At-A-Glance
With the onset of 2013, public
accountants once again prepare for their
busiest time of the year. In our first
article, we welcome the New Year with a
few reminders. The Auditing Standards
Board’s recently completed Clarified
Auditing Standards are now in effect, to
smooth the way and hopefully not to trip
up the unwary. Also, the PCAOB
re-emphasizes the importance of
professional skepticism in upcoming
audits, while British accounting bodies
look further ahead, exploring how the
auditor of the future will need to adapt
to remain relevant in a rapidly changing
world.
Next, we look behind the scenes of
the huge write-down taken by HP on the
Autonomy acquisition, and consider the
alleged accounting improprieties, the
roles played by each of the Big Four
accounting firms, and whether IFRS may
have played a part.
Finally, we look at “The Future of
IFRS,” a new report by the British
Chartered Accountants Institute that
highlights the accomplishments and
shortfalls of IFRS in its first decade,
while making a strong case for IFRS’
ultimate success, providing the right
steps are taken.
Editor Gerald E. Herter, CPA
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In This Issue
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Auditing in the New Year and Beyond
The Audit Season is here with Reminders and
Concerns
As the New Year begins, auditors gear up for
the hectic months ahead, fine-tuning policies
and procedures, as they implement the latest
standards and directives. Meanwhile, the
profession seeks direction in the pursuit of
future relevance, amidst troubling fallout from
an increasingly complex and demanding world.
On the immediate horizon, the Clarified
Auditing Standards (CAS), produced by the
AICPA’s Auditing Standards Board, are now in
effect for December year end audits. The
Statements on Auditing Standards (SAS) have each
been redrafted in a standardized format with the
goal of making them easier to read, understand,
and apply. However, they were also converged
with the International Standards on Auditing
(ISA), so there are more than cosmetic changes
to consider. Among other things, the auditor’s
report has been reworded, procedures to detect
noncompliance with laws and regulations are
required, and opening balances on initial audits
require more than just reviewing the
predecessor’s work papers. For assistance in
dealing with the new clarified standards, the
AICPA has a number of resources available for
download from their website.
In the public arena, The PCAOB is speaking
out in an effort to stem the increase of
deficiencies that continue to be found from
inspections of audit firms. In a recent speech
at Baruch College, PCAOB Chairman, Jim Doty,
noted that in an environment where accounting
firms’ “audit fees have stagnated” and the audit
has “become a commodity to be contained with
other compliance costs,” consulting fees have
been growing “rapidly.” He stresses that “we are
in a high risk period that merits more attention
to the audit, not less.” Interestingly enough,
just four days later, AICPA chairman Richard
Caturano commented at an AICPA conference that
“Just a few years ago, auditing was being called
a commodity. You don’t hear that any more.
Auditors are being scrutinized more closely than
ever, and are taking on more responsibility.”
There are clearly different perspectives when
seen through the eyes of the entrepreneurial
audit firm wanting to spur growth, as compared
to the regulator concerned that ongoing
deficiencies result from the distractions of
that aggressive growth mentality.
In a more formal way, the PCAOB in December
issued Staff Audit Practice Alert No. 10:
Maintaining and Applying Professional Skepticism
in Audits. The issuance of a Staff Audit
Practice Alert by the PCAOB is a major
occurrence to which all firms, PCAOB registered
or not, should give serious thought. This one is
a practical sixteen page guide that is useful
for public and private entity auditors alike,
with specific examples of shortcomings observed
in inspections. The alert reiterates that “PCAOB
standards define professional skepticism as an
attitude that includes a questioning mind and a
critical assessment of audit evidence.”
Fundamentals covered include:
- A discussion of
due professional care that emphasizes that
professional skepticism a) is required
throughout the audit, b) is particularly
important with regard to significant management
judgments or transactions outside the normal
course of business, and c) is needed in the
consideration of fraud;
- The alert warns
against impediments that can cause undue
pressure, such as unconscious human biases,
filing deadlines, fee level concerns, desires to
cross-sell other services, long-term client
relationships, scheduling and workload demands;
- The elements and importance of the auditor’s
system of quality control are itemized;
- Supervision by the engagement partner and senior
team members set the tone and provide direction;
and
- Application throughout the audit by each
team member with regards to risk assessment,
control tests and substantive procedures, and
evaluation of audit results.
Looking further ahead, while legislation
affecting the audit profession works slowly
forward in Europe and the US, the debate
continues as to how best to reform the audit
function. In the aftermath of the financial
crisis and high profile corporate downfalls, the
investment community cannot be faulted for
questioning the accounting profession’s role as
the public watchdog.
The UK regulator, the Financial Reporting
Council, and the Institute of Chartered
Accountants of Scotland are having a study
performed to answer the question: “What mix of
attributes, competencies, professional skills
and qualities need to be combined in an audit
team in order for it to perform a high quality
public interest audit in a modern and complex
global business environment?” Not intended to be
a mere revision of procedures and rules, the
goal is to step back and take a “philosophical
perspective.” In other words, start from the
beginning, look at the world as it exists today
and in the future, and re-visualize what users
of financial reports need and how the auditor
can effectively provide that information. For
instance, how should training change, what areas
of specialized knowledge are required, how is
the audit process carried out, what information
should be presented, and how can that
information be presented in a way that gives the
user what is needed to make informed decisions?
The study is expected to be completed later in
2013.
For further information, see
Clarified Auditing Standards—Learning and
Implementation Plan,
Maintaining and Applying Professional Skepticism
in Audits, and
Competencies and Professional Skills of Auditors
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HP Write-down of Autonomy Acquisition: Implications for
IFRS?
Bad Press for Big Four and all of Accounting Profession
HP’s vastly overpriced purchase of Autonomy may renew
the debate of the relative value of principles based
versus rules based accounting standards. In the wake of
a multi-billion dollar write-down of goodwill from the
acquisition, HP is claiming intentional accounting
misdeeds by the Autonomy accountants that allegedly were
missed by Deloitte, Autonomy’s auditors, Ernst & Young,
HP’s auditors, and KPMG, brought in to perform due
diligence on the acquisition. Of the Big four accounting
firms, that left PricewaterhouseCoopers, who uncovered
the supposed improprieties when called in to do “after
the fact” forensic work on the fiasco.
Accounting issues raised by HP include 1) hardware
sales classified as software sales, with some of the
costs reclassified as marketing expenses, 2) sales
recognized to resellers where the reseller had no
corresponding sale to an end user, and 3) multi-year
software license agreements where all revenue was
recognized in the initial year.
An intriguing aspect of the debacle is that Autonomy
is a British company whose financial reporting falls
under IFRS, while HP is an American company that reports
using US GAAP. The former owner of Autonomy, Mike Lynch,
in interviews with Reuters and others, contended that
the Autonomy accounting was properly reported under
IFRS, and that HP’s allegations are mistaken because
they are applying US GAAP, which is different than IFRS.
Revenue recognition with regards to technology is a
highly complex area, where hardware, software,
licensing, maintenance, and programming modifications
are often bundled into major contracts. As discussed in
our May 2012 issue, the FASB and IASB have been trying
for over ten years to converge the differing standards
of IFRS and US GAAP. Interestingly enough, the
principles-based IFRS covers revenue recognition
primarily in the 12 page IAS 18, whereas the rules-based
US GAAP draws from over 150 areas of guidance and
hundreds of pages of material, much of which is now
consolidated in the FASB Standards Codification and SEC
releases.
The question with regards to the first issue was
whether the hardware bundled with software should have
been reported separately, and whether the customer’s
agreement to assist with marketing as part of the
bundled sale, justified reclassifying part of the cost
as marketing expense. The result was a higher reported
gross margin on sales.
The second issue, involving resellers, was at what
point did Autonomy have a completed sale. Did the sale
occur when the product was provided to the reseller, or
when the reseller sold the product to the end user?
The third issue concerned at what point revenue
from long term software hosting agreements should be
recognized.
Only time and further revelations will divulge
whether these are the actual issues that caused HP to
overvalue the price paid for Autonomy, and whether they
were the result of improprieties, oversights by the
accounting firms, and/or conflicting interpretations of
the standards. But the long and protracted efforts to
synchronize global standards, as exemplified by the
still unresolved revenue recognition differences between
IFRS and US GAAP, can’t be helping.
On a broader scale, questions remain and may be
growing as to the adequacy of a principles based IFRS to
address these issues, or whether too much flexibility
defeats the goal of uniform standards. On the other
hand, while a rules based US GAAP may provide more
clarity for the specific issues raised here, does that
clarity come at too big a price, where the rules can
give way to manipulation? Possibly a middle ground is
needed. See what a British group has to say, in the next
article.
For further information, see
Trustees publish IFRS Foundation Staff Analysis of SEC
Final Staff Report on IFRS
The Future of IFRS
British accountants’ society weighs in strongly
Though the British may have wanted to keep America in
the fold a couple of centuries ago, now when it comes to
joining forces for current day International Financial
Reporting Standards, they appear to be having second
thoughts. The Institute of Chartered Accountants in
England and Wales (ICAEW) on December 12 published a
report, “The Future of IFRS,” that calls for the cause
of IFRS to move forward, with or without the US.
The ICAEW, the British counterpart to the AICPA,
issued “The Future of IFRS” as part of its ongoing
program on thought leadership, known as the Information
for Better Markets Initiative. Through periodic papers
and conferences, the program “subjects key issues in
financial reporting to careful and impartial analysis,
and focuses on three broad themes: disclosure,
measurement and regulation.” A recent example of the
program’s work is the 2011 study “Reporting Business
Risks: Meeting Expectations,” which explored why risk
reporting was inadequate leading up to the financial
crisis, and offered concrete suggestions for
improvement.
With IFRS the law of the land in the European Union
for ten years now, the ICAEW felt it was time to “step
back, to put things in perspective.” As alluded to in
our preceding article, the protracted march toward
global accounting standards has encountered some
resistance, stalling momentum. That resistance is
personified primarily by the US SEC’s recent staff
report issued on July 13, 2012, which is long on
concerns, but lacking in a decisive recommendation.
“The Future of IFRS” points out the accomplishments
of the past decade: over 100 countries require or allow
use of IFRS, academic studies have revealed substantial
benefits, and increasing international trade and
investment advocate for the uniformity of IFRS.
Remaining concerns are also considered: excess
complexity, compromise of quality from convergence,
inconsistent implementation, national differences,
financial crisis implications, and the hesitancy of the
US, which countries like Japan and India tend to follow.
“The Future of IFRS” acknowledged shortcomings in
financial instrument accounting, but found no evidence
implicating IFRS in the global financial crisis. The
delay by the US was seen as beneficial, by allowing the
IASB time to digest the achievements of the past ten
years, while making needed reforms, before tackling the
formidable task of integrating the US with the rest of
the IFRS world. Differences in how countries implemented
IFRS were seen as minor and not inhibiting to the
overall goal. The move to IFRS will prove to be an
improvement, with differences diminishing in time.
“The Future of IFRS” respects that the move to IFRS
will be difficult for countries with already strong
standards like US GAAP. However, the position is clearly
stated that IFRS is now a highly respected set of
standards in its own right, and consequently the time
has come to step away from any dependency on US GAAP. A
call is made for the IASB to end the convergence
process, acknowledge the good that it has done, and move
ahead in the future, focusing its work on the needs of
the 100 plus countries that have adopted IFRS. Even so,
the United State should be encouraged to continue
participating on the IASB boards, at least for now.
Finally, “The Future of IFRS” gives the IASB advice
for managing an organization that now has over a hundred
diverse constituents. Governments are called upon for
greater support, regulators for more active enforcement,
and the IASB to proceed as “an organization that listens
and learns as well as leads.” Principles-based standards
are strongly affirmed, with little interest shown for
industry-specific information, application guidance, or
interpretations, for that matter. Professional judgment
reigns supreme, while detailed rules are disdained for
their danger of manipulation. Only time will tell if the
next decade matches the progress made in the past ten
years.
For further information see
The Future of IFRS
Additional A&A News
The following links provide a selection of current articles
devoted to highlighting other A&A topics currently making
news.
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Barry Melancon, AICPA
President, looks ahead
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Audit needs to adapt or risk becoming irrelevant
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U.S.-China Audit Clash Could Have Broad Reach
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Private Company Council Initial Issues
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Hedge standard unlikely to be adopted
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PCAOB Finds Problems with Audits of Internal
Controls
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