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Audit & Accounting Alert Newsletter

Issue 5 | May 2014

At-A-Glance

Gerry Herter

The parallel roles of audit and accounting are prominent in the international news this month. Changes that have long-term implications in both fields are coming to pass. Our first article explores the ongoing quest in search of the optimal balance between an audit that is without risk of failure and one that comes at an acceptable cost. Another seemingly endless pursuit is toward the goal of worldwide accounting standards. While that journey proceeds at a crawl, broader, potentially more complex reporting issues are gaining traction. Our second article highlights new regulatory measures that inject non-financial measures into the financial reporting arena. Finally, we round out this issue with our quarterly Worldwide Update, with news from organizations across the globe.

Editor Gerald E. Herter, CPA

In This Issue 

The Elusive Goal of Audit Perfection

Persistent audit deficiencies continue to raise alarms

The challenge to preventing an audit failure is similar in some respects to that of preventing a terrorist attack. No matter how many resources are applied, the attainment of success 100% of the time cannot be guaranteed. Nevertheless, when a failure occurs, the inevitable question asks what more could have been done. When an Enron or 9/11 occurs, all the stops are pulled out to prevent a similar occurrence. The result, at least temporarily, is usually a decrease in comparable events. Eventually though, either the guard is let down, or new methods of attack are devised, such that the cycle of bad outcomes increases again. 

Stakeholders may demand perfection while not realistically assessing the cost such results would require. Consequently, auditors, preparers and users of financial statements must continually strive for a balance that provides an acceptable level of protection at a feasible cost.

A variety of organizations around the world are addressing aspects of the audit dilemma, striving to improve outcomes and lessen the instances of failure. The International Forum of Independent Audit Regulators (IFIAR) in April issued its 2013 Survey of Audit Inspection Findings. The European Parliament in early April instituted new rules requiring mandatory auditor rotation, expanded audit reporting, and limiting auditor advisory services for audit clients. The PCAOB is gauging feedback on a proposal that would also expand audit reporting. Also, companies and their auditors are implementing the new COSO internal control framework while assessing the role of internal audit.      

IFIAR includes regulators from 49 jurisdictions around the world. Its periodic surveys are intended to highlight common audit performance issues that occur throughout the world. The recently issued 2013 survey does not pass judgment quantitatively on whether audit quality has improved or deteriorated since the 2012 survey. However, the findings indicate that the same major shortcomings continue to occur.

 For public entity audits, the three major areas of deficiency were:

  1.  Fair value measurement
  2.  Internal control testing
  3.  Adequacy of financial statement disclosures.

For financial institution audits, the three major areas of deficiency were:

  1. Audit of allowance for loan losses and loan impairments
  2.  Internal control testing
  3. Audit of valuation of investments and securities.

For inspections of internal control systems, the three major areas of deficiency were:

  1. Engagement performance
  2.  Human resources
  3.  Independence and ethics requirements.

The problems in auditing fair value, investment valuation, and loan impairment are not surprising considering the difficulty the FASB and IASB are having in developing effective standards for financial instruments. While internal control testing is at the very heart of audit fundamentals, the rapidly changing nature of systems and technology pose an ongoing challenge just to keep up.

The European Parliament’s approach addresses the concerns indirectly, by placing more restrictions on auditors. Companies will need to change auditors every ten years, though that period can be extended to twenty years if the audit is at least put out to bid, or to 24 years if more than one audit firm is involved in the audit. Audit reporting transparency is expanded as well, requiring the presentation of more audit procedure details to the audit committee, and public disclosures concerning risks of material misstatement and going concern uncertainties. Additionally, in order to enhance independence, auditors will be prevented from providing tax, financial and investment advice, or other non-audit services.

The PCAOB has dismissed the idea of mandatory auditor rotation, but is considering audit report expansion. A proposal for changes to the auditor’s report, currently out for discussion, has drawn spirited feedback, pro and con. The proposal calls for the disclosure of “critical audit matters” (CAM) in the audit report. Proponents feel that CAM would provide users with informative insights into the audit process that the current boilerplate reports lack. Indeed, significant energy can be spent during an audit between the company and the auditor evaluating whether a potentially problematic issue needs to be disclosed. Requiring disclosure would reduce undue pressure on the auditor to remain silent. Critics raise the concern of added legal liability for the auditor, and added cost for matters that are considered company responsibilities to disclose, not the auditor’s.

 Finally, the new COSO framework is intended to enable a more current and effective implementation of measures that can complement the auditor’s efforts to assure adequate safeguards and accurate financial reporting. Adequate training of firm financial personnel, internal auditors, and external auditors will be crucial as the new framework is introduced. Also, a detailed analysis of existing controls, as contrasted to the new framework, will be needed to reveal gaps that have emerged over time as systems have evolved.

For further information, see IFIAR Global Survey of Inspection Findings


Laws and Causes Target Financial Reporting Standards

Costs, benefits and relevance fuel the debate

As deliberations continue over International Financial Reporting Standards (IFRS), various organizations and regulatory jurisdictions push forward with their own specific agendas. In the headlines this month are issues such as conflict minerals, sustainability, human rights and corruption.

The Dodd-Frank Act was passed in 2010 by the United States Congress to restrain behaviors that led to the recent financial crisis. However, as often happens, unrelated measures got added on, as was the case with conflict minerals legislation. Designed to shed light on and reduce the use of minerals production to fund armed conflicts and human rights abuses, this provision added complex and costly financial reporting disclosure requirements on public companies. While use of conflict minerals is a troublesome issue, determining whether a company’s products use minerals of this nature can require extensive research and analysis. Private companies can be impacted as well, since they may sell so called “tainted” components that go into the public company’s products.

Surprisingly, a United States Appeals Court ruled parts of the law unconstitutional on the basis of interference with free speech guarantees. While the ultimate outcome remains to be seen, the conflict minerals legislation shows how passionate political issues can impinge on the ostensibly detached world of financial reporting standards.

While the SEC considers how to respond to the conflict minerals developments, one of its commissioners has lashed out at the Sustainability Accounting Standards Board (SASB). In our October 2013 issue, we described the SASB’s work in establishing specific industry standards for reporting ESG (environmental, social and governmental) factors in SEC 10-k reports. 

In a speech at the Tulane University Law School Annual Corporate Law Institute, Commissioner Daniel Gallagher expressed concern that Federal legislation has given the SEC too much authority for corporate governance, which he feels is best left at the state level. However, in the area of corporate filings and disclosures, Gallagher remarked that the SEC has been given sole responsibility, such that third parties like the SASB should not get involved. He pointed out that SASB is not an authoritative board, and that it engages in areas other than sustainability. 

In response, the SASB stated that it “does not mandate disclosure, and we have no intention of displacing or undercutting the SEC’s authority to prescribe disclosure standards. Rather, SASB develops standards that help companies report on material sustainability factors in a decision-useful way for investors.” The SASB noted its support for the SEC objectives of materiality and long-term investor protection that Gallagher mentioned, by providing resources that help to eliminate immaterial disclosures and promote disclosures that assist in assessing the long-term viability of entities. 

Moving differently than the SEC, the European Parliament on April 15, 2014 adopted the Directive on disclosure of non-financial and diversity information by large companies and groups. This directive will require large companies to disclose “information on policies, risks and results as regards environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues, and diversity on boards of directors.” Citing not only the ethical imperatives, Michel Banier speaks to the importance for the future of companies and Europe alike in stating that “Companies, investors and society at large will benefit from this increased transparency. Companies that already publish information on their financial and non-financial performances take a longer term perspective in their decision-making. They often have lower financing costs, attract and retain talented employees, and ultimately are more successful. This is important for Europe’s competitiveness and the creation of more jobs. Best practices should become the norm.”

Though the European Parliament indicated that SMEs could also benefit from efforts in these areas, SMEs with fewer than 500 employees were exempted, after negotiations with the European Council, due to the administrative burden that would be incurred by smaller companies. Even those required to comply will only need to provide concise, useful information, rather than a detailed analysis. The format is flexible. Overall, the directive is much less in scope than that envisioned by the comprehensive report under development by the International Integrated Reporting Council.

For further information, see Court Decision Won't be Final Word on Conflict Minerals and Disclosure of non-financial and diversity information by large companies and groups


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. Discussion Paper - Accounting for Dynamic Risk Management: a Portfolio Revaluation – issued on April 17, 2014, addresses macro hedging accounting. The IASB separated this topic from IFRS 9-Financial Instruments, which is in the final stages of development. Macro hedging manages risk on a portfolio basis rather than on individual contracts. IASB seeks input on a possible approach that revalues changes in managed risk through profit and loss. The comment deadline is October 17, 2014.
  2.  Proposed amendments to IAS 1, Presentation of Financial Statements, – issued on March 25, 2014, as part of a broader Disclosure Initiative that is designed to make disclosures more effective “instruments of communication and not simply compliance documents,” according to IASB Chairman Hans Hoogervorst. The proposal 1) clarifies materiality, 2) clarifies disaggregation of items in the financials, 3) specifies presentation of subtotals in the financials, 4) clarifies flexibility in the order of footnotes, and 5) cleans up guidance on accounting policies. The comment deadline is July 23, 2014.
  3.  Revenue Recognition and Lease Proposal Status – The proposed joint IASB-FASB standard, Revenue from Contracts with Customers, is in final drafting, but issuance has been pushed back to the second quarter 2014, to allow more time for incorporating revisions and references. The differences between the IASB and FASB on the proposed joint IASB-FASB standard, Leases, have still not been completely resolved. An April 24, 2014, joint meeting was scheduled to address some, but not all, of the issues. Consequently, the timing for finalization of the proposal is currently unclear.
  4. IFRS Research Centre – web-based resource launched on April 22, 2014, to increase awareness of issues, and to encourage engagement in research and contributions to the standard setting process by research professionals.  

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

  1.  Agreement to develop professional accountancy organizations in emerging economies – UK Department for International Development will provide funding for efforts in Asia, the Caribbean, Middle East and Africa. Infrastructure support will help to improve professional and ethical standards.
  2.  IAASB Proposes International Auditing Standard 720 (Revised), The Auditor’s Responsibility Relating to Other Information – The International Auditing and Assurance Standards Board proposal was reissued in response to significant comments that were supportive but indicated much needed clarification of auditor objectives, scope of documents and work effort. The proposal focuses responsibility on information in a company’s annual report, and requires the auditor to consider whether there are material inconsistencies with the financial statements or other knowledge obtained during the audit. A separate section of the auditor’s report would disclose findings without any opinion. Comments are requested by July 18, 2014.
  3.  Proposed Guidance - Developing and Reporting Supplementary Financial Measures—Definition, Principles, and Disclosures – The February, 2014, Exposure Draft intends to “establish a benchmark for good practice in developing and reporting supplementary financial measures to assist management, investors, and other stakeholders in understanding some aspect of an organization’s performance.” Supplementary financial measures are defined as “those financial measures not specifically identified by a GAAP framework.” An example is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Comments are due by May 26, 2014. 

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

 1. CDSB Framework 2.0 Consultation Draft – issued in February, 2014. – The Climate Disclosure Standards Board is a consortium of business and environmental organizations, whose purpose is for members to “jointly to develop and advocate an international reporting framework for use by companies when making disclosures in, or linked to, their mainstream financial reports.” Its Technical Working Group is represented by the major accounting organizations and firms. The Consultation Draft expands the original Framework’s focus on the risks and opportunities posed by climate change, to include information on water and forest risk commodities.

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

  1. Breaking out: public audit’s new role in a post crash world – report issued in February, 2014, by ACCA’s Global Forum for the Public Sector. Contributors weigh in on the future role of auditors in the public sector, emphasizing the need to be involved earlier in the process of how funds are allocated, and to be a catalyst for improvement, along with the traditional role of providing assurance and assessing accountability.
  2.  Enhancing the value of the audit committee report – report issued in March, 2014, providing examples of how company audit committees are complying with the UK Corporate Governance Code (FRC 2012), that calls for a more customized and company specific audit committee report, which also discloses the most significant financial statement issues.
  3. Understanding investors: the changing corporate perspective- report issued in February, 2014, based on a survey of 200 CFOs from Great Britain. Faster external and internal reporting is favored by investors and considered feasible, though not at the sacrifice of accuracy. 40% of those surveyed have moved forward with integrated reporting, while the rest are taking a ‘wait and see’ approach. Lower audit fees and more competition are desired, but not at the cost of audit quality.

CIMA – Chartered Institute of Management Accountants (www.cimaglobal.co)

  1. Global Management Accounting Principles Consultation Draft-released February 10, 2014, to assist CFOs and boards with assessing and enhancing management accounting principles, in order to further the success of the business. See March, 2014, Audit & Accounting Alert for details on this new resource. Comments are due by May 10, 2014.

AAA – Americas, Australia & Asia

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

  1. FASB issued Accounting Standards Update 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Issued on April 10, 2014, and effective for 2015, the ASU narrows discontinued operation reporting to only include disposals that represent a strategic shift in operations. Disclosures for discontinued operations are to have more information about the affected assets, liabilities, income and expenses. For significant disposals that do not qualify, the pre-tax income impact is to be disclosed.
  2. FASB issued Accounting Standards Update No. 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. Issued on March 20, 2014, effective for 2015, with early adoption allowed. See April, 2014, Audit & Accounting Alert for details.
  3. FASB issued Exposure Draft: Conceptual Framework for Financial Reporting: Chapter 8: Notes to Financial Statements. Issued on March 4, 2014, the ED proposes an approach to facilitate the development of effective, yet practical standards for financial statement disclosures. Comments are due by July 14, 2014. See April, 2014, Audit & Accounting Alert for details.
  4. Revenue Recognition and Lease Proposal Status – See IASB above. .

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

  1. Auditing Standards Board (ASB) –issued three interpretations to Statement on Auditing Standards No. 122: Clarification and Recodification, relating to audit evidence, and special considerations for group financials, single financials, and specific elements of a financial. These interpretations are in response to the new GASB standards that impact governmental multiple-employer pension plans and their participants.
  2. Technical Practice Aids – The AICPA Financial Reporting Center issued guidance in April, 2014, for disclosures in compilation, review and audit reports on comparative financial statements. Where, in accordance with current Private Company Council GAAP, but not in accordance with prior year GAAP, VIE’s were not consolidated, the TPA explains how the report should read.

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

  1. Cooperative Agreement with Sweden for oversight of audit firms – signed in March, 2014, allows regulators for both countries to review work of auditors subject to both jurisdictions. The PCAOB has similar agreements with the European Union countries of Finland, France, Germany, the Netherlands, Spain and the United Kingdom, as well as with Switzerland, Norway, and several regulators in North America, the Middle East, Asia and Australia.

SEC – U.S. Securities and Exchange Commission (www.sec.gov)

  1. Draft Strategic Plan for 2014-2018 – released on February 3. Under the objective that covers the establishment and maintenance high-quality financial reporting, the SEC includes an initiative to promote higher quality financial reporting worldwide and consider “whether a single set of high-quality global accounting standards is achievable.”

Europe, Middle East, India & Africa

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

  1. Proposed Revisions to UK Corporate Governance Code-Consultation Document issued in April, 2014, covering various compensation issues, the going concern basis of accounting, risk assessment and management, stating the ability to continue in business, and the monitoring and annual review and reporting on internal control systems effectiveness. Comments are due by June 27, 2014.
  2. FRED 53: Draft Amendments to FRS101: Reduced Disclosure Framework (2013/14) – issued in April, 2014, to update financial reporting disclosures consistent with IFRS issued during the past year. Comments were due by April 30.
  3.  FRED 54: Draft Amendments to FRS 102-The Financial Reporting Standard applicable in the UK and Republic of Ireland: Basic financial instruments – issued in February, 2014, to address unintended accounting consequences in relation to basic debt instruments. Comments were due by April 30.

EP – European Parliament (www.europarl.europa.eu/)

  1. Audit reforms pass in European Parliament- on April 3, 2014. See first article above.
  2. Directive on disclosure of non-financial and diversity information by large companies and groups – adopted by EP on April 15, 2014. See second 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. Caught Between A Great Wall And A Hard Place: Issues For U.S. Public Companies In Responding To Regulatory Requests For Chinese Data
  2. New XBRL GAAP Pension Analysis Tool Finds Errors in SEC Filings
  3. Turkey Cabinet Revises Its Decree On Companies Subject To Independent Audit
  4. Cyber security: the weakest link in M&A transactions
  5. US Department of Justice v KPMG: Document Shows “Too Few To Fail” Was Opening Premise
  6. The Search for Suspect Accounting

 

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