At-A-Glance

The presumption, which is often taken for granted when reading financial statements, is that a company is a going concern that will continue in business indefinitely. In recent years with the increased volatility and instability in many parts of the world, the future viability of a business is likely to come into question on a more regular basis. While auditors are charged with evaluating going concern as a standard practice, the accounting standards have lacked specific direction in this regard for the preparers of financial statements. With a newly issued pronouncement, the Financial Accounting Standards Board (FASB) spells out the responsibilities and procedures for reporting going concern under US GAAP. As our first article discloses, there remain differences with the international community as to defining and applying the issue of going concern. The contrasting roles of financial reporting and auditing are the focus of our second article as well. The new revenue accounting standard was jointly issued with profuse fanfare by the FASB and the International Accounting Standards Board in May, 2014. Accurate and effective reporting of revenue is one of the most critical and challenging areas of accounting. Reports of ongoing deficiencies in the audit of revenue are discussed along with a recap of the significant shortcomings, and examples of some fraudulent results. Finally, our quarterly Worldwide Update covers news from organizations across the globe.  Editor Gerald E. Herter, CPA

In This Issue 

• When Going Concern Becomes an Issue

  Approaches for reporting and disclosure differ across the Atlantic

• Revenue Recognition-a Persistent Challenge for Auditors

  New accounting standard draws attention to ongoing audit concern

• Worldwide Update

  Roundup of recent and upcoming actions and activities by audit and accounting organizations

• Additional A&A News

When Going Concern Becomes an Issue

Approaches for reporting and disclosure differ across the Atlantic

Assessment of an entity’s ability to continue as a going concern has always been a key requirement for auditors. However, there has been no clear guidance on the reporting and disclosure of the issue in US GAAP, as reflected in the Financial Accounting Standards (FAS). Consequently, on August 27, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The ASU clarifies that management is responsible for evaluating and disclosing substantial doubts regarding going concern. Also, the new guidance should enhance consistency in the timing and content of disclosures.

The ASU first starts with a definition of substantial doubt:

Substantial doubt about an entity’s ability to continue as a going concern exists when conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable).

Then management is charged with the responsibility for 1) performing an evaluation every reporting period, 2) considering the effect of plans for mitigation if substantial doubt is determined, and 3) disclosing pertinent information in the footnotes.

The ASU draws upon current auditing standards for the following examples that may be indicators of substantial doubt, noting that they are not all-inclusive:

1. Negative trends - such as operating losses, negative cash flow, or adverse key financial ratios,
2. Other indications - such as loan defaults, unpaid dividends, supplier credit issues, need for financial restructuring,
3. Internal matters – such as labor problems, difficulties with major projects or commitments,
4. External matters – such as litigation, legislation, key customer, supplier or licensing issues, or natural catastrophes.

Examples of management plans for mitigation, similarly drawn from the auditing standards, are also presented for consideration:

1. Plans to dispose of assets,
2. Plans to borrow money or restructure debt,
3. Plans to reduce or delay expenditures,
4. Plans to increase ownership equity.

If substantial doubt is determined, a statement should be included in the footnotes noting that there is substantial doubt in the ability of the entity to continue as a going concern for a period of one year after issuance of the financial statements. Also to be disclosed are:

1. The principal conditions or events that raise substantial doubt,
2. Management’s evaluation of the significance of those conditions or events in relation to the organization’s ability to meet its obligations, and
3. Management’s plans that have or are intended to mitigate the conditions or events that raise substantial doubt.

The ASU is generally effective for all entities with years ending after December 15, 2016, with early application permitted.

The PCAOB was quick to respond with a Staff Audit Practice Alert, No. 13, on September 22, 2014, stating that there had been no change in the already existing audit standards. “…The auditor's evaluation of whether substantial doubt exists is qualitative based on the relevant events and conditions and other considerations set forth…” in the audit standards. The financial accounting standards are not conclusive as to whether an explanatory paragraph is required. “… Auditors should make a separate evaluation of the need for disclosure in the auditor's report in accordance with the requirements of…” the audit standards.

The International Financial Reporting Standards (IFRS) appear to have a generally similar approach to going concern as does US GAAP, placing the responsibility on management to perform the evaluation and disclosure. International Accounting Standard 1 (IAS1) states that “when management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties.” However, “material uncertainties” and “significant doubt” are not defined, so different interpretations can occur. Also, the IAS includes an open-ended future period for consideration: “…at least, but is not limited to, twelve months from the end of the reporting period.”

The Financial Reporting Council (FRC) of the United Kingdom went a step further than the IAS when issuing an updated version of the UK Corporate Governance Code on September 17, 2014. When addressing going concern, the Code directs that “companies should state whether they believe they will be able to continue in operation and meet their liabilities taking into account of their current position and principal risks, and specify the period covered by this statement and why they consider it appropriate. It is expected that the period assessed will be significantly longer than 12 months.” FRC CEO Stephen Haddrill explained: “Recognising the different circumstances for business, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business. Crucially the directors should explain their reasoning to investors.”

For further information, see FASB Issues Guidance to Improve Financial Reporting of Going Concern Uncertainties and PCAOB Issues Staff Audit Practice Alert on the Auditor’s Consideration of a Company’s Ability to Continue as a Going Concern and FRC updates UK Corporate Governance Code.

Revenue Recognition-a Persistent Challenge for Auditors

New accounting standard draws attention to ongoing audit concern

Much attention has been given to the monumental new revenue accounting standard issued in May, 2014. The expectation, when the standard takes effect in the next several years, is that financial reporting will be improved significantly, by the replacement of a myriad of different accounting approaches for revenue recognition with one universal and consistent financial reporting standard that applies to public and private entities alike. As discussed in our September issue, the new Transition Resource Group is addressing implementation issues as they arise, with guidance expected at some point.

Whether financial statement audit results will improve, as a result of the new financial reporting standard, remains to be seen. Revenue misstatement has been the largest factor in financial reporting fraud for at least the latest 20 years studied, according to COSO reports analyzing SEC filings through 2007. With the substantial audit reform measures instituted by the Sarbanes-Oxley Act in 2002, the incidence of fraud would be expected to have declined in more recent years. However, an analysis reported on by professors from Bucknell University in Insurancenewsnet.com on June 10, 2014, indicated mixed and uncertain results, stating “Evidence indicates that SOX might have improved financial reporting quality, although it might not have deterred actual fraudulent behavior.” Furthermore, The Network’s 2014 Corporate Governance and Compliance Hotline Benchmarking Report indicated an increase in fraud related incidents from 2012 to 2013.

In light of these concerns and the continued significant revenue audit deficiencies observed in recent inspections, the Public Company Accounting Oversight Board (PCAOB) on September 9, 2014, issued Staff Audit Practice Alert (SAP) No. 12: Matters Related to Auditing Revenue in an Audit of Financial Statements.

In the SAP, the PCAOB discusses, in depth, areas where significant deficiencies have occurred, such as:

1. Testing the recognition of revenue from contractual arrangements.
2. Evaluating the presentation of revenue—gross versus net revenue.
3. Testing whether revenue was recognized in the correct period. For these three areas, there was a “failure to perform sufficient procedures to test whether revenue was recognized in conformity with the applicable financial reporting framework.”
4. Evaluating whether the financial statements include the required disclosures regarding revenue. The evaluation was omitted or insufficient.
5. Responding to risks of material misstatement due to fraud associated with revenue. There was a failure to address fraud risks.
6. Testing and evaluating controls over revenue. Here there was “unsupported reliance on controls over revenue because either controls were not tested sufficiently or identified control deficiencies were not evaluated sufficiently.”
7. Applying audit sampling procedures to test revenue. Testing and sampling were found to be insufficient.
8. Performing substantive analytical procedures to test revenue. These were not sufficient.
9. Testing revenue in companies with multiple locations. Testing was insufficient.

The SAP exhorts auditors to take a fresh look at the audit standards, to review their audit methodologies and how they are implemented, and to consider additional training of staff. The onus is placed on the engagement partner and senior engagement team members, as well as engagement quality reviewers, to oversee the audit team and assure that the standards are adhered to.

The Securities and Exchange Commission (SEC) has recently established an Office of Risk Assessment. The new office will provide additional data-driven tools to assist several areas, including the identification of financial reporting irregularities that may indicate financial fraud.

A couple recent examples where the SEC has uncovered fraud involving accounting for revenue include AirTouch Communications Inc. of Newport Beach, California, and AgFeed Industries of Hendersonville, Tennessee. The AirTouch case involved recognition of over a million dollars of revenue on inventory that was shipped to a Florida warehouse, but was not sold. Company executives were trying to falsely show that the company was doing better than it was, and they used that deception to get a loan. AgFeed had an operation in China that kept two sets of books. Their hog farms reported fake sales of hogs on the books provided to the auditors to make them look better The sales reportedly reflected $18 million in false profits. The correct set of books was hidden from the auditors.

For further information, see Staff Audit Practice Alert No. 12: Matters Related to Auditing Revenue in an Audit of Financial Statements

Worldwide Update

Roundup of recent and upcoming actions and activities by audit and accounting organizations

Periodically, we summarize significant items impacting the accounting world.

International

IASB – International Accounting Standards Board (www.ifrs.org)

1. Discussion Paper - Reporting the Financial Effects of Rate Regulation – issued September 17, 2014, addresses whether ‘defined rate regulation,’ a method which contains elements of cost recovery and incentive approaches, adequately addresses the primary financial effects of rate regulation. IASB seeks input on this issue and whether any resulting proposals should be dealt with in IFRS 14, Regulatory Deferral Accounts. The comment deadline is January 15, 2015.
2. Exposure Draft - Measuring Quoted Investments in Subsidiaries, Joint Ventures and Associates at Fair Value (Proposed amendments to IFRS 10, IFRS 12, IAS 27, IAS 28 and IAS 36 and Illustrative Examples for IFRS 13) – published September 16, 2014, to clarify that an entity should measure the fair value of quoted investments and quoted cash-generating units as the product of the quoted price for the individual financial instruments that make up the investments held by the entity and the quantity of financial instruments. Comment period ends January 16, 2014.
3. IAS 10 and IAS 28 amendments – published September 11, 2014, clarify an inconsistency between the two IFRS by requiring that a full gain or loss be recognised when a sale or contribution transaction between an investor and its associate or joint venture involves a business, and that a partial gain or loss be recognised when such a transaction involves assets that do not constitute a business. Effective generally for years beginning in 2016.
4. Exposure Draft - Recognition of Deferred Tax Assets for Unrealised Losses (Proposed amendments to IAS 12) – published August 20, 2014, proposes guidance that clarifies how to account for deferred tax assets related to debt instruments measured at fair value. Comment period ends December 18, 2014.

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

1. Developing and Reporting Supplementary Financial Measures—Definition, Principles, and Disclosure, - International Good Practice Guidance – published September 22, 2014, offers suggestions for a standardized set of supplementary financial measures beyond what GAAP requires, to enhance financial reporting. These measures should reflect the same qualitative characteristics that the IASB and FASB have established in the Conceptual Framework for Financial Reporting.
2. International Ethics Standard Board for Accountants (IESBA) Exposure Draft - Proposed Changes to Certain Provisions of the Code Addressing the Long Association of Personnel with an Audit or Assurance Client – published August 14, 2014, proposes changes aimed to enhance the independence provisions in the Code of Ethics for Professional Accountants by 1) strengthening general provisions applicable to all audit engagements regarding the threats created by long association; 2) increasing the mandatory “cooling-off” period in partner rotation, from two to five years, for the engagement partner on the audit of a public interest entity; 3) strengthening restrictions on the type of activities that can be undertaken with respect to the audit client and audit engagement by any former key audit partner during the cooling-off period; and 4) requiring the concurrence of those charged with governance regarding the application of certain exceptions to the rotation requirements. Comment period ends November 12, 2014.

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

1. Realizing the Benefits: The Impact of Integrated Reporting – research study published in September, 2014, in partnership with Black Sun Plc. Survey results from 66 companies participating in the IIRC Pilot Program for Integrated Reporting. Results showed highly positive feedback in areas of 1) breakthroughs in understanding value creation, 2) improving what is measured, 3) improving management information and decision making, 4) a new approach to shareholder relations, and 5) connecting departments and broadening perspectives.
2. Corporate performance: What do investors want to know? – research study published in September, 2014, by Pwc showing that 63% of investment professionals agree that “disclosure in an annual report about strategy, risks and opportunities and other value drivers can have a direct impact on a company’s cost of capital.

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

1. China’s next 100 global giants – report issued in September, 2014, describing the characteristics of emerging Chinese companies, to provide finance professionals insights into this dynamic marketplace.
2. Financial insight: challenges and opportunities – joint report with IMA issued in September, 2014, suggesting “ways the finance function can improve current approaches to business partnering. It proposes nine pragmatic actions to improve partnering practices anchored in three core component parts: creating the mandate, fixing the information and deploying the talent.”
3. A risk challenge culture - joint report with IMA issued in August, 2014, encouraging an environment of questioning throughout an organization. The elements discussed include professional skepticism and board oversight of risk; board diversity and expertise development in enterprise risk management (ERM); conversations and roles in a risk challenge culture; information asymmetry and risk reporting; decision making and cognitive biases; risk culture –assessment, diagnostics, and signs; risk appetite; strategy and risk; and incentives and risk.

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

1. Using analytics to reduce days sales outstanding – report issued in September, 2014, by Infosys in association with CIMA, “alerts finance professionals to new ways of using data to improve cash flow and ensure the value of the organization is maintained.”
2. Tomorrow's Relationships - Unlocking value – report issued in August, 2014, in partnership with KPMG, CIMA, CIPD and Linklaters, “seeks to recognize the full value of relationships. It provides a practical resource for boards and senior management teams to help them map the relationships of their business, understand how and why they are important, and help them decide what to do next.”

AAA – Americas, Australia & Asia

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

1. Exposure Draft - Technical Corrections and Improvements - issued September 15, 2014, provides minor amendments to the Codification that will correct, clarify, simplify and improve various sections without making any significant changes to the standards. The comment period ends December 1, 2014.
2. Presentation of Financial Statements—Going Concern ASU 2014-15: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern – issued August 27, 2014. See the first article above.
3. Exposure Draft - Intangibles—Goodwill and Other—Internal-Use Software - Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement - issued August 20, 2014, addresses whether a cloud computing arrangement includes a software license. If it does, the software license is accounted for consistent with other software licenses. If it doesn’t, the arrangement is accounted for as a service contract. The comment period ends November 18, 2014.
4. Receivables—Troubled Debt Restructurings by Creditors ASU 2014-14: Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure- issued August 8, 2014, requires that government guaranteed mortgage loans be derecognized and recorded as separate other receivables upon foreclosure at the expected recovery amount, if the creditor intends to convey the property to the guarantor and a fixed amount is determined and recoverable. Effective generally for years beginning in 2015.
5. Consolidation ASU 2014-13: Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity – issued August 5, 2014, addresses how to measure assets and liabilities of entities such as collateralized debt obligations (CDO) and collateralized loan obligations (CLO). Effective generally for years beginning in 2016. 

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

1. Auditing Standards Board (ASB): 
   1. Exposure Draft - Reporting on an Examination of Controls at a Service Organization Relevant to User Entities’ Internal Control Over Financial Reporting: Clarification and Recodification - issued September 18, 2014, provides further conformity of the attestation standards as part of the clarity project. Comments are due by December 18, 2014.
   2. Exposure Draft - An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements - issued September 10, 2014, reorganizes standards by moving attestation standard for internal control into the audit standards. Comments are due by December 10, 2014.
2. Enhancing Audit Quality, Plans and Perspectives for the U.S. CPA Profession – Discussion paper issued August 7, 2014. See September, 2014, Audit & Accounting Alert article for details.

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

1. Staff Audit Practice Alert No. 13 –Matters Related to the Auditor’s Consideration of a Company’s Ability to Continue as a Going Concern- issued September 22, 2014. See the first article above.
2. Staff Audit Practice Alert No. 12 - Matters Related to Auditing Revenue in an Audit of Financial Statements - issued September 9, 2014. See the second article above.
3. Staff Consultation Paper: Auditing Accounting Estimates and Fair Value Measurements, issued August 19, 2014, seeks input “on current audit practice, the potential need for changes to PCAOB standards, and possible alternative actions related to auditing accounting estimates and fair value measurements, as well as derivative instruments and securities.” Details of a comprehensive staff-developed potential new standard are presented. Comments are due by November 3, 2014.

EMEIA – Europe, Middle East, India & Africa

EFRAG – European Financial Reporting Advisory Group (www.efrag.org)

1. The Role of the Business Model in Financial Statements Research Paper –Feedback Statement published September 4, 2014. Responses revealed general support for the paper’s view “that accounting standards should mandate financial reporting that faithfully represents the business model” and “that the business model should play a role in financial reporting, including financial statements.” However, there was a diversity of opinion as to how to accomplish that goal. The Conceptual Framework process is a place that the issue could be developed.
2. Separate Financial Statements – Discussion Paper issued September 1, 2014, addressing issues of separate financial statements that IFRS does not adequately cover, since IFRS focuses on consolidated financial statements. Comments are due by December 31, 2014.

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

1. Updates UK Corporate Governance Code- issued September 17, 2014. See first article above.
2. Accounting standards for small entities - Implementation of the EU Accounting Directive – Consultation Document issued September 1, 2014, proposing new, simpler financial reporting standards for micro-entities (annual turnover less than £632,000) (FRSME), and revisions to the financial reporting standards for unlisted entities (FRS 102) to include small entities (annual turnover less than £10.2 million), however with more straightforward presentation and disclosure requirements. Comments are due by November 30, 2014.
3. Exposure Draft: FRED 55 Draft Amendments to FRS 102 – Pension obligations – issued August 20, 2014, to clarify that UK and Irish GAAP would not include IFRS complexities regarding certain liabilities and surplus. Comments are due by November 21, 2014.
4. Amendments to FRS 101: Reduced Disclosure Framework (2013/14 Cycle) – issued July 23, 2014, to improve and ease the reporting of hedge accounting and the classification of certain financial instruments. Effective January 1, 2015.

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

1. Directive of the European Parliament and of the Council as regards disclosure of non-financial and diversity information –adopted September 29, 2014, “will require certain big EU companies to draw up, on a yearly basis, a statement relating to environmental, social and employee-related matters, respect for human rights, anticorruption and bribery matters. The statement will have to include a description of the policies, outcomes and the risks related to those matters.

Additional A&A News 

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

1. PCAOB may consider different mechanism for naming engagement partner
2. Spanish profession demands end to anti-competitive practices in audit tenders
3. Surge in auditor warnings for Australian ASX-listed companies
4. Dispatches From the Front on COSO Implementation
5. At Tesco everyone is at fault and no one to blame
6. India to have IFRS-compliant accounting standards by December

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: [email protected]