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Audit & Accounting Alert Newsletter

Issue 2 | March 2017

At-A-Glance

Gerry Herter

Artificial intelligence is rapidly changing many aspects of how our world functions. Self-driving cars are starting to appear, while robots take over more of the manufacturing operations. The accounting profession is not immune to the trend. The future vitality of the profession may depend on how well the potential and challenges of artificial intelligence are embraced. Our first article explores possibilities and concerns.

Approaches for determining the proper values of businesses and certain assets, such as goodwill, have been the source of debate as long as accountants have tried to account. The standards and designations for specialists practicing in this area can vary depending on the organization to which the professional belongs. In an effort to encourage uniformity, the International Valuation Standards Council (IVSC) has issued a new set of standards. Our second article considers the new standards, as well as a new credential also announced in January, 2017 by a separate group. 

Finally, our Worldwide Update covers news from organizations across the globe.

Editor Gerald E. Herter, CPA

In This Issue 

Artificial Intelligence: Will the Accounting Profession be Ready?

Opportunities and threats for auditors

American politicians debate whether expansion of manufacturing in the country will bring new jobs or just new opportunities for companies to further embrace the growing attraction of robotic technology. Accountants and auditors need to watch this development closely, and not just to develop methodologies that track the accounting measurement and reporting for their companies and clients. Robots and other forms of artificial intelligence (AI) are rapidly progressing to take over many of the tasks traditionally performed by them.

With each previous advance in automation, the accounting profession has endured and indeed prospered. Computers streamlined bookkeeping and then tax preparation, diminishing the need for practitioners at the entry levels of data input and organization. Nowadays, however, outsourcing to accountants is booming as smaller companies realize that automated accounting systems are only as good as the input fed into them. Tax software suffers from a similar shortcoming, while at the same time freeing up accountants from regulatory calculations, such as those required by the alternative minimum tax, so contorted only a computer could love them.

But can a computer actually feel love? Maybe not, but with the geometric expansion of processing power and the explosion of data accessible in recent times, supercomputers and advanced robots can eerily appear to simulate even human emotions. Applying the potential of these rapidly growing technological capabilities has been the focus of massive investment by the Big Four accounting firms. The lasting fortunes of the profession may well hinge on the speed and effectiveness by which the emerging techniques are integrated with accounting and audit processes.

Big Four firm, Deloitte, has developed an AI tool, Argus, which is equivalent to IBM’s AI platform, Watson. As discussed in the April, 2016 issue of the Audit & Accounting Alert, Deloitte uses Argus in the audit of its client, H & R Block. Ironically, this year H & R Block is touting the use of Watson to promote its tax services.

A new study reported in the Fall 2016 issue of the Journal of Emerging Technologies in Accounting, an American Accounting Association publication, addresses future possibilities: Research Ideas for Artificial Intelligence in Auditing: The Formalization of Audit and Workforce Supplementation. The study describes the use of “deep learning,” an AI technology which utilizes the increased computing power and data available, to perform multi-layered analysis of data to formulate responses. For example, applying information “learned” from extensive arrays of electronic product images, the computer can analyze photos taken by drones to identify and quantify inventories. Similar types of analysis can determine the meaning of text, the classification of text, and even the evaluation of speech captured electronically.

The basic question asked by the study is whether AI will replace the audit function or supplement it. Using an analogy from the automotive world, a GPS navigation system is a supplement that can assist a driver, while an auto-piloting vehicle is a replacement of the driver.

Supplementation will be readily available to perform routine repetitive audit tasks. In this sense, supplementation refers to the idea of assisting with or supplementing tasks. Auditors find the review of contracts and leases to be tedious but necessary tasks. AI can review and analyze masses of these documents incredibly faster than humans, while reporting anomalies and exceptions more effectively. Performance of such functions will increase the coverage and reduce the work at the basic document level, while supplementing the other functions of setting parameters and evaluating results.

The study indicates that the accounting profession has not kept pace in embracing AI because of outdated standards, as well as the preference for billing by the hour, and the need for formalization of audit steps, such as planning, assertions, adoption of quantitative weighting of evidence, and integration with corporate control systems. An audit production line driven by AI is envisioned to span the whole range from the pre-planning phase through to the issuance of the audit report. With companies developing AI systems to provide continuous real-time checking of their processes, the danger exists that they will be more advanced than the auditors.

Judgement, which is considered too complex to give way to automation, has been the predominant factor claimed as the solitary domain of the auditor. While that may be the auditor’s saving grace, the study points out that as complex tasks are further broken down into more manageable pieces, and analyzed by techniques such as deep learning, the role of judgment may grow progressively smaller. The self-driving car is given as an example of a task that was once thought to be too complex for AI.

In any event, accountants and auditors of the future will need to be much better trained in the latest technological advances, in order to maintain a necessary role alongside AI. .

For further information see Research Ideas for Artificial Intelligence in Auditing: The Formalization of Audit and Workforce Supplementation.


Valuations Take a Step Toward Global Conformity

International Boards issue broad standards of practice and a new credential

Valuations have presented a chronic, long-standing challenge to the financial reporting community. The lack of precision and consistency with the determination of the fair values of businesses and intangibles, such as goodwill, patents, trademarks, customer lists and non-compete agreements, have continually given rise to questions as to valuation methods and the qualifications of the professionals performing the valuations.

The results of the International Forum of Independent Audit Regulators’ (IFIAR) fourth annual survey of audit inspection findings (reported in the April, 2016 issue of the Audit & Accounting Alert), found that fair value measurement was one of top areas for audit deficiencies in every year of the survey.

Though the global accounting community is gradually coalescing around International Financial Reporting Standards (IFRS), with the United States a notable holdout, the valuation community still exhibits a variety of standards and designations, adding to the confusion when attempting to assess reports from the different professional organizations. For example, the American Institute of Certified Public Accountants promulgates the Statements on Standards of Valuation Services (SSVS) for its members to follow.

Furthermore, even the terminology employed must be considered with care when crossing over into the world of valuation, as valuation expert and former Integra International Global Chairman Don DeGrazia, CPA, ABV, CFF, a Partner at Gold Gerstein Group LLC, states:

“It is necessary to differentiate between the world of “Fair Market Value” and “Fair Value” in the accounting context. They can be very different. FMV is a market transaction oriented standard of value for an ownership interest in an entity or property … ‘The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.’ This standard is used in the real valuation world … appraisals of businesses or business interests for income tax, estate and gift tax, mergers & acquisitions, stockholder disputes, divorce actions, etc. Whereas fair value is an accounting or regulatory mandated context developed for the specific purpose of financial statement measurement. The definition of ‘Fair Value’ demonstrates the difference: ‘The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.’ The accounting guidelines define this as an ‘Exit Price.’”

In a move to improve the reputation of the valuation industry and promote uniformity, at least in the fair value reporting arena, the International Valuation Standards Council (IVSC) on January 17, 2017, issued International Valuation Standards 2017 (IVS 2017). The IVSC, according to its website, is “an independent, not-for-profit organisation that produces and implements universally accepted standards for the valuation of assets across the world in the public interest.” With broad representation regionally and professionally, including the AICPA, the IVSC is chaired by Sir David Tweedie, former chairman of the International Accounting Standards Board.

IVS 2017 consists of three parts:

  1. The IVS Framework covers the general principles of objectivity, judgement, competence, and acceptable departures that are to be followed by those performing valuations in accordance with IVS 2017.
  2. IVS General Standards cover the scope of work, terms of conduct for investigations and compliance with other standards, bases of value, valuation approaches and methods, and reporting.
  3. IVS Asset Standards cover the specific asset categories, including business and business interests, intangible assets, plant and equipment, real property interests, development property, and financial instruments. The General Standards are applied to these asset categories with additional requirements and modifications as appropriate.

Prior to issuance, IVS 2017 went through a consultation period where over 100 comments from various interested parties were considered. A Standards Review Board has been established to maintain and update the Standards, which are effective as of July 1, 2017.

Whether acceptance of IVS 2017 follows a path similar to the protracted pace of the IFRS remains to be seen. But Chairman Tweedie made a strong case in October when he stated “valuation is not a profession. If valuers wish to become a profession, and continue with self-regulation, then valuation profession organizations must adopt IVS and enforce compliance – no exceptions.”

With similar timing to IVS 2017, a group consisting of the AICPA, American Society of Appraisers (ASA), and Royal Institution of Chartered Surveyors (RICS) issued on January 10, 2017, the Certified in Entity and Intangible Valuations (CEIV) credential. The credential website states that the CEIV “will be issued to valuation professionals who perform fair value measurements for businesses, business interests, intangible assets, certain liabilities, and inventory for financial reporting purposes.”

The credential is designed to demonstrate a consistent and stringent level of qualifications for those in the valuation profession. Requirements for the credential include specified education and training in the profession, experience of 3,000 hours performing fair value measurements, successful completion of the CEIV examination, and ongoing education, experience and compliance through quality reviews and adherence to the Mandatory Performance Framework (MPF). According to the credential website, the MPF “is a practical non-authoritative framework that defines the level of documentation and performance that is necessary to provide supportable and auditable fair value measurements.” The MPF was authored by the credential founders mentioned above, and issued in January, 2017, also.

The Association of International Certified Professional Accountants’ Executive Vice President for Public Practice, Susan Coffey, stated in a press release the hoped for goal of the CEIV credential: “The quality oversight of credential holders will provide clients, regulators, auditors, investors, and the public greater confidence that they are receiving accurate information in financial statements when fair value measurements are performed by someone holding the CEIV credential.”

DeGrazia points out that “the new credential is not needed unless you do fair value work, then it will be mandatory before long...Over half of the PCAOB issues are FV related so they thought this would lessen those inconsistences.” Even so, DeGrazia questions the rationale by which the SEC brought this mandate to fruition. 

Further details can be found at IVSC launches new global standards for valuation profession and A Credential for Professionals Performing Fair Value Measurements for Corporate Entites and Intangible Assets


Worldwide Update

Periodic roundup of recent and upcoming actions and activities by audit and accounting organizations throughout the world

International

IASBInternational Accounting Standards Board (www.ifrs.org)

  1.  Exposure Draft – Annual Improvements to IFRS Standards 2015–2017 Cycle published January 12, 2017, proposes amendments to three standards. For IAS 12 Income Taxes, clarification is proposed that “an entity should account for all income tax consequences of dividends in the same way, regardless of how the tax arises.” For IAS 23 Borrowing Costs, clarification is proposed as to “which borrowing costs are eligible for capitalisation as part of the cost of an asset in particular circumstances.” For IAS 28 Investments in Associates and Joint Ventures, clarification is proposed “that an entity should apply IFRS 9 Financial Instruments to long-term interests in an associate or joint venture to which it does not apply the equity method." Comment period ends April 12, 2017.

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

  1.  Enhancing Organizational Reporting: Integrated Reporting Key – Policy Position Paper published January 10, 2017, “addresses reporting that provides decision-useful information to organizational stakeholders beyond that which is provided in traditional financial reporting and financial statements, and may provide important links between that financial reporting and other organizational reporting.”
  2.  International Public Sector Accounting Standards Board (IPSASB) – IPSAS 40, Public Sector Combinations, standard published January 31, 2017, “provides the first international accounting requirements that specifically address the needs of the public sector when accounting for combinations of entities and operations.” The standard classifies public sector combinations as either amalgamations requiring a modified pooling of interests method of accounting, or as acquisitions applying the same approach as IFRS 3. Effective January 1, 2019, with earlier adoption encouraged. 

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

  1.  Business models of the future: emerging value creation – report issued January 25, 2017. “New business models can provide better blueprints for creating value, which economies and societies can use to tackle the challenges they face and allow them to flourish. This report examines six business models and assesses their characteristics and the world in which they operate: platform-based, mass customisation 2.0, frugal, modern barter, 'pay what you want,' mega-hyperlocal. Each model is examined through the 'Full Stack' - an end-to-end framework to support the understanding and assessment of the value creation potential of business models of the future. Finally the report examines the role professional accountants play in start-ups and larger organisations seeking to learn from new business models.” 
  2.  ACCA culture-governance tool – aid issued January 6, 2017. “Corporate culture encourages behaviours that support or impede the achievement of organisational objectives. The challenge is understanding how to nurture a culture that promotes behaviours consistent with organisational objectives. The ACCA culture-governance tool seeks to support organisations with their culture goals.”

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

  1.  Ensuring corporate viability in an uncertain world – Framing the board conversation on risk – report issued in January, 2017, “recommends that while risk started as a component of compliance it now needs to be raised to a strategic level which ‘leads to different conversations’, particularly at a time of increasing complexity and uncertainty in global markets.” 

Africa, Europe, India, and the Middle East (AEIME)

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

  1. Audit Quality Thematic Review: The Use of Data Analytics in the Audit of Financial Statements – issued January 30, 2017, found that “UK audit firms are at the forefront of developing and using data analytic techniques with the potential to improve audit quality. A more structured approach to their deployment could accelerate their effective use.” However, actual use of these techniques is not yet widespread, so the FRC wants to encourage more and better usage.
  2.  FRS 103: Insurance Contracts, revised standard issued February 13, 2017, to update in accordance with changes in the regulatory framework.
  3.  Developments in Audit - February 2017 Update – report issued February 14, 2017, found that work is still needed on audit quality in the areas of independence, corporate governance and culture, and skepticism. Also, audit quality can be improved through more root cause analysis and use of data analytic tools. Audit tendering was found to have positive results.

Americas, Asia, Australia and New Zealand (AAANZ)

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

  1. Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets – ASU 2017-05, issued February 22. 2017, to clarify guidance in ASU 2014-09, Revenue from Contracts with Customers, with regards to partial sales of nonfinancial assets. Effective generally in 2018 for public and certain other entities, and in 2019 for all others, with early application permitted under specified conditions.
  2. Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment – ASU 2017-04, issued January 26, 2017, “to simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill… Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Board also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary” Effective generally in 2020 for SEC filers, 2021 for public, non-SEC filers, and 2022 for all others.
  3. Accounting Changes and Error Corrections, and Investments—Equity Method and Joint Ventures: Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings – ASU 2017-03, issued January, 2017, for consistency with SEC notices. Effective when related pronouncements are applied.
  4. Not-for-Profit Entities—Consolidation: Clarifying When a Not-for-Profit Entity That Is a General Partner or a Limited Partner Should Consolidate a For-Profit Limited Partnership or Similar Entity - ASU 2017-02 – issued January 12, 2017, designates that “once the amendments in Update 2015-02 are effective, GAAP will require an NFP that is a general partner of a for-profit limited partnership or similar legal entity to apply the general consolidation guidance in Subtopic 810-10.” Effective generally in 2017.
  5. Exposure Draft - Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent) – issued January 10, 2017, “to improve financial reporting by simplifying guidance used to determine whether debt should be classified as current or noncurrent in a classified balance sheet. It would replace the existing, fact-specific guidance with an overarching, cohesive principle for debt classification that focuses on a borrower’s contractual rights and obligations that exist as of the reporting date. Under the proposed ASU, a borrower would continue to classify its debt as noncurrent when a violation of a debt covenant has been waived, if a borrower receives a waiver before the financial statements are issued (or are available to be issued) and the waiver meets certain conditions. The proposed amendments could result in a shift in the classification of certain debt arrangements between noncurrent liabilities and current liabilities as compared with current balance sheets in the following ways:
    •  Short-term debt that is refinanced on a long-term basis after the balance sheet date would no longer be classified as a noncurrent liability.
    •  Companies with debt that contains subjective acceleration clauses would no longer be required to assess the likelihood of acceleration of the due date when determining whether the debt is a noncurrent or current liability.”
    The comment period ends May 5, 2017.
  6. Exposure Draft - Disclosure Framework—Changes to the Disclosure Requirements for Inventory – issued January 10, 2017, “to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of a reporting organization’s financial statements. The proposed ASU would increase inventory disclosure requirements for all reporting organizations, including:
    • Changes in inventory that are not related to the ordinary course of manufacturing, purchasing, or selling inventory
    • Inventory disaggregated by major components
    • Inventory disaggregated by measurement basis
    • Qualitative description of costs capitalized.” Additional disclosure guidance is provided for the retail inventory method, LIFO and segment reporting.
    The comment period ends March 13, 2017.
  7. Business Combinations: Clarifying the Definition of a Business – ASU 2017-01 – issued January 5, 2017, “is intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses…The amendments in the ASU provide a more robust framework to use in determining when a set of assets and activities is a business. They also provide more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable…The amendments in this Update provide a screen to determine when a set is not a business. The screen requires that when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business…If the screen is not met, the amendments in this Update (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements.” Effective generally in 2018 for public companies and 2019 for all others, with specified early adoption allowed.

GASBGovernmental Accounting Standards Board (www.gasb.org)

  1. GASB Statement No. 84 – Fiduciary Activities, issued on January 31, 2017, “ to improve guidance regarding the identification of fiduciary activities for accounting and financial reporting purposes and how those activities should be reported. This Statement establishes criteria for identifying fiduciary activities of all state and local governments. The focus of the criteria generally is on (1) whether a government is controlling the assets of the fiduciary activity and (2) the beneficiaries with whom a fiduciary relationship exists.” Effective for periods beginning after December 15, 2018, with earlier application encouraged. 
  2.  Invitation to Comment - Financial Reporting Model Improvements—Governmental Funds, issued January 4, 2017, “to obtain feedback from stakeholders at an early stage of the Board’s financial reporting model reexamination project” The comment period ends March 31, 2017.

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

  1. Certified in Entity and Intangible Valuations (CEIVM) credential, announced January 10, 2017, jointly by AICPA, ASA and RICS, “to Improve quality, consistency and transparency of Fair Value Measurement results in financial reporting.” See first article above for details.
  2. Financial Reporting Executive Committee (FinRec) a. Exposure Drafts – Various Implementation Issues in the Airlines, Gaming, Telecommunications, Timeshare, Insurance and Software Revenue Recognition industries, arising from ASU 2014-09 - issued at various dates from December 7, 2016, through January 31, 2017. The comment periods end variously from February 1through April 3, 2017.
  3. Auditing Standards Board (ASB) a. Statement on Auditing Standards (SAS) No. 132 - The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, issued February 1, 2017, supersedes SAS No. 126 of the same name, and amends SAS No. 122, Clarification and Recodification: Special Considerations – Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks. The SAS addresses the audit implications of the FASB ASU 2014-15, Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. Effective for audits of financial statements for periods ending on or after December 15, 2017.

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

  1. Staff Guidance – Form AP, Auditor Reporting of Certain Audit Participants and Related Voluntary Audit Report Disclosure Under AS 3101, Reports on Audited Financial Statements updated February 16, 2017, to provide guidance on treatment of staff involved in secondment arrangements. “Each registered public accounting firm must provide information about engagement partners and accounting firms that participate in audits of issuers by filing a Form AP, Auditor Reporting of Certain Audit Participants ("Form AP"), for each audit report issued by the firm for an issuer.” This updated guidance addresses treatment of professional staff assigned exclusively on a temporary basis (secondment arrangement) to a firm in another country for at least three months.
  2. Staff Questions and Answers – Audits of Mainland China Issuers by Registered Firms Outside of Mainland China, issued December 30, 2016, states that the China Ministry of Finance Rule, Interim Provisions on Auditing Operations Conducted by Accounting Firms Concerning the Overseas Listing of Domestic Chinese Companies, issued in 2015, does not effect a firm’s obligations to provide its audit documentation and other information to the PCAOB in PCAOB inspections and investigations.

SASBSustainability Accounting Standards Board (http://www.sasb.org)

  1. SASB Rules of Procedure and the SASB Conceptual Framework, issued February 15, 2017, are “, two governance documents that establish the principles and processes of SASB's approach to standards development.” A two-tier governance structure is instituted that separates fiduciary duty from standards-setting activity. The Conceptual Framework “sets out the basic concepts, principles, definitions, and objectives that guide the appointed technical Sustainability Accounting Standards Board members in its approach to setting standards for sustainability accounting.”

Additional A&A News

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

  1. Accounting Standards not Upended by President Trump’s Two-for-one Regulation Cut
  2. Brexit to have ‘positive impact’ on accountancy profession
  3. 77% of financial execs expect blockchain for post-trade use within 5 years
  4. Melancon: Issues Facing CPAs Include Globalization, Economic Recovery
  5. Accounting standards in the spotlight as life insurers take strain
  6. Should U.S. CFOs Worry About EU Cyber

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.herter@integra-international.net