \47\ For example, debt may have been issued to fund the 
construction of a new plant, which will allow the company to expand 
its operations into a specific geographic area. Understanding that 
relationship and the expected commencement date of plant operations 
puts the cash requirement for the debt into an appropriate context 
to understand liquidity.
    \48\ Companies are reminded of their related disclosure 
obligations under Item 504 (Use of Proceeds) of Regulation S-K [17 
CFR 229.504] and the requirement to update this disclosure in Item 
701(f) (Use of Proceeds) of Regulation S-K [17 CFR 229.701(f)].
---------------------------------------------------------------------------

    Companies should address, where material, the difficulties involved 
in assessing the effect of the amount and timing of uncertain events, 
such as loss contingencies, on cash requirements and liquidity. Any 
such discussion should be specific to the circumstances and 
informative, and companies should avoid generic or boilerplate 
disclosure. In addition, because of these difficulties and 
uncertainties, companies should consider whether they need to make or 
change disclosure in connection with quarterly as well as annual 
reports.

B. Sources and Uses of Cash

    As with the discussion and analysis of the results of operations, a 
company's discussion and analysis of cash flows should not be a mere 
recitation of changes and other information evident to readers from the 
financial statements. Rather, MD&A should focus on the primary drivers 
of and other material factors necessary to an understanding of the 
company's cash flows and the indicative value of historical cash flows.
    In addition to explaining how the cash requirements identified in 
MD&A fit into a company's overall business plan, the company should 
focus on the resources available to satisfy those cash requirements. 
Where there has been material variability in historical cash flows, 
MD&A should focus on the underlying reasons for the changes, as well as 
on their reasonably likely impact on future cash flows and cash 
management decisions. Even where reported amounts of cash provided and 
used by operations, investing activities or financing have been 
consistent, if the underlying sources of those cash flows have 
materially varied, analysis of that variability should be provided. The 
discussion and analysis of liquidity should focus on material changes 
in operating, investing and financing cash flows, as depicted in the 
statement of cash flows, and the reasons underlying those changes.
1. Operations
    The discussion and analysis of operating cash flows should not be 
limited by the manner of presentation in the statement of cash 
flows.\49\ Alternate accounting methods of deriving and presenting cash 
flows exist, and while they generally yield the same numeric result in 
the major captions, they involve the disclosure of different types of 
information. When preparing the discussion and analysis of operating 
cash flows, companies should address material changes in the underlying 
drivers (e.g. cash receipts from the sale of goods and services and 
cash payments to acquire materials for manufacture or goods for 
resale), rather than merely describe items identified on the face of 
the statement of cash flows, such as the reconciling items used in the 
indirect method of presenting cash flows.\50\
---------------------------------------------------------------------------

    \49\ See Instruction 4 to Item 303(a) of Regulation S-K [17 CFR 
229.303(a)].
    \50\ See SFAS No. 95.
---------------------------------------------------------------------------

    For example, consider a company that reports an overall increase in 
the components of its working capital other than cash \51\ with the 
effect of having a material decrease in net cash provided by operations 
in the current period. If the increase in working capital was driven 
principally by an increase in accounts receivable that is attributable 
not to an increase in sales, but rather to a revised credit policy 
resulting in an extended payment period for customers, these facts 
would need to be addressed in MD&A to the extent material, along with 
the resulting decrease in cash provided by operations, if not otherwise 
apparent. In addition, if there is a material trend or uncertainty, the 
impact of the new credit policy on cash flows from operations should be 
disclosed.\52\ While a cash flow statement prepared using the indirect 
method would report that various individual components of working 
capital increased or decreased during the

[[Page 75064]]

period by a specified amount, it would not provide a sufficient basis 
for a reader to analyze the change. If the company reports negative 
cash flows from operations, the disclosure provided in MD&A should 
identify clearly this condition, discuss the operational reasons for 
the condition if material, and explain how the company intends to meet 
its cash requirements and maintain operations. If the company relies on 
external financing in these situations, disclosure of that fact and the 
company's assessment of whether this financing will continue to be 
available, and on what terms, should be considered and may be required.
---------------------------------------------------------------------------

    \51\ Working capital is defined as current assets less current 
liabilities. See Chapter 3, AICPA Accounting Research Bulletin (ARB) 
No. 43, Restatement and Revision of Accounting Research Bulletins 
(June 1953).
    \52\ To the extent that this change also materially impacts 
results of operations, discussion and analysis would also be 
required in that section, but companies should attempt to avoid 
unnecessary or confusing duplication.
---------------------------------------------------------------------------

    A company should consider whether, in order to make required 
disclosures, it is necessary to expand MD&A to address the cash 
requirements of and the cash provided by its reportable segments or 
other subdivisions of the business, including issues related to foreign 
subsidiaries, as well as the indicative nature of those results.\53\ A 
company also should discuss the effect of an inability to access the 
cash flow and financial assets of any consolidated entities. For 
example, an entity may be consolidated but, because the company lacks 
sufficient voting interests or the assets are legally isolated, the 
company may be unable to utilize the entity's cash flow, cash on hand, 
or other assets to satisfy its own liquidity needs.
---------------------------------------------------------------------------

    \53\ See Item 303(a) of Regulation S-K [17 CFR 229.303(a)].
---------------------------------------------------------------------------

2. Financing
    To the extent material, a company must provide disclosure regarding 
its historical financing arrangements and their importance to cash 
flows, including, to the extent material, information that is not 
included in the financial statements. A company should discuss and 
analyze, to the extent material:
    [sbull] Its external debt financing;
    [sbull] Its use of off-balance sheet financing arrangements;
    [sbull] Its issuance or purchase of derivative instruments linked 
to its stock;
    [sbull] Its use of stock as a form of liquidity; and
    [sbull] The potential impact of known or reasonably likely changes 
in credit ratings or ratings outlook (or inability to achieve changes).
    In addition to these historical items, discussion and analysis of 
the types of financing that are, or that are reasonably likely to be, 
available (or of the types of financing that a company would want to 
use but that are, or are reasonably likely to be, unavailable) and the 
impact on the company's cash position and liquidity, should be 
considered and may be required. For example, where a company has 
decided to raise or seeks to raise material external equity or debt 
financing, or if it is reasonably likely to do so in the future, 
discussion and analysis of the amounts or ranges involved, the nature 
and the terms of the financing, other features of the financing and 
plans, and the impact on the company's cash position and liquidity (as 
well as results of operations in the case of matters such as interest 
payments) should be considered and may be required.\54\
---------------------------------------------------------------------------

    \54\ We believe that disclosure satisfying the requirements of 
MD&A can be made consistently with the restrictions of Section 5 of 
the Securities Act. See, e.g., Securities Act Rules 135c [17 CFR 
230.135c].
---------------------------------------------------------------------------

C. Debt Instruments, Guarantees and Related Covenants

    There are at least two scenarios in which companies should consider 
whether discussion and analysis of material covenants related to their 
outstanding debt (or covenants applicable to the companies or third 
parties in respect of guarantees or other contingent obligations)\55\ 
may be required.\56\
---------------------------------------------------------------------------

    \55\ See FASB Interpretation No. (FIN) 45, Guarantor's 
Accounting and Disclosure Requirements for Guarantees, Including 
Indirect Guarantees of Indebtedness of Others (Nov. 2002); 2003 Off-
Balance Sheet Release; and the discussion infra, regarding off-
balance sheet arrangements.
    \56\ See In the Matter of America West Airlines, Inc., Release 
No. 34-34047 (May 12, 1994) (finding that the company failed to 
discuss uncertainties regarding its ability to comply with 
covenants).
---------------------------------------------------------------------------

    First, companies that are, or are reasonably likely to be, in 
breach of such covenants \57\ must disclose material information about 
that breach and analyze the impact on the company if material. That 
analysis should include, as applicable and to the extent material:
---------------------------------------------------------------------------

    \57\ Companies also must take a similar approach to discussion 
and analysis with respect to mandatory prepayment provisions, 
``put'' rights and other similar provisions.
---------------------------------------------------------------------------

    [sbull] The steps that the company is taking to avoid the breach;
    [sbull] The steps that the company intends to take to cure, obtain 
a waiver of or otherwise address the breach;
    [sbull] The impact or reasonably likely impact of the breach 
(including the effects of any cross-default or cross-acceleration or 
similar provisions) on financial condition or operating performance; 
and
    [sbull] Alternate sources of funding to pay off resulting 
obligations or replace funding.
    Second, companies should consider the impact of debt covenants on 
their ability to undertake additional debt or equity financing. 
Examples of these covenants include, but are not limited to, debt 
incurrence restrictions, limitations on interest payments, restrictions 
on dividend payments and various debt ratio limits. If these covenants 
limit, or are reasonably likely to limit, a company's ability to 
undertake financing to a material extent, the company is required to 
discuss the covenants in question and the consequences of the 
limitation to the company's financial condition and operating 
performance. Disclosure of alternate sources of funding and, to the 
extent material, the consequences (including but not limited to the 
cost) of accessing them should also be considered and may be required.

D. Cash Management

    Companies generally have some degree of flexibility in determining 
when and how to use their cash resources to satisfy obligations and 
make other capital expenditures. MD&A should describe known material 
trends or uncertainties relating to such determinations. For example, a 
decision by a company in a highly capital-intensive business to spend 
significantly less on plant and equipment than it has historically may 
result in long-term effects that should be disclosed if material. 
Material effects could include more cash, less interest expense and 
lower depreciation, but higher future repair and maintenance expenses 
or a higher cost base than the company would otherwise have.

V. Critical Accounting Estimates

    Many estimates and assumptions involved in the application of GAAP 
have a material impact on reported financial condition and operating 
performance and on the comparability of such reported information over 
different reporting periods. Our December 2001 Release reminded 
companies that, under the existing MD&A disclosure requirements, a 
company should address material implications of uncertainties 
associated with the methods, assumptions and estimates underlying the 
company's critical accounting measurements.\58\ In May 2002 we proposed 
rules, which remain under consideration, that would broaden the scope 
of disclosures beyond those currently required.\59\
---------------------------------------------------------------------------

    \58\ December 2001 Release.
    \59\ See 2002 Critical Accounting Policies Proposal.
---------------------------------------------------------------------------

    When preparing disclosure under the current requirements, companies 
should consider whether they have made

[[Page 75065]]

accounting estimates or assumptions where:
    [sbull] The nature of the estimates or assumptions is material due 
to the levels of subjectivity and judgment necessary to account for 
highly uncertain matters or the susceptibility of such matters to 
change; and
    [sbull] The impact of the estimates and assumptions on financial 
condition or operating performance is material.
    If so, companies should provide disclosure about those critical 
accounting estimates or assumptions in their MD&A.
    Such disclosure should supplement, not duplicate, the description 
of accounting policies that are already disclosed in the notes to the 
financial statements. The disclosure should provide greater insight 
into the quality and variability of information regarding financial 
condition and operating performance. While accounting policy notes in 
the financial statements generally describe the method used to apply an 
accounting principle, the discussion in MD&A should present a company's 
analysis of the uncertainties involved in applying a principle at a 
given time or the variability that is reasonably likely to result from 
its application over time.
    A company should address specifically why its accounting estimates 
or assumptions bear the risk of change. The reason may be that there is 
an uncertainty attached to the estimate or assumption, or it just may 
be difficult to measure or value. Equally important, companies should 
address the questions that arise once the critical accounting estimate 
or assumption has been identified, by analyzing, to the extent 
material, such factors as how they arrived at the estimate, how 
accurate the estimate/assumption has been in the past, how much the 
estimate/assumption has changed in the past, and whether the estimate/
assumption is reasonably likely to change in the future. Since critical 
accounting estimates and assumptions are based on matters that are 
highly uncertain, a company should analyze their specific sensitivity 
to change, based on other outcomes that are reasonably likely to occur 
and would have a material effect. Companies should provide quantitative 
as well as qualitative disclosure when quantitative information is 
reasonably available and will provide material information for 
investors.
    For example, if reasonably likely changes in the long-term rate of 
return used in accounting for a company's pension plan would have a 
material effect on the financial condition or operating performance of 
the company, the impact that could result given the range of reasonably 
likely outcomes should be disclosed and, because of the nature of 
estimates of long-term rates of return, quantified.

Amendments to the Codification of Financial Reporting Policies

    The ``Codification of Financial Reporting Policies'' announced in 
Financial Reporting Release 1 (April 15, 1982) [47 FR 21028] is 
updated:
    1. By adding to the following new sections to the Financial 
Reporting Codification from the release:
    (III) Overall Approach to MD&A.
    (IV) Liquidity and Capital Resources.
    (V) Critical Accounting Estimates.
    2. By revising the footnotes from those sections of the release 
which contain a short form citation to include the complete citation 
form rather than the short form.
    3. By renumbering the footnotes from those sections of the release 
to run in the Financial Reporting Codification consecutively from 
number 1 through number 37.
    The Codification is a separate publication of the Commission. It 
will not be published in the Code of Federal Regulations System.

List of Subjects in 17 CFR Parts 211, 231 and 241

    Securities.

Amendments to the Code of Federal Regulations

0
For the reasons set forth above, the Commission is amending title 17, 
chapter II of the Code of Federal Regulations as set forth below:

PART 211--INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS

0
1. Part 211, Subpart A, is amended by adding Release No. FR-72 and the 
release date of December 19, 2003 to the list of interpretive releases.

PART 231--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES ACT OF 
1933 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
2. Part 231 is amended by adding Release No. 33-8350 and the release 
date of December 19, 2003 to the list of interpretive releases.

PART 241--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES 
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
3. Part 241 is amended by adding Release No. 34-48960 and the release 
date of December 19, 2003 to the list of interpretive releases.

    Dated: December 19, 2003.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-31802 Filed 12-24-03; 8:45 am]
BILLING CODE 8010-01-P