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Audit & Accounting Alert Newsletter

Issue 2 | February 2014

At-A-Glance

Gerry Herter

In recent months, the United States and Europe have each found more cooperation on accounting and audit matters within their own jurisdictions, than they have internationally, where they are often going in different directions. Our first article describes the formal first fruits that have matured since America’s Financial Accounting Standards Board established the Private Company Council to address longstanding frustrations of the private sector. A new framework will pave the way for distinguishing financial reporting differences between public and private companies. Meanwhile, the European Union has given the green light on major audit reforms for its members to follow, as described in our second article. Nevertheless, as can be gleaned from our quarterly worldwide update, international convergence on financial reporting and auditing matters is still a distant dream. The International Federation of Accountants rightly expresses concerns about the differences when, for example, mandatory auditor rotation is moving forward in the European Union at the same time that the United States has rejected it.   

Editor Gerald E. Herter, CPA

In This Issue 

FASB and Private Company Council Attain Milestone

Private Company Decision-Making Framework and Definition of a Public Business Entity Published

For the past two years, we have been watching with cautious skepticism as the Financial Accounting Standards Board tried yet another tactic to quell the concerns of the private company financial reporting community. The concerns arose out of the ever growing cost and complexity of applying accounting pronouncements that were of questionable relevance to private companies. The suspicion was warranted since prior efforts by the FASB fell short in the attempt to bridge the gap between the needs of the public and private sectors. However, with the December 23 joint issuance by the FASB and PCC of the Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies, a major step has been taken in demonstrating that the Board has gotten the message. 

When the PCC was formed as a quasi-independent affiliate of the FASB, the need for a mutually agreeable set of ground rules was recognized. The Framework responds to that need. Simultaneously, the FASB issued Accounting Standards Update No. 2013- 12, Definition of a Public Business Entity: An Addition to the Master Glossary. This ASU standardizes the definition, in order to clarify the difference between private and public entities for purposes of the new Framework, as well as for other objectives. Generally, a public entity is one that publicly files financial statements, either with the SEC or as specified by law, contract or regulation, or whose securities are on an exchange or over-the counter market. Employee benefit plans and non-profits are excluded from the definition.

The Framework describes how the financial reporting needs of public and private companies differ. The five major differences are listed as:   

  1. The number of primary financial statement users and their access to management  - Public companies have a much larger number of users, but those users typically have little access to management compared to private company users.
  2.  The investment strategies of primary users - While both are interested in cash flow, public company users have other means of realizing their investments, such as public markets.
  3.  The ownership and capital structures - Private companies have a strong tax focus, giving rise to pass-through and related entities, while public companies are more typically C corporations.
  4.  Accounting resources - Private companies often have more limited and less sophisticated accounting resources, and therefore are less able to take part in standard setting, and have less time and skill to deal with new standards
  5.  The manner in which preparers learn about new financial reporting guidance - Public companies have quarterly reporting requirements, and therefore tend to have continuous education through the year, while private companies obtain education less often, thereby needing more time and deferred effective dates to learn from public company efforts. 

The Framework also elaborates on the five areas where differing financial accounting and reporting approaches may be appropriate for public and private companies:     

  1. Recognition and measurement - Is current GAAP relevant to private companies, and, if so, is it cost effective? If relevant but not cost effective, what alternatives might be considered? A list of questions is offered to aid in analyzing relevance and cost. The impact of industry-specific guidance is also discussed.
  2.  Disclosures - For areas of focus to typical users, consider relevance and cost. A list is provided of areas where disclosure alternatives should not be considered, such as cash flow, borrowings, contingencies and restrictions, write-offs, related parties, and accounting methods and changes.
  3.  Display - Presentation of financial statements in most cases should be the same for private and public companies, but provision is made for considering exceptions or alternatives, such as the one that already applies to earnings per share.
  4.  Effective dates - Generally effective dates for private companies should be a year later than the first annual period for which public companies are required to comply, unless there is a compelling reason for a shorter or longer period.
  5.  Transition method - If retrospective application is required for public companies, consider whether private companies can use prospective application, or an alternative if cash, cash flow, EBITDA, or other important areas are concerned, or whether there is adequate access to management, or systems modification requirements or other costs are significant. 

The FASB subsequently issued, on January 16 of 2014, the first two Accounting Standards Updates that arose out of the new FASB-PCC relationship. Accounting Standards Update No. 2014-02, Intangibles-Goodwill and Other Topics, allows private companies to amortize goodwill over ten years or less, and provides for a simplified impairment model. Accounting Standards Update No. 2014-03, Derivatives and Hedging: Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting allows private companies to use a simplified hedge accounting approach for interest rate swaps that converts variable-rate interest payments to fixed-rate payments. 

For further information, see FASB

 

Audit Reforms Coming to European Union

Similar measures blocked in United States

After several years of negotiations, representatives of the member states of the European Parliament in December endorsed an agreement calling for significant reforms of the audit market in the European Union. After final drafting and formalities, the new rules are expected to take effect in the coming months. The press release states that “The reform is aimed at increasing transparency and confidence in the audit market by enhancing the credibility of the audited financial statements of public-interest entities,” as well as “facilitating a wider choice of audit providers,” thereby enhancing competition. Public-interest entities include publicly listed companies, banks, and insurance companies.

The primary provisions of the agreement are:

  1. Mandatory rotation of auditors - The audit firm will need to be changed at least every 10 years unless the audit is put out for public tender at that time, in which case the audit firm’s tenure can be up to 20 years. Additionally, if the audit is performed by multiple firms, called a “joint audit,” the maximum time before mandatory rotation is 24 years.
  2. Prohibition and restriction on the provision of non-audit services - The audit firm will not be allowed to provide certain tax, consultancy and advisory services, since these could compromise independence or result in conflicts of interest. Some of these services may be allowed by member states if not material and not directly related to the audit. For non-audit services provided that are not prohibited, fees cannot exceed 70% of the annual audit fee.
  3. Cooperation of audit oversight bodies - The Committee of European Auditing Oversight Bodies will be responsible for administering the law, with assistance from the European Securities and Market Authority for facilitating international cooperation. 

These audit reforms are in response to the financial crisis of 2008. When first proposed, as covered in the February 2012 Audit & Accounting Alert, mandatory auditor rotation was set at 6 years, extendable to 9 years for a joint audit. At the time, Steve Haddrill, CEO of Britain’s Financial Reporting Council (FRC), called the proposal “extremely damaging and threatening to the quality of audit.” Haddrill is more conciliatory these days. In 2012, his FRC had devised a 10 year audit retendering plan. He is pleased that a similar provision is now in the EU agreement, and he accepts the subsequent 20 year mandatory auditor rotation as “a good compromise.”

The United States may be headed in the opposite direction on mandatory auditor rotation. The Public Company Accounting Oversight Board (PCAOB) had considered the soundness of mandatory auditor rotation in a 2011 concept release and in a series of roundtables in 2012. However, as PCAOB Board member, Jay Hanson, mentioned at the AICPA National Audit Committee Forum in September, “we heard that mandatory rotation is not a good idea. It is hard to implement and potentially very costly. Moreover, it is entirely unclear whether frequent auditor rotation would improve or harm audit quality. In my view, it is unlikely that we will move forward with a proposal for mandatory auditor rotation.”

The PCAOB’s position is a practical one, since the US Congress House of Representatives passed a bill in July prohibiting the PCAOB from doing any such thing as mandatory auditor rotation. For better or worse, the Big Four accounting firms and others wielded their significant clout in the process.

Nevertheless, there are potential problems with the EU agreement that US companies may have to address. The impact on audits of US subsidiaries of European companies and European subsidiaries of US companies remains to be seen.

For further information, see Audit Reform EU Press Release


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 Study on IFRS adoption – See January 2014 Audit & Accounting Alert for article describing global expansion of IFRS to well over 100 countries, but not including the United States.
  2.  IFRS for SMEs Comprehensive Review – Deadline for Comments on Exposure Draft is March 3, 2014. See article in November 2013 Audit & Accounting Alert.
  3.  Revenue Recognition and Lease Proposal Status – The proposed joint IASB-FASB standard, Revenue from Contracts with Customers, is in final drafting with planned first quarter 2014 release. The proposed joint IASB-FASB standard, Leases, is being redeliberated in light of substantial resistance to the proposal, which would require most leases to be reported on the financial statements as assets with corresponding liabilities, and then generally have equipment and vehicle lease costs divided each period between liability interest expense and asset amortization, while real estate lease costs are simply amortized on a straight-line basis. Consequently, the timing for finalization of the proposal is currently unclear.

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

  1. IPSASB Publishes Exposure Draft 54—Recommended Practice Guideline on Reporting Service Performance Information – The International Public Sector Accounting Standards Board develops standards for governmental entities. Providing service is a primary function for these entities.
  2.  IFAC Calls for Renewed Focus on Global Regulatory Convergence to Advance Sustainable Economic Recovery – As the global body representing the profession, IFAC “reiterated its call on global policymakers to refocus on regulatory convergence, and said their failure to do so is stifling business confidence, economic stability, and ambitions for a sustainable recovery.” IFAC decried the continued instances of countries going their own way on specific issues of financial reporting and auditing.
  3.  The IAASB’s Proposed Strategy for 2015–2019 and Proposed Work Program for 2015–2016 – The International Auditing and Assurance Standards Board proposal, titled Fulfilling our Public Interest Mandate in an Evolving World, states the following objectives: 1) develop and maintain high-quality ISAs that are accepted as the basis for high-quality financial statement audits; 2) ensure the IAASB’s suite of standards continues to be relevant in a changing world by responding to stakeholder needs; and 3) collaborate and cooperate with contributors to the financial reporting supply chain to foster audit quality and stay informed. Comments are requested by April 4, 2014.
  4.  IAESB Proposes Revised Standard, IES 8, on Professional Competence of the Audit Engagement Partner – Proposal calls for “learning outcomes that engagement partners need to demonstrate in areas relating to technical competence, professional skills, and professional values, ethics, and attitudes. As the career of an engagement partner progresses, practical experience also becomes increasingly important in maintaining and further developing the necessary depth and breadth of professional competence.” Comments are due by April 17, 2014. 

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

  1. Integrated Reporting Framework Released – on December 9, 2013. See article in January, 2014 Audit & Accounting Alert. As the Framework states: “The primary purpose of an integrated report is to explain to providers of financial capital how an organization creates value over time.” the Framework sets out guiding principles and content elements for development of the report.
  2.  Memorandum of Understanding – between IIRC and the Sustainability Accounting Standards board signed December 17, agreeing to cooperate, with the IIRC developing a framework for integrated reporting and the SASB developing industry-specific sustainability standards that will be mutually compatible.

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

  1. Big data: its power and perils – Report issued in conjunction with the Institute of Management Accountants in November to assess the opportunities and challenges for the accounting profession over the next 5 to 10 years in working with Big data. Though the transition will not be easy, the report states that “Big data can offer accountants and finance professionals the possibility of reinvention, the chance to take a more strategic, ‘future-facing’ role in organizations.”

AAA – Americas, Australia & Asia

FASBFinancial Accounting Standards Board (www.fasb.org)

  1. FASB and PCC Issue Private Company Framework; FASB Issues Definition of Public Business Entity – See first article above.
  2.  FASB issues Accounting Standards Updates on Goodwill and Interest Rate Swaps See first article above.
  3.  Revenue Recognition and Lease Proposal Status – See IASB above.

AICPAAmerican Institute of Certified Public Accountants (www.aicpa.org)

  1. Accounting and Review Services Committee (ARSC) – issued proposal for reporting on compilation and review engagements that would redraft standards to use the same structure and conventions that have been adopted by the Auditing Standards Board out of the clarity project.

PCAOBPublic Company Accounting Oversight Board (www.pcaob.org)

  1. Report on Implementation of Auditing Standard on Engagement Quality Review – issued in December describing issues noted in inspections concerning Auditing Standard No. 7. See PCAOB article in January, 2014 Audit & Accounting Alert
  2.  PCAOB Reproposes Amendments to Improve Transparency by Requiring Disclosure of the Engagement Partner and Certain Participants in the Audit - See PCAOB article in January, 2014 Audit & Accounting Alert
  3.  Dodd-Frank Conforming Amendments for Broker-Dealer Audits and Certain Other Updates and Clarifications approved– The amendments insert references to audits and auditors of broker-dealers in relevant PCAOB rules, and call for broker-dealer audit client information on the PCAOB's registration, withdrawal, and reporting forms. The amendments also require that registered firms that audit broker-dealers comply with certain of the PCAOB's professional practice standards; update a number of PCAOB rules and forms based on the PCAOB's experience administering and enforcing PCAOB rules; and make certain updates to the Board's ethics and independence requirements.

SEC

  1. Staff Report on Review of Disclosure Requirements for Public companies – issued December 20 as required by the 2012 JOBS Act, recommending that SEC disclosure rules be evaluated to determine how to make them more effective and efficient for companies and investors. The SEC will coordinate with the FASB as part of the process.

Europe, Middle East, India & Africa

EFRAGEuropean Financial Reporting Advisory Group (www.efrag.org)

  1. Research Paper: The Role of the Business Model in Financial Statements – issued December 18 in conjunction with the FRC, promoting greater use of the business model concept in the Conceptual Framework. “The business model provides insight into how value is captured and net cash flows generated through income in the normal course of a business.” The impact of the business model should be considered when setting standards.

FRCFinancial Reporting Council of the UK (www.frc.org.uk)

  1. Review of Conceptual Framework – response issued in January commends the IASB in many areas, while encouraging a return to the use of the terms prudence, stewardship and reliability as necessary concepts, as well as further discussion of the measurement of assets and liabilities.
  2.  Proposed Update to Reduced Disclosure Framework (FRS 101) – issued December 17, proposing simplification of disclosures in reporting impairment of assets and the international accounting practice for investment entities.
  3.  Audit Quality Thematic Review - Materiality – report issued December 16 requiring “greater focus by auditors on the needs and expectations of users in setting and revising overall materiality levels and for audit committees to seek to better understand the related judgments made by auditors.”
  4.  FRED 52: Draft Amendments to the Financial Reporting Standard for Smaller Entities - Micro-entities – issued December 10, “allow micro-entities taking advantage of the new legal provisions, which permit reduced disclosure, to continue to apply the accounting principles of the FRSSE.”

EPEuropean Parliament (http://www.europarl.europa.eu/)

  1. Agreement on the reform of the audit market– See article above.

Additional A&A News 

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

  1. UK Top 50 Audit analysis: Squeezed until the pip squeaks
  2. PCAOB Works to Reduce Remediation Backlog
  3. Task Force Urges Reforms in State Financial Reporting
  4. SEC charges Diamond Foods over nutty accounting
  5. Private-company GAAP alternatives could unlock savings
  6. ICAEW joins green coalition

 

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