Audit & Accounting Alert Newsletter

Issue 8 | October 2013

At-A-Glance

Gerry Herter

Integra International was honored to host a representative from the International Accounting Standards Board (IASB) at the June regional conference held in Bristol, England. The presentation of current IASB initiatives provided timely input to the expanding worldwide member base of Integra. Our first article highlights topics covered along with subsequent developments. Then in our second and third articles, we address the call for changes that address the declining relevance and credibility of the auditor’s report and financial statements. In recent and proposed directives, auditors are expected to describe major areas of audit focus and details of the audit process, while companies need to address non-financial factors that will impact long term sustainability.

Editor Gerald E. Herter, CPA

In This Issue 

IASB Activities Update

International Board Implementation Director Reports at Integra Conference

At the annual spring meeting of Integra International’s regional section that serves Europe, the Middle East, India and Africa (EMEIA), Michael Stewart, Director of Implementation Activities at the IASB, presented a comprehensive look at the current work and plans of the global accounting standard setter. Stewart’s appearance grew out of a meeting with Integra Global Board members Mark Saunders and Steve Austin at the IASB headquarters in London last November. Stewart gave a brief review of the IASB structure and process, and then looked at the status of IFRS adoption, the IASB work plan, IFRS interpretations, and IFRS for SMEs.

As reported in our August issue, of the 66 jurisdictions that had completed profiles with the IASB at that time, 95% were committed to supporting IFRS, 80% had adopted IFRS for public companies, few temporary, local modifications were made, and over 50% had adopted IFRS for SMEs or planned to. The remaining 15 jurisdictions in the European Economic Area that Stewart referred to, subsequently submitted profiles, bringing the total number of completed profiles to 81, raising the IFRS support numbers to 96% committed and 85% adopting IFRS for public companies. Also, the goal is to have about 50 more countries, including the remaining IFAC members, post profiles by the end of the year. Of the 15% of the 81 profiled jurisdictions that have not yet adopted IFRS, the most notable are Japan, the United States, China, India, Pakistan and Indonesia. Those countries represent about half of the world’s population.

The IASB work plan is subjected to an agenda consultation every three years that strives to balance improvement of the standards, through issuance of new IFRS, with maintenance of the standards, through implementation practices. Post implementation reviews are conducted when appropriate, as well as efforts to identify needed improvements. 

A high priority indicated from the consultation called for an update of the conceptual framework. Following Stewart’s report, the IASB on July 18 issued a Discussion Paper: A Review of the Conceptual Framework for Financial Reporting (DP). The DP states that the Conceptual Framework “sets out the concepts that underlie the preparation and presentation of financial statements. The IASB’s preliminary view is that the primary purpose of the Conceptual Framework is to assist the IASB by identifying concepts that it will use consistently when developing and revising IFRSs.” 

The current Conceptual Framework was found to not cover certain important areas, while guidance for others was unclear or out of date. Consequently, the DP focuses on these areas, which include (a) definitions of assets and liabilities; (b) recognition and derecognition of assets and liabilities; (c) measurement; (d) equity; (e) profit or loss and other comprehensive income (OCI); and (f) presentation and disclosure.  

Originally, this project was jointly begun by the IASB and FASB in 2004, with eight separate phases anticipated. Early phases resulted in the issuance of two chapters in 2010 covering the objective of general purpose financial reporting and qualitative characteristics of useful financial information. Though further work was underway, the joint project was suspended in 2010 in deference to more pressing projects. In restarting the project on its own, the IASB plans to produce a set of proposals that will update, improve and fill out the existing Conceptual Framework in one undertaking without phases, so as to facilitate correlations between the sections.

Emphasizing the importance of the Conceptual Framework, Hans Hoogervorst, Chairman of the IASB said in the press release announcing the DP: “The Conceptual Framework underpins the work of the IASB and affects all IFRS that we develop.  This Discussion Paper gives people the opportunity to help us to shape the future of financial reporting by discussing the concepts that drive our work.” 

Of the major joint standard projects mentioned in Stewart’s presentation, final IFRS are expected in the third quarter for revenue recognition and hedge accounting, exposure drafts are now out for leases and insurance contracts, and deliberations continue on the other aspects of financial instruments. Narrow scope amendments and research are also in process for a variety of standards and topics, as is work on post-implementation reviews and interpretations. 

The goal and applicability of IFRS for SMEs was discussed. Characterized as “good financial reporting made simple,” IFRS for SMEs, issued in 2009, was built on an IFRS foundation that was simplified by 1) omitting IRFS topics irrelevant to private entities, 2) including only the simpler of multiple options, 3) simplifying recognition and measurement, 4) reducing disclosures, and 5) simplifying financial report drafting. To further assist the application of IFRS for SMRs by the smallest of entities, the anticipated guidance for those micro-sized entities was subsequently issued on June 27.

For further information, see International Accounting Standards Board


Major Auditor Report Changes

New laws are enacted in the UK and proposed in the USA and internationally

While judgment plays a significant role during an audit, the resulting auditor’s report in recent times has been pretty cut and dry. The entity, auditor, and financial reports are identified, the standards employed are stated, and the resulting opinion (unqualified, qualified, adverse, or disclaimer) is declared. However, with recent actions by Britain’s Financial Reporting Council (FRC), and proposals in the works by the International Auditing and Assurance Board (IAASB), and the United States’ Public Company Accounting Oversight Board (PCAOB), judgment will have a more prominent part in determining what additional content to include in the report. While a predominant goal in all cases is to provide more information about significant issues to investors and other financial report users, each organization has a slightly different approach. 

On August 13, the PCAOB issued two proposals. The first, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, would require:

  • the communication of critical audit matters as determined by the auditor;
  • the addition of new elements to the auditor's report related to auditor independence, auditor tenure, and the auditor's responsibilities for, and the results of, the auditor's evaluation of other information outside the financial statements; and, 
  • enhancements to existing language in the auditor's report related to the auditor's responsibilities for fraud and notes to the financial statements.

The second, The Auditor's Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor's Report, would:

  • Apply the auditor's responsibility for other information specifically to a company's annual report filed with the Securities and Exchange Commission; 
  • Enhance the auditor's responsibility with respect to other information by adding procedures for the auditor to perform in evaluating the other information based on relevant audit evidence obtained and conclusions reached during the audit; 
  • Require the auditor to evaluate the other information for a material misstatement of fact as well as for a material inconsistency with amounts or information, or the manner of their presentation, in the audited financial statements; 
  • Require communication in the auditor's report regarding the auditor's responsibilities for, and the results of, the auditor's evaluation of the other information.

On July 25, the IAASB issued an Exposure Draft, Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing (ISAs), that would require:

  • prominent placement of the auditor’s opinion and other entity-specific information in the auditor’s report; 
  • auditor reporting on “Key Audit Matters;” 
  • auditor reporting on going concern; 
  • auditor reporting on other information in documents containing audited financial statements; 
  • an explicit statement that the auditor is independent of the entity and has fulfilled the auditor’s other relevant ethical responsibilities, with disclosure of the source(s) of those requirements;
  • Disclosure of the name of the engagement partner;
  • Improved description of the responsibilities of the auditor and key features of the audit. 

While supportive of the IAASB’s work, the FRC has already taken action. On June 4, the FRC issued a revised standard, ISA 700 (UK and Ireland) "The Independent Auditor’s Report on Financial Statements,” which requires auditors to:

  • Describe the risks that had the greatest effect on: the overall audit strategy, the allocation of resources in the audit, and  directing the efforts of the engagement team;
  • Provide an explanation of how they applied the concept of materiality in planning and performing the audit.
  • Provide an overview of the scope of the audit, showing how this addressed the risk and materiality considerations;

This new standard followed the issuance of a previous ISA revision in September/October, 2013, that required:

  • Audit committees to report their activities, including on their communication with the auditor, to the board;
  • Boards to describe the work of the audit committee in the annual report;
  • The auditor to inform the audit committee about significant audit judgments; and
  • The auditor to report if the board’s disclosures do not address the matters it communicated to the audit Committee.

 These proposals and actions seek to give users insights into those areas where the auditors focused their attention. Using terms like “critical audit matters,” “key audit matters,” “risks that had the greatest effect,” they emphasize specifically where the user may want to be concerned, in case such information was not apparent from a reading of the financials. They all call for expanded content about auditor responsibilities, with the IAASB and FRC asking for even more specifics about aspects of the audit process. Also, reporting of auditor assessments of information included elsewhere, such as in the annual report, is expanded.

Whether this added information enhances the user’s ability to assess the audited entity remains to be seen. The credibility of the audit and the auditor’s report has taken a beating in recent years amidst the financial crises and audit failures. Users are seeking other means of evaluating companies. So the changes may be warranted in hopes of restoring the relevance and perceived usefulness of the audit.

There is also a concern of the impact on potential legal liability. The possibility exists that the auditor will be held liable if a subsequent problem develops in an area that had not been addressed as significant in the audit report. However, the expanded reporting may also provide greater protection by shedding specific light on areas that may not have been obvious to the user.

The comment periods for the IAASB and PCAOB proposals end November 22 and December 11, respectively. The FRC also issued an Invitation to Comment, for input prior to its submission of a response to the IAASB, as to the relationship of the FRC pronouncements to the IAASB proposal.

For further information, see PCAOB Proposes a New Auditing Standard and International Standards on Auditing and FRC issues revised auditing standards


Sustainability Focus in Financials Offers Long-Term Benefits

Healthcare sector first to receive standards of sustainability reportings

In our September 2012 issue, we mentioned that the American-based Sustainability Accounting Standards Board (SASB) planned to design industry-specific ESG (environmental, social and governmental) standards that can be adapted for inclusion in the risk factors section of SEC 10-k reports. On July 31, the SASB issued the first of those provisional standards for six industries in the healthcare sector, one of ten sectors and 88 industries that the Board intends to address in the next two years. While companies are not required to apply these specific standards, securities regulations do require “that companies describe known trends, demands and uncertainty that have a material impact on financial results.” “Material” is defined by the U.S. Supreme Court as “presenting a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.”

The SASB designed the standards to provide a consistent and measurable means for companies to present comparable information. The healthcare industries covered by the standards include biotechnology, pharmaceuticals, medical equipment and supplies, health care delivery, health care distribution, and managed care. A universal set of 40-plus ESG issues was established in the five broad areas of environment, social capital, human capital, business model & innovation, and leadership & governance. Then they were adapted for each industry. For example, product quality and safety is an issue that is listed under the area of business model & innovation. For the biotechnology industry, an applied issue of that type is drug safety & side effects. A couple measurable “metrics” could be fatalities and recalls with regards to company products.

While the SASB produces industry standards, Britain’s FRC, in recent legislation, begins to require large companies, with years starting after September, to include in their annual reports an analysis of key non-financial performance indicators relating to environmental and employee matters, that are necessary for an understanding of the business. For public companies, that analysis is expanded to include future trends and factors that are likely to affect the business with regards to “(i) environmental matters (including the impact of the company’s business on the environment), (ii) the company’s employees, and (iii) social, community and human rights issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies.”

The AICPA has taken a broader approach with its Enhanced Business Reporting Consortium (EBRC) initiative. Within the Sustainability Reporting and Assurance section of that initiative, a June 2013 white paper covers “The Economics of Sustainability Initiatives.” While acknowledging the importance of specific measures to report relationships between financial and nonfinancial performance, the white paper calls for a longer range view. This approach may help to overcome the short-sighted mentality that lives and dies by quarterly earnings reports. By grasping the implications underlying the ESG data reported, a company will be better positioned to produce a strategy that enhances the ability to create sustainable value in a manner compatible with the world around it.

Supporting this position, the white paper refers to the Edelman Trust Barometer which “tells us that in 2008 operational excellence drove corporate reputation. In 2013, operational excellence is near the bottom of the Edelman Trust Barometer list of attributes that form the basis for trust, falling below other societal concerns such as “has ethical business practices,” “treats employees well,” and “addresses society’s need in its everyday business.” The Edelman Trust Barometer is a survey of 31,000 respondents worldwide, by Edelman, the world’s largest public relations firm, which measures trust in institutions, industries and leaders.

As the white paper concludes, a company needs to “balance the imperative for long term viability—for both shareholders and society—with demands for short term competitiveness and profitability. Sustainable strategies are the only way a business can create value in ways that benefit the interests of shareholders and society.”

The issue of sustainability does not only affect large companies and Big 4 accounting firms. A recent survey by the International Federation of Accountants (IFAC) indicates that local accounting firms have service opportunities in this arena, and that many are already involved. Commenting on the survey, Small- and Medium-sized Accounting Practices (SMP) Committee Chair Giancarlo Attolini stated: “The widespread provision of sustainability services suggests that small businesses are increasingly recognizing the tangible benefits of operating more sustainably. This, in turn, seems to be fueling a desire to seek advice from their professional accountants. SMPs can help their SME clients in many ways, for example, advising on the costs and benefits of behavioral changes aimed at reducing waste, appraising potential investments in alternate sources of energy, and assisting with the implementation of an environmental management system (EMS). This is a large and growing area of demand that SMPs need to be prepared to meet.”

For further information, see Sustainability Accounting Standards Board and Financial Reporting Council Regulations 2013 and Enhanced Business Reporting Consortium


Additional A&A News

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

  1. FASB to improve Financial Reporting for Development Stage Entities
  2. IASB chair states case for leases on balance sheets
  3. Why SEC let Lehman Brothers Execs off the Hook
  4. FRC fines Deloitte 14 million pounds over MGR over advice
  5. Accounting profits adjusted to satisfy information hungry market
  6. New India Companies Act draft rules put a cap on term of auditors

 

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