Considerations for changing fiscal year-end: PwC

Considerations for changing fiscal year-end

The decision to change fiscal year-end can be transformational for an organization, requiring extensive cross-functional involvement. Changing fiscal year-ends can yield many benefits, including providing the opportunity to optimize financial reporting exposure to seasonal fluctuations, enhancing comparability among peers and promoting workforce flexibility. It also can impact a company’s growth story and valuation for entities that are pursuing an initial public offering (IPO) to access the capital markets. As such, IPO candidates may be more likely than existing registrants to recast.

But companies should be aware that changing a fiscal year-end is a large-scale undertaking with operational impacts far beyond financial statements. Careful planning and analysis from key personnel across an organization are crucial when considering whether to adopt the change prospectively, retrospectively or not at all.

Reassessing an entity’s optimal fiscal year-end should begin with an evaluation of the business strategy, including the sectors and geographies it operates in and the fiscal year-ends of its peers. This analysis may expose current misalignment and incentivize an entity to pursue and adopt a more optimal fiscal year-end.

Why it matters

Common advantages

Several driving forces may lead an organization to change its fiscal year. Common advantages include the following:

Changing fiscal year-end may better align results with industry peers, enabling analysts to better compare competitors. For example, a January 31 year-end is common in the retail industry to accurately capture the entirety of holiday sales in annual results.

Companies may change their fiscal year-end to adjust for seasonality and allow for more consistent quarter-to-quarter reporting. For example, software companies may also elect to report on a January 31 year-end to flatten seasonality in results by selecting a date that may break up the seasonal period (particularly calendar-year Q3). Alternatively, retail organizations may shift their fiscal year away from a calendar year-end close, given the significant estimates that may be required in December to accrue for returns and price adjustments around the holidays.

Moving sales targets to a non-calendar year-end may reduce pricing pressures or resource constraints at customers that are typically driven by high volumes of vendors seeking to meet sales targets at the same time.

Depending on the industry, shifting busier times to non-holiday seasons allows for more flexible work schedules, which can help improve culture, morale and employee retention.

For companies that are going public, adjusting the fiscal year-end can optimize financial reporting and allow management to better communicate the company’s business strategy and growth trajectory, thereby better positioning its equity story to investors.

Cross-functional impact

While the most direct impact from changing a fiscal year-end is on an entity’s financial reporting processes, this decision creates an extensive and complex operational transformation for a broad range of functions within a company. Such transformation requires cohesive coordination among functions to successfully execute both the financial and operational changes for this undertaking. Significant diligence and procedures are usually required to ensure a company appropriately addresses the impact of this change across an organization well in advance of its effectiveness.

Furthermore, given the extensive operational and financial implications of changing a fiscal year-end, using a project management team can help ensure a smooth and thorough transition. Firmwide projects require a dedicated team to manage timelines, communications and resources across functions. Particularly in the context of an IPO, the employees impacted by the adoption of a new fiscal year-end are often the same ones dedicated to the IPO process and normal business operations. As such, project managers will need to carefully consider the possibility of resource constraints prior to undertaking a change to the firm’s fiscal year.

Impacted functions and actions may include:

Adjustments to accounting and financial reporting, close and cut-off procedures, financial preparation and disclosures. This may include conducting walk-throughs of significant processes to understand the impact from changing cut-off timing (e.g., inventory management, invoice processing, procurement)

Changes to systems and technology, as well as the downstream impact to internal controls and internal audit functions. For example, systems should be assessed and tested to ensure they can accommodate procedures within a shortened transition period. Adjustments may be required to materiality, scoping and sampling strategies.

Impact to legal agreements, including notification clauses, updated processes to maintain compliance with debt covenants and other potential changes to terms and conditions.

Changes to compensation plans and outstanding equity awards, amendments to performance targets, and employee payroll reconciliation and payroll tax updates. For example, the measurement criteria and performance targets used for the transition period and subsequent fiscal years must be reassessed and updated. In addition, compensation strategies, such as commissions structures, may need to be reevaluated to adjust for changes to quarterly and annual reporting periods.

Changes to budgeting and forecasting to align with the new fiscal calendar, including possible adjustments to lead times and action levers that could impact future cash-flow planning, forecasting and reporting based on revised reporting dates.

Transition-year tax returns may be required, along with IRS clearance to change tax reporting years.

SEC guidance and transition methods

The SEC rules provide two acceptable methods for adopting a change in fiscal year-end: a prospective (“stub period”) or retrospective (“recast”) approach. While the SEC rules apply to public companies, private companies — particularly those considering an IPO — typically follow this guidance.

Stub period approach

This allows a company to prospectively adjust their fiscal year-end and have an audit performed on the transition period (i.e., the period from the company’s prior fiscal year-end to the opening date of the new fiscal year). Comparative financial information is required and may be unaudited in a footnote.

Transition report or “stub period” approach

Benefits
- Limited recast of historical financial information, rework and potential re-audits required
- Allows additional time to address broader organizational impacts
- Alignment of tax year-end and historical provisions from both a consolidated and statutory perspective
Challenges
- Depending on metrics presented, a stub period presentation may confuse investors (impact on cohorts, definition of KPIs, comparability of MD&A, business trends, etc.)
- Preparation of unaudited comparative financial information is required, although it can be presented on an unaudited basis in a footnote
- Depending on timing and requests from the working group, recasting quarters could be required (but not mandatory)

Recast approach

This requires a registrant to adjust all periods presented to reflect the newly selected fiscal year. This includes not only the audited financial statements but also any other financial information in an SEC filing. This method applies the change as if the company has always reported under the new fiscal year-end.

Benefits
- Consistent presentation in Form S-1
- Easier to follow growth trajectory of business, KPIs, etc.
- Clarity for investors and eases SEC review process
- Presents MD&A on an “apples to apples” basis
- Recast may be limited for EGCs (one or two years) as opposed to non-EGCs
Challenges
- Recast of historical financial statements requires incremental close procedures (including cutoff), additional audit work, and reissuance of historical financial statements
- Disconnect between tax returns and historical tax provisions

Transition report

When a company changes its fiscal year, it is required to file a transition report covering the transition period and prior year. A transition period is the period between the closing of the registrant’s most recent fiscal year and the opening date of its newly selected fiscal year, and the length of such period impacts reporting requirements as described below.

Note that while the stub-period approach limits the recasting of prior period information, in some instances the auditing of the stub-period transition period may need to be accelerated, specifically, when considering registration statement requirements for public offerings. See below for reporting requirements based on the length of the transition period for companies.

Length of transition period	Reporting requirements
> 6 months	File a transition report on the Form 10-K after the later of the election to change the fiscal year or the end of the transition period. The transition period financial statements must be audited.
< 6 months	File a transition report on the Form 10-K or on Form 10-Q after the later of the election to change the fiscal year or the end of the transition period. The transition period may be unaudited in Form 10-Q, but the next Form 10-K must contain audited financial statements of the transition period.
< 1 month	No separate transition report is required. However, if the registrant does not file a transition report on either Form 10-Q or 10-K, the transition period financial statements must be included in the next periodic report filed on Form 10-Q. The transition period may be unaudited, but the next Form 10-K must contain audited financial statements of the transition period.

Financial reporting: Beyond the basics

Companies should also be prepared to address various accounting and reporting implications of adjusting their normal close and cut-off procedures, as most (if not all) financial statement line items and disclosures will be impacted. This could include but is not limited to the following areas of impact:

Revenue recognition cut-off processes and estimates, as well as potential impacts to customer reporting obligations, such as service level agreements.

Valuation and impairment testing dates may need to be moved to align with the new period-end. This could include periodic valuation and testing of investments, hedges and post-retirement benefit plans. In addition, impairment testing dates for goodwill and intangibles may need to be reconsidered and appropriately performed annually despite a change in fiscal year-end. Changes to those annual testing dates would constitute accounting policy changes, which have incremental reporting considerations.

Rollforward disclosures require updating, unrecognized compensation costs should be recalculated, and other weighted-average disclosures should be updated. There can also be unintended impacts to performance-based awards when the company’s fiscal year-end changes, which can result in modification accounting for share-based compensation.

Depending on whether the stub period or the recast approach is taken, there could be a disconnect between the historical tax returns and the tax provisions in the company’s financial statements. Further, income tax balances in the financial statements will require adjustment.

So what’s next?

Changing your fiscal year-end provides an opportunity to optimize financial reporting and better align results with those of industry peers. However, careful planning and preparation is critical to the success of this cross-functional and transformational event. Weighing the pros and cons of each transition approach and assessing the impact to an organization’s people, process and technology is a key part of preparation.

Changing fiscal year-end? Be aware, the impact is much broader than financial reporting