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Audit & Accounting Alert Newsletter

Issue 7 | August 2014

At-A-Glance

Gerry Herter

The joint release by the FASB and IASB of the comprehensive new revenue accounting standard was a triumph for international cooperation. Unfortunately, the successful decade-long effort is seen by many as more of a grand finale, rather than as the decisive steppingstone toward the ultimate goal of a single worldwide set of financial reporting standards. Our first article explores the differing attitudes that have risen in recent months. There is a more positive feel for the early efforts of the FASB in working with the Private Company Council to address long held concerns of nonpublic entities. An example is the alternative treatment approved for goodwill accounting. Our second article describes how the new goodwill option will ease the burden for SMEs. The reception has been so favorable that the FASB is considering the possibility of offering the option to public companies as well. Finally, our quarterly Worldwide Update covers news from organizations across the globe.

Editor Gerald E. Herter, CPA

In This Issue 

End of the Road for IFRS/US GAAP Convergence?

Landmark revenue standard may be a final tribute to the troubled joint effort

The joint release by the FASB and the IASB of the new standard, Revenue from Contracts with Customers, in May, 2014, was met with great fanfare. Considering that the two standard setting groups required fourteen years to work out an agreeable pronouncement, the result is nothing short of remarkable. Even so, the protracted process foretells an ominous road ahead for the cause of convergence.

Voices on both sides of the Atlantic were quick to sound the death knell to the prospect of the United States ever fully converging with IFRS. Former Securities and Exchange Commission Chair Christopher Cox speaking in June 2014 to a conference in California stated bluntly: “The prospect of full scale IFRS in our lifetimes has ceased to be. It is bereft of life. It rests in peace.” Integra International Global Board member Steve Austin’s firm attended the conference. Steve indicated that Cox’s presentation as the keynote speaker was “stunning and surprising to the audience”… “We were riveted to our chairs.”

Subsequently, Ian Mackintosh, vice chairman of the IASB, at an IFRS Foundation Conference in London, accused the FASB of “turning back the clock.” He characterized the current FASB approach as “remarkably similar” to the pre-IASB effort that after 25 years “failed miserably.” That effort was intended to reduce differences between national accounting standards, but did not succeed. Each of the nine participating countries retained their unique preferred standards in areas of divergence, rather than work toward a common goal.

The IASB was formed in 2001 to replace the failed effort with a determined path to a single universally shaped and accepted set of accounting standards. At present, with 105 countries already requiring most public entities to use IFRS, the cause has accomplished much.

Macintosh indicated that country differences in IFRS application are few and generally temporary. Those results appear to contradict Jim Kroeker, Vice Chairman of the FASB, who Macintosh quotes as saying “…we recognize that one size may not fit all. By that, I mean that we understand that differences in standards will persist because of the legal, regulatory and cultural differences among different jurisdictions.” Also, the IFRS Foundation and IOSCO, the international network of securities regulators, are working jointly to make IFRS application more consistent.

The final three formal areas of the IASB/FASB convergence effort reflect the futile nature of the process. After years of deliberating accounting for leases, financial instruments, and insurance, the Boards have practically resigned themselves to the prospect that each will issue their own standard, which will show agreement in some areas, but may differ in others.

Similarly, FASB member Thomas Linsmeier, in a June 2014 speech to the rate-regulated utilities industry, stated that “While we have pledged to work with the IASB to make our standards as comparable as possible, our primary responsibility – and obligation – is first to improve and protect the quality of GAAP. That may well mean that we opt to diverge with the IASB rather that adopt their model on rate-regulated accounting.”

Linsmeier points out an issue in the utilities industry that strikes to the very core of the overall difficulty with bringing IFRS and US GAAP into synch. US GAAP has a well worked out set of industry-specific rules for utilities to follow, while IFRS does not. IFRS is principles based, while US GAAP is rules based. At the height of the US enthusiasm for moving to IFRS, the country was reeling from the Enron and related financial disasters, which were enabled by unscrupulous exploitation of the “bright lines” of US GAAP rules. That caused suspicion which clouded all of US GAAP, evoking calls to move to a more principles based set of standards, where judgment would replace form with substance.

After these many years of efforts at convergence, the furor from the financial crises has calmed somewhat. Also, there is a realization, at least in some circles, that there is value in the vast depth of rules developed over decades in forming US GAAP. Principles based standards are not immune from abuse or bad judgment.

A possible solution would be to have standards based on an overall set of principles where judgment prevails as the ultimate test, but which are underpinned by detailed rules that minimize confusion or deceptive practices. The recent ‘True and Fair’ Statement published by the Financial Reporting Council of the United Kingdom touches on this concept from a slightly different direction. The Statement acknowledges that in a “vast majority of cases” the standards as written will provide a “true and fair” view. But there could be particular situations where the application of a standard causes the accounting to be misleading. In such cases, the “standard should be overridden” to assure that the financial statements are true and fair.

For further information, see IASB's Macintosh speech- Turning back the Clock? and FASB’s Linsmeier speech


Simplified Goodwill Reporting for US SMEs

Relief provided from the complex impairment rules

Before creation of the Private Company Council (PCC), the FASB tried, unsuccessfully, to address private company concerns through its normal standard setting process. The FASB standard for Goodwill had been especially onerous and costly. Prior to 2011, all entities were required to first determine, quantitatively, the fair value of goodwill annually. Then, if goodwill was less than carrying value, a second step would be required to determine the amount of impairment. Valuations usually necessitated the use of an outside appraiser, which was burdensome for smaller companies. Furthermore, the users of their financial statements, typically lenders, often eliminated goodwill from their analysis, anyway.

Accounting Standard Update 2011-08 introduced the option of first qualitatively assessing whether it was more likely than not that the fair value of goodwill was less than the carrying value. If not, then there was no need to perform the costly and often useless valuation. An express purpose of this amendment was to address private company concerns. However, the qualitative assessment still had to be done annually, and the calculation of impairment, if needed, was still complicated.

The establishment of the PCC eliminated the difficult task of attempting to forge standards that would apply to public and private companies alike. In some regards, the tables have been turned. The private company alternative devised for goodwill has been so well received that the FASB is deliberating whether it should be extended to public companies.

The private company alternative, Accounting Standards Update (ASU) 2014-02, Accounting for Goodwill, allows a private company to elect to amortize goodwill over ten years, or a lesser term if appropriate. Under this election, impairment testing is required only if a triggering event occurs, and then can be performed at the company or reporting unit level. Also, a simplified method is allowed for computing the difference between fair value and the carrying amount. Sample triggering events include:

1. Macroeconomic conditions like a deterioration of the general economy
2. Industry conditions like the competitive environment
3. Cost factors affecting earnings
4. Decline in revenue, earnings or cash flow
5. Changes in management or key personnel.

Disclosures required include total goodwill, amortization period, current and accumulated amortization expense and accumulated impairment loss. If an impairment loss has occurred, related details, amounts and determination methods are required. A tabular reconciliation of goodwill changes during the year is not required.

While ASU 2014-02 is expected to significantly reduce costs in this area for adopters, companies should evaluate whether other factors need to be considered before moving forward. If a company contemplates going public at some time in the future, any current cost savings from adoption may be more than offset by the added costs required to retroactively restate financials later to meet public GAAP standards. Also, debt covenants should be reviewed for conditions that may be affected.

ASU 2014-02 is effective for 2015, but may be adopted earlier.

Meanwhile, the FASB is considering whether to extend applicability of ASU 2014-02 to public companies and non-profits. Though no decision has been made as of yet, four alternatives are being addressed:

1. Terms consistent with ASU 2014-02
2. Amortization of goodwill with impairment testing over the useful life up to a maximum number of years
3. Direct writeoff of goodwill at acquisition date
4. Nonamortization approach using a simplified impairment test.

Separately, the FASB is deliberating whether to simplify, for private companies, the accounting for intangibles when initially acquired in a business combination. A possibility would generally allow intangibles to be lumped together into one goodwill amount, rather than requiring a potentially costly analysis to separate the intangibles into components. This project is at the discussion and research stage.

Internationally, IFRS for SMEs is similar to ASU 2014-02, requiring goodwill to be amortized over its useful life, with the provision that if an entity is unable to make a reliable estimate of the useful life, then ten years is used. For full IFRS, IAS 3 has a generally similar approach to US GAAP, using nonamortizable fair value subject to impairment testing. IAS 3 is also currently under reconsideration. Interestingly, the UK, through its new FRS 102 standard will be going from a maximum 20 year goodwill amortization period to a 5 year maximum, when a specific, reliable useful life cannot be estimated.

For further information, see FASB Accounting Standard Update 2014-02 - Goodwill


Worldwide Update

Roundup of recent and upcoming actions and activities by audit and accounting organizations

Periodically, we summarize significant items impacting the accounting world.

 International

IASBInternational Accounting Standards Board (www.ifrs.org)

  1. Revenue Recognition: IFRS 15 - Revenue from Contracts with Customers - The final converged standard was jointly issued with the FASB on May 28, 2014, designed to improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. A five step process includes identifying the customer and the separate performance obligations, determining and allocating the transaction price, and recognizing revenue upon satisfaction of performance obligations. Also, on June 3, 2014, the two boards formed the Joint Transition Resource Group for Revenue Recognition (TRG), which will assist with implementation issues that arise. Effective generally for years beginning in 2017. Early adoption is permitted. See the June 2014 issue of the Audit & Accounting Alert for a discussion of this topic
  2.  Charter: The IASB and other accounting standard-setters - Working together to develop and maintain global financial reporting standards – updated in May 2014 to reinforce cooperation between the IASB and the International Forum of Accounting Standard Setters (IFASS), consisting of national and regional accounting standard setters.
  3.  IAS 16 and IAS 38 amendments – published in May 2014, establishes that the basis of depreciation and amortisation should be the expected pattern of consumption of the future economic benefits of an asset, and generally not revenue-based methods.
  4.  Exposure Draft - Investment Entities–Applying the Consolidation Exception (Proposed amendments to IFRS 10 and IAS 28). – published in June 2014 to clarify the application of the requirement for investment entities to measure subsidiaries at fair value instead of consolidating them. Comment period ends September 15, 2014.
  5.  IFRS 2013 Annual Report: “Charting progress towards global accounting standards” – published in May 2014, highlights required use of IFRS by more than 100 jurisdictions worldwide.

IFACInternational Federation of Accountants (www.ifac.org)

  1. 2013 IFAC Annual Review: “Delivering on our Global Advantage” – published in June 2014, highlights the impact of a new business model that supports standards development, quality and capacity, the global accountancy profession, and global representation and advocacy.
  2. International Ethics Standard Board for Accountants (IESBA) Exposure Draft - Proposed Changes to Certain Provisions of the Code Addressing Non-Assurance Services for Audit Clients – published in May 2014, proposes changes aimed to enhance the independence provisions in the Code of Ethics for Professional Accountants by 1) providing additional guidance and clarification regarding what constitutes management responsibility, including enhanced guidance regarding how the auditor can gain better satisfaction that client management will make all judgments and decisions that are the responsibility of management, when the auditor provides non-assurance services to an audit client; 2) providing better guidance and clarification on the concept of “routine or mechanical” services relating to the preparation of accounting records and financial statements for non-public interest entity audit clients; and 3) removing the provision that permits an audit firm to provide certain bookkeeping and taxation services to public interest entity audit clients in emergency situations. Comment period ends August 18, 2014.
  3. International Auditing and Assurance Standards Board (IAASB) Exposure Draft -Proposed Changes to the International Standards on Auditing (ISAs)–Addressing Disclosures in the Audit of Financial Statements – published in May 2014, proposes to clarify expectations of auditors when auditing financial statement disclosures. The proposals include new guidance on considerations relevant to disclosures—from when the auditor plans the audit and assesses the risks of material misstatement, to when the auditor evaluates misstatements and forms an opinion on the financial statements.

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

  1.  Corporate Reporting Dialogue (CRD) was launched in June, 2014. The CRD is an initiative to promote greater coherence, consistency and comparability between corporate reporting frameworks, standards and related requirements relevant to <IR>, leading to improved efficiency and effectiveness. The CRD brings together nine organizations that have significant influence on the corporate reporting landscape, including the IASB, FASB, Sustainability Accounting Standards Board and Climate Disclosure Standards Board.
  2. Unlocking Investment in Infrastructure-Is current accounting and reporting a barrier? – report issued in June 2014, commissioned by the B20, the business forum that advises G20 governments, and prepared by the six largest international accounting networks. The report identifies "Integrated reporting principles as a means by which improved corporate reporting could be achieved" and says that the <IR> Framework "has been designed to achieve a more holistic view of how value is created over time by providing more insight into business strategies, performance and prospects in corporate reports."

ACCAAssociation of Chartered Certified Accountants (www.accaglobal.com/)

  1. Business and investors: providers and users of natural capital disclosure – report issued in June 2014 by ACCA, KPMG and Flora & Fauna International calling for “robust reporting on the management and use of key commodities including commitments to reduce impacts on natural capital.” Key commodity usage covered includes beef, cotton, palm oil, soya and sugar. The report links an organization’s strategy for managing the use of these commodities with the impact on the natural world, and points out the corporate risk associated with unsustainable use.
  2.  Sustainability Matters – ACCA Policy Paper issued in May 2014, setting out ACCA thinking and the role accountants have in making organizations more accountable on six sustainability-related issues: sustainability reporting; integrated reporting; the assurance of non-financial reporting and disclosure; climate change; natural capital and the green economy.

CIMAChartered Institute of Management Accountants (www.cimaglobal.com)

  1.  Accounting for Natural Capital: the elephant in the boardroom – report issued in July 2014 by CIMA, EY and IFAC “examines the business issues associated with natural capital erosion, arguing that action is needed to account for the growing risks this poses to business sustainability.” “Accountants and finance professionals… have a vital role to play in helping companies navigate the challenges and opportunities which natural capital depletion will bring. Accountants have the skills, experience and oversight to draw out the connections between natural capital, commercial opportunity and business risk, and, ultimately, financial performance.”
  2.  Building clinical engagement with costing – report issued in July 2014, based on interviews with England’s National Health System costing and clinical personnel, assessing the status and the need that “the clinical and financial professions must work together to drive efficiency and deliver better-quality patient outcomes. In order to achieve this goal, greater clinical ownership of costing information is essential.”

AAA – Americas, Australia & Asia

FASBFinancial Accounting Standards Board (www.fasb.org)

  1. Revenue Recognition: ASU 2014-09 - Revenue from Contracts with Customers - The final converged standard was jointly issued with the IASB on May 28, 2014, designed to improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. A five step process includes identifying the customer and the separate performance obligations, determining and allocating the transaction price, and recognizing revenue upon satisfaction of performance obligations. Also, on June 3, 2014, the two boards formed the Joint Transition Resource Group for Revenue Recognition (TRG), which will assist with implementation issues that arise. Effective generally for years beginning in 2017 for public companies and 2018 for private companies. Early adoption is permitted. See the June 2014 issue of the Audit & Accounting Alert for a discussion of this topic
  2.  Development Stage Entities: ASU 2014-10 - Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance – issued June 10, 2014, removes all incremental financial reporting requirements from GAAP for development stage entities, and adds an example of how information about the risks and uncertainties related to current activities can be disclosed. Also, an exception for consideration as a variable interest entity is removed. Effective generally for years beginning in 2015.
  3.  Transfers and Servicing: ASU 2014-11 - Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures – issued on June 12, 2014, requires the transactions to be accounted for as secured borrowings, along with disclosures that reflect the transferor’s obligations and risks. Effective generally for years beginning in 2015.
  4.  Compensation—Stock Compensation: ASU 2014-12 - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period - issued on June 19, 2014, to fill a lack in specific guidance, providing that a performance target achievable after the requisite service period, that affects vesting, be treated as a performance condition. Effective generally for years beginning in 2015, with early adoption permitted.
  5.  Exposure Draft - Business Combinations: Pushdown Accounting - issued April 28, 2014, would allow an acquired entity to apply pushdown accounting (a new accounting and reporting basis) in its separate financials upon occurrence of an event in which the acquirer obtains control of the acquired entity. The comment period ends July 31, 2014.
  6.  Exposure Draft – Inventory: Simplifying the Measurement of Inventory - issued July 15, 2014, proposes that inventory be measured at the lower of cost or net realizable value, as opposed to current GAAP which requires that inventory be measured at the lower of cost or market, where market could be net realizable value, replacement cost, or net realizable value less a normal profit margin when measuring inventory. The comment period ends September 30, 2014.
  7.  Exposure Draft - Income Statement–Extraordinary and Unusual Items: Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items-issued July 15, 2014, proposes to lower cost and complexity by eliminating the concept of extraordinary items. The comment period ends September 30, 2014.
  8.  Financial Accounting Foundation 2013 Annual Report – issued on May 8, 2013, with the theme, The Road Ahead, highlights accomplishments, and addresses future goals to work toward more comparable global accounting standards, to provide accounting alternatives for private companies while preserving the strength and consistency of GAAP, and to make the financial position of governments more transparent for taxpayers, bond buyers and other users of financial statements.

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

  1.  Auditing Standards Board (ASB) –two more interpretations to Statement on Auditing Standards No. 122: Clarification and Recodification, issued in June 2014, relating to audit evidence, and special considerations for single financial statements, and specific elements of a financial statement. These interpretations are in response to the new GASB standards that impact governmental multiple-employer pension plans and their participants.
  2.  Enhancing Audit Quality Initiative – announced in May 2014, represents a comprehensive approach by the AICPA to improve monitoring and evaluation of audit and peer review practices, along with the development of new tools and resources in support of members. Discussion and concept papers detailing the initiative are expected in coming months.
  3.  Peer Review Board – Exposure Draft – Engagement Reviews – Pass with Deficiencies vs. Fail, issued May 20, 2014, proposes a change whereby when multiple engagements contain the same deficiency, but no other deficiencies, the peer review would result in a fail report instead of the current pass with deficiencies report. Comments were due by July 5, 2014.

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

  1.  Auditing Standard No. 18, Related Parties, and Amendments on Significant Unusual Transactions and a Company’s Financial Relationships and Transactions with its Executive Officers - issued on June 10, 2014. The standard requires specific audit procedures 1) for the auditor's evaluation of a company's identification of, accounting for, and disclosure of transactions and relationships between a company and its related parties, 2) to improve the auditor's identification and evaluation of significant unusual transactions, and to enhance the auditor's understanding of their business purposes, and 3) to obtain, during the risk assessment process, an understanding of a company's financial relationships and transactions with its executive officers. Effective generally for years beginning in 2015.
  2.  Staff Guidance for Auditors of SEC-Registered Brokers and Dealers, issued on June 26, 2014, to assist with the transition from GAAS to PCAOB standards. According to PCAOB Chairman James R. Doty, "This guidance is tailored to help auditors of smaller broker-dealers develop a cost-effective, scaled approach to their audits." Effective for fiscal years ending on or after June 1, 2014.
  3.  Staff Guidance on Economic Analysis in PCAOB Standard Setting, issued on May 15, 2014, sets forth the elements of economic analysis to be used for setting auditing and related professional practice standards: 1) describing the need for a rule, 2) developing a baseline for measuring the effects of a rule, 3) considering reasonable alternatives to the rule, 4) analyzing the economic impacts of the rule (and alternatives to the rule), including the benefits and costs.

EMEIA – Europe, Middle East, India & Africa

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

  1. Classification of Claims – Discussion Paper published on July 9, 2014, addresses the distinction between equity and liabilities on the balance sheet, including how many elements the claims on an entity should be classified into, the objective of classification requirements and how dilution can be depicted. Comments requested by October 31, 2014.

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

  1. Audit Quality Inspection Reports were issued in May, 2014, for the Big Four, as well as the FRC’s annual report. The annual report noted that, generally, there had been improvement over the prior year, with 60% of audits requiring little or no corrections, including 86% of FTSE 100 companies. However, consistency is lacking across all audit firms, since 15% of audits inspected required significant improvements. Audits of banks were specifically cited as falling below standards, especially in the area of testing of the provision for possible loan losses. Also, continued problems were noted for “letterbox” companies, those whose primary operations are outside the country.
  2. ‘True and Fair’ Statement – published June 4, 2014, to emphasize the fundamental requirement of financial reporting, in light of the many changes taking place in accounting standards. The FRC stated that “In the vast majority of cases a true and fair view will be achieved by compliance with accounting standards and by additional disclosure to fully explain an issue. However, where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the standard should be overridden.
  3.  Guidance on the Strategic Report – published on June 9, 2014, “gives an overview of the various components of an annual report and considers where information should best be placed. It aims to help companies think innovatively about communication. The Guidance also encourages companies to focus on ensuring disclosures are material, as a key step towards concise reporting.” The guidance is the first of several initiatives to assist with new rules regarding the content of annual reports.

Additional A&A News 

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

  1. China's audit office plays powerful but silent role in anticorruption
  2. Just 6% of companies switched auditors ahead of incoming rules
  3. Michel Prada defends IFRS Foundation governance
  4. FASB Chairman's Update
  5. The Sterner, Stricter SEC
  6. House Hearing Considers Cash Accounting for Small Biz

 

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