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Audit & Accounting Alert Newsletter

Issue 7 | August 2013

At-A-Glance

Gerry Herter

Politics has reared its ugly head in the world of American financial reporting. After years of stalled efforts, the FASB was finally making progress in addressing the needs of smaller private companies, with the Private Company Council (PCC). But responding to the growing frustration of many members, the AICPA moved ahead with its own Financial Reporting Framework for Small-and Medium-Sized Entities (FRF for SMEs), a less complex alternative to US GAAP. While some of the ruffled feathers have now been smoothed over, our first article explores underlying issues that prompted the uproar.

 Ironically, on the same day the AICPA announced FRF for SMEs, the FASB endorsed the first three PCC proposals geared toward simplifying private company financial reporting. Our second article discusses the alternative treatments proposed for intangible assets acquired in business combinations, goodwill, and certain derivatives that are basic interest rate swaps.

Finally, our quarterly worldwide update provides brief highlights of new and upcoming actions and activities of accounting organizations throughout the world. This section enables the reporting of items warranting a mention, but not a full article.

Editor Gerald E. Herter, CPA

In This Issue 

FRF for SMEs – Panacea or Pariah?

Turf war comes to private company financial reporting

Just when the AICPA and FASB appeared to have forged a truce in their battle for control over small company financial reporting, the National Association of State Boards of Accountancy (NASBA) and the Institute of Management Accountants (IMA) jumped into the fray. They were objecting to the Financial Reporting Framework for Small- and Medium- Sized Entities (FRF for SMEs), issued by the AICPA on June 10.

The December 2012 issue of Audit & Accounting Alert covered the unveiling of the FRF for SMEs Exposure Draft, while the April 2013 issue reported on the split reaction after the comment period ended. Despite a mere 90 day exposure period, and the substantial concerns expressed in 75 comment letters, the AICPA proceeded to publication, just over four months after the close of the comment period. According to Robert Durak, AICPA Director of Private Company Financial Reporting Standards, speaking at the AICPA Practitioners Symposium on the day of issuance, changes were made to the Exposure Draft, but nothing significant.

The AICPA has asked the state CPA societies to add their support. Interestingly enough, most of the state societies that submitted comment letters expressed substantial concerns with the new framework. While they tended to agree with the general idea and need for the framework, they felt that more work and time was needed for improvements.

Though the AICPA initially voiced puzzlement at the negative reactions, two obvious sources for the concerns arise from the lack of transparency in the process and the short timeline from exposure to issuance of the framework. Little has been said about how the framework was developed. The fact that the framework is primarily the work of the Canadian Institute of Chartered Accountants is hardly mentioned. Also, despite the volume of concerns with the Exposure Draft, there is scant, if any, discussion directed at how those concerns were addressed.

The FASB’s overseer, the Financial Accounting Foundation (FAF), subsequently clarified that while they had earlier expressed support for the AICPA project, the resulting framework has not been given the FAF’s nor the FASB’s blessing. In fact, reservations were raised in a letter from the FAF president, Terri Polley. Polley appears to distinguish FRF for SMEs from GAAP by stating that “financial statements prepared in accordance with GAAP are transparent, clear, comparable and reliable.” 

With the recent progress of the FAF’s Private Company Council (PCC) (see next article), Polley poses that companies adopting FRF for SMEs may later find that the move was unwarranted. Two primary goals of the PCC are to reduce the cost and complexity of financial reporting. She also reiterated the objections of the NASBA and IMA that the non-authoritative FRF for SMEs will be “difficult to regulate and enforce,” “will cause marketplace confusion,” and “does not require disclosure of the substantial differences between the framework and GAAP.”

A recent Thomson Reuters survey of over 200 accounting firms revealed that 54% were not familiar with the new FRF for SMEs. 40% felt that the most significant challenge to adoption would be the acceptance and understanding by lenders and other users. But a majority felt that some of their clients would consider using the new framework.

The AICPA has backed up its strong support for the FRF for SMEs by offering extensive toolkits directed specifically at CPA firms, financial statement users, and small businesses. These toolkits include introductions, videos, articles, PowerPoints, illustrative financials, and checklists, among other aids. A helpful component that had been requested in the comment letters is a comparison of the major differences between FRF for SME, US GAAP, tax basis and IFRS for SMEs. While more details would be useful at some point, this feature is a step in the right direction.

Who will prevail in this dispute remains to be seen. But I have learned not to bet against the AICPA’s CEO, Barry Melancon, after watching him survive a variety of controversies during his eighteen year tenure at the helm. The AICPA’s marketing effort so far has been impressive. Some of the current misgivings may had been diffused, had the AICPA directed some of that effort and time along the way by more closely collaborating with stakeholders, and addressing their concerns in a more transparent manner.

As if sensing a need to cool down the heated rhetoric, and to correct some of the missteps and overreaction, the AICPA and NASBA have subsequently come together, issuing a joint statement of cooperation. In part, they state: “The AICPA and NASBA are committed to engaging in an effort to ensure that the FRF for SMEs, as a non-authoritative framework, is not confused with GAAP and that entities that utilize GAAP or a non-GAAP solution do so in a suitable and transparent manner. To that end, the AICPA, with NASBA input, will develop a decision-making tool to assist entities with determining whether use of the FRF for SMEs is suitable or not. Additionally, illustrative financial statements and disclosures will be developed to distinguish FRF for SMEs-based financial statements from GAAP-prepared statements.” The statement also praises the work of the PCC, and looks to its “eventual success in developing a GAAP-based financial reporting model for all private companies. CPAs who report on financial statements prepared in accordance with GAAP, or a special purpose framework, such as the FRF for SMEs, will be held to the highest standards of professional practice by U.S. Boards of Accountancy.”

For further information, see Financial Reporting Framework for SMEs


FASB Advances three Private Company Council Proposals

Relief is finally on the way for private company financial reporting

Making good on promises made last fall by newly appointed Private Company Council (PCC) chair, Billy Atkinson, the FASB on July 1 issued proposed Accounting Standard Updates (ASU) relating to business combinations, goodwill and certain derivatives. Though there are numerous areas of the FAS’s that need the PCC’s attention, the three items initially addressed convey a positive impression of the FASB’s commitment to provide practical alternatives for private companies in their struggle to deal with the complexities of the standards.

The first ASU reduces the number of intangible assets that private companies are required to report separately from goodwill in a business combination. Determining fair value for intangibles, such as customer relationships, can be difficult and not of much help to users of the financials. Only in cases of intangibles arising from non-cancellable agreements or other legal rights, are the separate identification provisions applicable. Interestingly enough, the FAF’s post-implementation review of the Business Combinations Topic 805 (formerly FASB Statement 141R), the standard that all companies are currently required to follow, found that stakeholders questioned the credibility of the separately reported intangibles, because of the complexity in determining their fair value. Consequently, the FASB will reconsider whether to change this standard for all companies. The IASB is also reviewing this standard which is converged with the FASB version.

The second ASU allows goodwill to be amortized over the useful life of the primary asset acquired, not to exceed ten years, and eliminates the need for annual impairment assessments. Impairment need only be assessed upon the occurrence of a trigger, and then using a simplified method that determines company-wide excess of the carrying amount over fair value. Examples of triggering events could include significant changes in the economy, industry, market, cost factors, financial performance, management or personnel, customers, potential bankruptcy or litigation.

The third ASU addresses those derivatives that are basic interest rate swaps. Typically for private companies, the only hedging activity occurs when a company enters into a swap to effectively convert a variable-rate loan into the equivalent of a fixed-rate loan. The ASU simplifies the complex derivative provisions by providing two alternatives to account for the swap: 1) the combined instruments approach which considers the loan and swap as one instrument, providing they cover the same time period; or 2) the simplified hedge accounting approach, where the swap and loan are accounted for separately, using settlement value in the financials instead of fair value. Under both methods, the interest reported on the income statement would be similar to that of a fixed rate loan.

Along with these three proposed updates, the FASB and PCC have approved the Private Company Decision Making Framework for issuance. Also, during the third quarter, an exposure draft defining a nonpublic entity is expected, and the PCC has requested that the FASB endorse a proposal to exempt private companies from the requirement to consolidate variable interest entities (VIEs) arising from common control leasing arrangements.

While the ongoing controversy over FRF for SMEs brings out the wide scope of complexities that the FAS’s impose on companies, the PCC’s efforts and the FASB’s support thus far, may indicate a welcome new attitude toward the needs of smaller companies.

For further information, see FASB Endorses Three Private Company Council Proposals


Worldwide Update

Quarterly roundup of recent and upcoming actions and activities by audit and accounting organizations

International

IASB – International Accounting Standards Board (www.ifrs.org)

  1. IFRS for SMEs – A comprehensive Fact Sheet as of July 2013 indicates that over 80 countries have adopted IFRS for SMEs or announced plans to do so. Training materials in various languages and workshops in various locations are available. A comprehensive review of the original July 2009 IFRS for SMEs is underway.
  2. Accounting for Insurance Contracts – A revised Exposure Draft issued on June 20 updates the 2010 ED that seeks to provide a consistent basis for accounting for insurance contracts, and assisting users in understanding the impact on financials.
  3. Assessment of Global Adoption of IFRS – 1st phase completed June 5. Profiles are published of 66 jurisdictions, including all of the G20. 95% are committed to supporting IFRS, 80% have adopted IFRS for public companies, few temporary, local modifications were made, and over 50% have adopted IFRS for SMEs or plan to.

IFAC – International Federation of Accountants (www.ifac.org)

  1. Memorandum of Understanding (MoU) with the Institute of Internal Auditors (www.theiia.org) signed on July 17 strengthening their “commitment to restore confidence in the general public in business reporting and enhancing governance processes in the private and public sectors” by joining forces for “enhanced coordination, collaboration, and resource sharing.
  2. The International Accounting Education Standards Board (IAESB) issued on July 3 an Exposure Draft, 2014-2016 IAESB Strategy and Work Plan. The IAESB mission is to serve the public interest by strengthening the worldwide accountancy profession through the development and enhancement of education. The IAESB issues standards, promotes adoption, develops benchmarks, and advances international debate.
  3. The International Auditing and Assurance Standards Board (IAASB) on June 7 issued its 2012 annual report, Responding to the Needs of an Interconnected World, highlighting standards issued during the year and projects in process.

IIRC - International Integrated Reporting Council (www.theiirc.org)

  1. Memorandum of Understanding (MoU) with the World Intellectual Capital Initiative (WICI) is signed to promote cooperation, ensuring that “intellectual capital” is reflected as a crucial and essential source of an organization’s value within Integrated Reporting <IR>. Intellectual capital is organizational, knowledge-based intangibles, including intellectual property, tacit knowledge, systems, procedures, and intangibles associated with the brand and reputation. Additional MoU’s were signed in July with the Carbon Disclosure Project (CDP) and the Climate Disclosure Standards Board (CDSB), organizations committed to protecting natural resources and the health of the planet by setting standards for measuring and reporting on environmental factors and their impact on financial reports. 

ACCA – Association of Chartered Certified Accountants (http://www.accaglobal.com/)

  1. Investors: directions for corporate reporting – Survey issued in June where almost two-thirds of investors indicated that managers have too much discretion over the financial numbers they report and a sizeable majority say they place more value on information generated from outside a company, such as the news and social media, than on traditional corporate reports.
  2. Understanding investors: the changing landscape – Report issued in June reviews emerging investment developments, such as equity markets becoming increasingly short-term, effects of ultra-low interest rates, increasingly complex regulation, demands for more and enhanced information reporting, decreasing equity holdings, and focus on risk management.

AAA – Americas, Australia & Asia

FASB – Financial Accounting Standards Board (www.fasb.org)

  1. Fair Value Measurement: Deferral of the Effective Date of Certain Disclosures for Nonpublic Employee Benefit Plans in Update No. 2011-04 – Accounting Standards Update No. 2013-09 issued July 8, 2013 defers indefinitely the disclosures of quantitative information about the significant unobservable inputs used in Level 3 fair value measurement, for investments that a nonpublic employee benefit plan holds in their plan sponsors’ own nonpublic entity equity securities. This ASU allows private companies to avoid disclosing proprietary information about their company’s value in a plan’s regulatory filing.
  2. Three PCC proposals issued as ASU’s – July 1, 2013 – see article above.
  3. Insurance Contracts – Exposure Draft issued June 27, 2013 improves consistency in financial reporting by bringing all contracts, that are defined as insurance, under one standard, regardless of what type of institution issues them. A building block approach is applied to life, annuity and long-term health contracts, while a premium allocation approach is applied to property, liability and short-term health contracts. This ED is part of a joint effort with the IASB working toward convergence.
  4. Presentation of Financial Statements: Disclosure of Uncertainties about an Entity’s Going Concern Presumption – Exposure Draft issued June 26, 2013 intended to improve and reduce diversity in disclosures by “clarifying management’s responsibilities about evaluating and disclosing going concern liabilities, while improving the timeliness and quality of footnote disclosures about them,” according to former FASB Chairman Leslie F. Seidman. Auditing standard principles are incorporated, as well as frequency and threshold guidance, and a required assessment period extending 24 months after the financial statement date.
  5. Financial Services—Investment Companies: Amendments to the Scope, Measurement, and Disclosure Requirements - Accounting Standards Update No. 2013-08 issued June 7, 2013 provides a set of characteristics for use in determining whether a company is an investment company, and fair value reporting guidance for those investment companies. The FASB and IASB are both working on this issue.
  6. Technical Corrections and Improvements Related to Glossary Terms – Exposure Draft issued May 6, 2013 provides updates and clarification of items in the Master Glossary of the FASB Accounting Standards Codification.
  7. Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes - Accounting Standards Update No. 2013-10 issued July 17, adds the Overnight Index Swap Rate (OIS) to US Treasury obligation rates (UST) and LIBOR as benchmarks that can be used for hedge accounting.
  8. Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists Purposes - Accounting Standards Update No. 2013-11 issued July 18, provides that such tax benefit be presented as a reduction to a deferred tax asset unless it is not available, or if available, not required to be used , and the entity does not intend to use.

AICPA – American Institute of Certified Public Accountants (www.aicpa.org)

  1. Auditing Standards Board (ASB)  Using the Work of Internal Auditors – Exposure Draft issued April 15, 2013 adapts the international standard ISA 610 for use in the United States, introducing the concept of requiring an evaluation before using the work of internal audit, to assure that the internal audit function follows a systematic and disciplined approach, including quality control.
  2. Financial Reporting Framework for Small-and Medium-Sized Entities (FRF for SMEs) – Issued on June 10, 2013. See article above

PCAOB – Public Company Accounting Oversight Board (www.pcaob.org)

  1. Enforcement Cooperation Agreement with Chinese Regulators – Memorandum of Understanding entered into in May, 2013 with the China Securities Regulatory Commission and the Ministry of Finance. According to the PCAOB, “the MOU establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in both countries’ respective jurisdictions. More specifically, it provides a mechanism for the parties to request and receive from each other assistance in obtaining documents and information in furtherance of their investigative duties.” The parties continue to discuss the further possibility of an agreement to permit inspections in China of PCAOB-registered audit firms that audit Chinese companies trading on U.S. exchanges.
  2. Related Parties – Reproposal of 2012 auditing standard proposals, issued for comment on May 7, 2013, would increase auditor focus on evaluation of a company’s identification of, accounting for, and disclosure of its relationships and transactions with related parties, as well as the identification and evaluation of a company’s significant unusual transactions. These areas has been an ongoing concern for financial reporting fraud.

US Congress – House of Representatives passes bill on July 8, 2013 prohibiting the PCAOB from requiring mandatory rotation of audit firms. The bill now goes to the Senate for consideration.

Europe, Middle East, India & Africa

EFRAG – European Financial Reporting Advisory Group (www.efrag.org)

  1. Two bulletins published in June, 2013 address the IFRS Conceptual Framework proposal, considering whether the business model approach provides useful information in financial reporting, and the role of a Conceptual Framework with regards to the purpose of the Framework for the IASB; the completeness of the Framework for setting requirements; the role of the Framework for preparers; the decision-making process derived from the Framework; and the consequences of a revised Framework for existing IFRS.

FRC – Financial Reporting Council of the UK (www.frc.org.uk)

  1. Code of Practice for the relationship between the external auditor and the supervisor – issued by the Financial Conduct Authority on Jul 12, 2013, sets out principles for the relationship, form and frequency of communication, and responsibilities and scope of sharing information between the auditor and supervisor (regulator).
  2. Accountancy Scheme – published on July 1, 2013 updates the disciplinary arrangements applying to members, so as to be more independent, efficient and effective.
  3. Prohibition of use of internal audit staff as “direct assistance” for external auditors – announced by FRC on June 19, 2013, effective for periods ending on or after June 15 2014.
  4. The Independent Auditor’s Report on Financial Statements – revisions to ISA 700 (UK and Ireland) issued on June 4, 2013, requiring auditors to explain more about their work to investors.

EC – European Commission (http://ec.europa.eu/)

  1. Commission Decisions on Equivalence of American public oversight system and Adequacy of US PCAOB – adopted on June 11 allowing EU audit regulators and the PCAOB to rely on each other’s work.

Additional A&A News

The following links provide a selection of current articles devoted to highlighting other A&A topics currently making news.

  1. The Cost of IFRS Transition in Canada
  2. Australia Securities Commission - Financial Reporting Areas of Focus
  3. Mandatory Auditor Rotation Coming to India?
  4. Effective Internal Audit in the United Kingdom Financial Services Sector
  5. ABA Issues New Auditor’s Letter Handbook
  6. Minimize Risks in micro-entity audits

 

Audit & Accounting Alert is a publication of Integra International intended to highlight emerging issues in the profession. The goal is to give Integra members an awareness of developments impacting the practice of Audit & Accounting, enabling them to stay on the forefront of industry trends.

Editor Gerald E. Herter  •  HMWC CPAs & Business Advisors, 17501 E. 17th Street, Suite 100, Tustin, CA 92780-7924
 •  Tel: 1 714 505-9000  •  Fax: 1 714 505-9200  •  Email: gerry@hmwccpa.com