At-A-Glance
Change has been with us a long time,
as attested by the fifth century BC
Greek philosopher Heraclitus, who coined
the phrase “The only thing that is
constant is change.” Indeed, changes in
the accounting profession fill the
paragraphs of the Audit & Accounting
Alert each month. This month is no
different. In our first article, we
report on the changes in leadership at
the FASB, SEC, and FRC, and ponder what
they portend for the future direction of
the profession in the United States and
the United Kingdom.
When speaking of change, we also can
thank nineteenth century French
novelist, Jean-Baptiste Alphonse Karr,
for the phrase “The more things change,
the more they stay the same.” In our
second article, the change comes in the
form of a new study of auditor
deficiencies, which shows that the
shortcomings are the same ones that
prior inspection reports have observed.
Finally, our third article on the
just released lease proposal may, for
some, bring to mind German-American
psychologist Erik Erickson’s quote: “All
change is perceived as loss.” However,
the FASB and IASB have succeeded in
coming together in simultaneously
issuing virtually identical new exposure
drafts for lease accounting. Time will
tell if the objectives of the radical
changes in this complex area are
achieved.
Editor Gerald E. Herter, CPA
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In This Issue
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New Leadership for Major American and British
Accounting Bodies
Changing of the guard at FASB, SEC and FRC
With a new leader on the way for the FASB,
speculation abounds whether incoming Chairman,
Russell Golden, will take the venerable standard
setter in a new direction. His predecessor,
current Chairman Leslie Seidman, came to power
at a time of controversy, upon the sudden
retirement of Robert Herz in 2010. Back then,
the FASB under Herz, pushing for strict fair
value accounting by banks after the financial
crisis, met stiff resistance from banks and
Congress. After his retirement, the FASB
refocused their approach somewhat.
Seidman was recognized by Jeffrey Diermeier,
chairman of the Financial Accounting Foundation
Board of Trustees, for setting “a high standard
as a champion of excellence and independence.”
Though only Chairman for three years, Seidman
has been on the Board the maximum ten years
allowed, so must step down. Following a similar
path as Seidman, Golden started out on the FASB
staff in 2004, later serving as technical
director and chairman of the Emerging Issues
Task Force, before being appointed to the Board
in 2010. Currently serving a second term
extending through 2017, Golden could be
reelected through 2020.
Golden has stated that his main priorities
will be convergence with global standards and
private company accounting standards. Echoing
his predecessor’s resolve for high standards,
Golden emphasizes “putting the interests of
investors first; working to make financial
reporting as clear, transparent and useful as
possible; and never losing sight of the balance
between costs and benefits.”
Though joint work with the International
Accounting Standards Board (IASB) on revenue
recognition, leases and financial instruments is
winding down, and despite the fact that the
United States has not yet decided whether to
adopt IFRS, the FASB was nevertheless named a
founding member on the IASB’s new Accounting
Standards Advisory Board (ASAF). With
representation worldwide from twelve national
accounting standard-setters and regional bodies
with an interest in financial reporting, the
ASAF was formed to provide a more direct channel
for offering technical advice and feedback to
the IASB. How Golden approaches this new
opportunity may foretell the FASB’s future
reputation on the world accounting scene.
In April, the SEC confirmed Mary Jo White as
SEC Chairman. As the first former prosecutor in
that role, the expectation would be for renewed
emphasis on vigorous enforcement. Indications
are that more attention will be paid to
occurrences of accounting fraud. After the
inexplicable failure of the SEC to detect the
massive Bernie Madoff fraud, the agency
restructured operations to enhance detection.
White can assure that follow-through continues
in this area.
White is pushing ahead to complete the
Dodd-Frank regulations, and has recognized the
need to take an international focus in rule
making. Seeking to add efficiency to cross
border regulation, the agency has proposed
“substituted compliance” in the derivatives
domain. White acknowledges that “we live neither
in a ‘my way or the highway’ world nor a world
of whole-cloth acceptance of another
jurisdiction’s regulatory regime. It builds on
the SEC’s ongoing efforts toward cooperation and
collaboration with foreign authorities…”
How White relates this attitude toward
international accounting standards could prove
enlightening. She points out in a May 1 speech
that the SEC has been accepting IFRS based
financials in filings by foreign private
issuers, without U.S. GAAP reconciliations,
since 2007. Also, she touts the active
engagement by the FASB with the IASB, but then
cautions that “the promise of global accounting
standards fades if there is not consistency in
their application, implementation, and
enforcement.”
China will also continue to be a challenge,
with the ongoing dispute over auditor workpapers
from Chinese company audits. That struggle is
not likely to go away since, as White notes “we
have brought numerous cases against China-based
issuers involving market manipulation,
accounting and disclosure violations, and
auditor misconduct among other charges.”
Meanwhile, in the United Kingdom, Baroness
Hogg has announced that she will step down as
chairman of the Financial Reporting Council
(FRC), Britain’s regulator of the accounting
profession and financial reporting. Though her
three year term was completed in April, a
successor has not as yet been named. Hogg has
served on the FRC almost nine years in total,
including a three year stint as Deputy Chairman
as well.
Hogg’s stature has grown over her tenure,
defending the accounting profession at times,
while maintaining the necessary independence of
a regulator. She served during the financial
crisis and afterwards, restructuring the agency
into a more responsive, yet efficient and
effective organization.
In the debate over mandatory auditor
rotation, Hogg favors retendering, concerned
that in certain sectors “there may be only a
couple of firms capable of doing the audit. In
those sectors, rotation would be simply a matter
of revolving doors, with no real competition or
incentive to offer superior quality. Even where
three or four major firms are in play, we think
it would be inimical to competition and quality
to restrict choice by excluding the incumbent.”
She defends the role that audit committees have
to take seriously their responsibility for
conducting a responsible retendering process.
We’ll have to wait and see how her successor
will respond.
For further information, see
Russell G. Golden Named Chairman of the
Financial Accounting Standards Board and
Mary Jo White Sworn in as Chair of Sec and
Baroness Hogg steps down as FRC Chairman
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Auditor Shortcomings cited in New Fraud Study
Findings consistent with other recent reports
The Center for Audit Quality (CAQ) is an independent
organization, formed in 2007 and affiliated with the
AICPA, whose vision is “dedicated to enhancing investor
confidence and public trust in the global capital
markets by:
- Fostering high quality performance by public
company auditors;
- Convening and collaborating with other
stakeholders to advance the discussion of critical
issues requiring action and intervention;
- Advocating policies and standards that promote
public company auditors’ objectivity, effectiveness
and responsiveness to dynamic market conditions.”
In May, 2013, CAQ issued a study, An Analysis of
Alleged Auditor Deficiencies in SEC Fraud
Investigations: 1998–2010, prepared by the authors of a
2010 COSO report, Fraudulent Financial Reporting:
1998–2007, An Analysis of U.S. Public Companies. Drawing
from the COSO report and subsequent data, the authors
compiled and described the nature of the deficiencies
that warranted sanction by the SEC of the auditor or the
audit firm.
The study is quick to point out that SEC allegations
of fraudulent financial reporting are rare. Considering
that annual filings by the approximately 9,500 companies
add up to some 120,000 filings over the 13 year period,
the discovery of 347 cases amounts to only .3% of all
filings. The 87 of those cases leading to SEC sanctions
against auditors amount to less than .1% of all filings.
Nevertheless, the CAQ emphasizes the importance of
continued awareness and vigilance toward the predominant
factors that cause fraudulent financial reporting to go
undetected by the auditor.
Not surprising, the findings are consistent with
audit firm inspection reports by the PCAOB, AICPA,
International Forum of Independent Audit Regulators
(IFIAR), and UK’s Audit Commission, as highlighted these
past few months in the Audit & Accounting Alert. The
audit problem areas noted and their frequency are listed
here:
| Audit Problem Area |
Per cent of Cases |
| 1. Failure to gather
sufficient competent audit evidence |
73% (59 cases) |
| 2. Failure to exercise
due professional care |
67% (54) |
| 3. Insufficient level
of professional skepticism |
60% (49) |
| 4. Failure to obtain
adequate evidence related to management
representations |
54% (44) |
| 5. Failure to express
an appropriate audit opinion |
47% (38) |
| 6.
Incorrect/inconsistent interpretation or
application of requirements of GAAP |
37% (30) |
| 7. Inadequate
consideration of fraud risks |
33% (27) |
| 8. Inadequate planning
and supervision |
35% (25) |
| 9. Failure to
adequately address audit risk and materiality
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21% (17) |
| 10. Inadequate
preparation and maintenance of audit
documentation |
20% (16) |
| 11. Failure to
adequately communicate with the audit committee
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17% (14) |
| 12. Failure to
recognize / ensure disclosure of key related
parties |
15% (12) |
| 13. Failure to
adequately perform audit procedures in response
to assessed risks |
15% (12) |
| 14. Inappropriate
confirmation procedures |
15% (12) |
| 15. Failure to evaluate
adequacy of disclosure |
15% (12) |
| 16. Internal
control-related issues including over-reliance
on internal controls, failure to obtain an
understanding of internal control, and failure
to obtain an understanding of the entity and its
environment |
14% (11) |
From these results, the study focused on four areas
that were determined to be the key issues, and offered
suggestions that firms should consider for evaluating
and strengthening their own audit function. The four
areas are:
- Failure to Exercise Due Professional Care - may
be caused by (a) a lack of understanding, which can
be addressed through education, training, hiring ,
and performance evaluation assessments, or ( b)
execution failure as a result of time pressure,
multi-tasking, or inadequate engagement level
quality control review procedures, which employee
surveys may help to uncover.
- Insufficient Levels of Professional Skepticism –
may be caused by (a) a lack of awareness of the
natural tendency to trust, which can be dealt with
by training, education, supervision, and the quality
control system, or (b) execution failure, which can
be reduced by reminders, accountability assessments,
enhanced quality reviews, and hindsight analysis to
detect skepticism-lacking patterns of behavior .
- Inadequate Identification and Assessment of
Risks – may be caused by oversimplifying the
complexities of risk assessment because of over
optimism or inexperience with fraud, which may
require more sophisticated risk management training.
- Failure to Respond to Identified Risks with
Appropriate Audit Responses to Gather Sufficient
Competent Evidence – will occur when (a) the first
three areas have not been addressed, (b) generic or
prior year audit programs are used without
adjustment for documented risks, (c) documented
risks are not linked to audit procedures, or (d) the
audit response is not commensurate with the risks
identified. Additional training and/or new tools and
techniques may be needed in this case.
With this study, the CAQ recognizes that while
financial reporting fraud may be the act of a
perpetrator, auditors have a responsibility “to plan and
perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement, whether caused by error or fraud.”
Reviewing audit shortcomings from the past can be
helpful for finding ways to reduce future occurrences.
For further information, see
An Analysis of Alleged Auditor Deficiencies in SEC Fraud Investigations: 1998 – 2010
Lease Accounting, Round 2
FASB and IASB issue revised proposal changing and
converging long held standard
Over a year ago, in the April 2012 issue of the Audit
& Accounting Alert, we recounted the rocky road of lease
accounting standards. Having stood in place since 1976
and 1982, respectively, the monumental FAS 13 and IAS 17
were finally subjected to the work of convergence in
2006. The fundamental differences between GAAP and IFRS
arose from the bright lines of the “rules based” GAAP as
contrasted with the more generalized approach of
“principles based” IFRS. Along with meshing the two
views, a goal was to have all leases brought on to the
balance sheet under a single approach. The Exposure
Draft, finally issued in 2010, met with wide resistance.
Since then, the FASB and IASB have gone back
and forth in spirited debate. Discord became so intense
that the whole process has taken an additional year
before the two sides were able to come together. The
revised exposure drafts, FASB’s Accounting Standards
Update, Leases (Topic 842) — A revision of the 2010
Proposed FASB Accounting Standards Update, Leases (Topic
840), and IASB’s ED/2012/6 - Leases were issued on May
16, 2013, with a comment period ending on September 13,
2013.
First of all, the Exposure Drafts (EDs) took a
practical step in excluding leases with a lease period
of not more than twelve months. All other leases are to
be recorded by the lessee on the balance sheet as
right-of-use assets, with corresponding lease payment
liabilities. Unable to settle on one approach for all
leases, the EDs proposes two types of lease. For
“equipment” leases, the lessee records a right-of-use
asset measured by the present value of the lease
payments, and amortizes the computed interest like a
loan, separately from amortization of the right-of-use
asset. For “real estate” leases, the lessee also records
a right-of-use asset measured by the present value of
the lease payments, but combines the interest and
right-of-use amortization into one lease expense,
computed on a straight-line basis.
Lessors would use an approach consistent with
lessees. For “equipment” leases, the underlying asset is
“derecognized” and separate lease receivable and
residual assets are established. Interest income on each
is recognized over the term of the lease. This approach
allows users to analyze the credit risk on the lease
receivable and the asset risk on the residual asset,
separately. The lessor is also required to disclose how
the exposure is managed. Any profit that arises from
entering the lease is recognized at commencement of the
lease. For “real estate” leases, the lessor retains the
property as an asset, and recognizes lease income on a
straight-line basis, similar to current practice.
One of the criticisms to changes in the lease
accounting standards has been the considerable cost
involved in converting, as well as new complexities. The
EDs addressed those concerns to some extent by excluding
1) variable lease payments in the lease liability (such
as payments based on percentage of sales), 2) optional
renewal periods unless there is a significant economic
incentive to exercise the option, and 3) short-term
leases as mentioned above.
Though the FASB and IASB EDs are essentially the
same, only the FASB version allows private companies and
non-public not-for-profit organizations to use a
risk-free rate to discount the lease liability. Also,
the lease liability disclosures do not need to include a
reconciliation of the balance from the beginning to the
end of the year.
Another widespread objection to the EDs stem from the
economic impact on financial statements. Adding major
liabilities to the balance sheet, while a primary
purpose for the new standard, may potentially harm a
company’s credit rating or lead to loan covenant
violations. The front-loaded amortization on equipment
leases may cause similar effects from resultant lowered
earnings. Consequently, the EDs may still have a
difficult time in the short-term. However, after the
initial impact from implementation, those arguments
should, in time, fade away.
Even so, getting to this point has been taken a
substantial effort for the FASB and IASB. Considering
that the FASB vote in favor of the ED was only 4-3,
there is likely to be further deliberation, once the
comment period has ended, before a final pronouncement
is issued, hopefully in 2014.
For further information, see
FASB - Lease Standard
and
IASB - Lease Standard
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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European Parliament Taking
Aim at International Accounting Standards
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New COSO Guidelines Could Help Deter Fraud
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Success of new UK financial reporting standard (FRS
102) needs to be replicated on going concern
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SEC Adopts 2013 U.S. GAAP
Taxonomy
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Governments using accrual accounting set to soar
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US-China audit fight: Armageddon averted?
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