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Audit & Accounting Alert Newsletter

Issue 8 | September 2014

At-A-Glance

Gerry Herter

With the prospects of a single set of worldwide financial reporting standards no longer a priority, the FASB and IASB are moving forward, but not always on the same path. Displaying solidarity for the new monumental revenue accounting standards, the IASB/FASB Joint Transition Resource Group has begun work, as has the AICPA. Initial efforts are summarized in our first article.

In contrast to those efforts, long, protracted attempts to converge lease and financial instrument reporting have found the two boards parting ways. Our second article reports that while their individual approaches move in similar directions, the results are different.

Finally, in our third article we return to the ongoing push for enhanced audit quality. With initiatives from several sources targeting the audits of public companies, the AICPA has turned its attention to private companies, with a new discussion paper addressing both auditors and their peer reviewers.

Editor Gerald E. Herter, CPA

In This Issue 

Revenue Recognition Standard – Early Issues and Resources

The long rollout begins

After taking fourteen years to reach agreement about revenue accounting, the FASB and IASB anticipated that questions would arise, even allowing for three years prior to implementation. Elimination of the multitude of detailed, industry-specific rules, will also add to the challenge. Consequently, a joint Transition Resource Group (TRG) was established to assist with addressing issues as they arise. Also, the AICPA has moved quickly to create an online presence of helpful implementation resources within its Financial Reporting Center.

The new standard is technically not effective until 2017 for public companies and 2018 for nonpublic companies. However, if full retrospective application is elected, years as early as 2015 will need to be presented on a comparative basis in the year of adoption.

The aids on the AICPA website can facilitate the transition. Task forces for sixteen industries have been set up to coordinate discussions of application issues, as well as to develop new industry-specific accounting guides. Along with links to articles and educational opportunities, the following documents are now available:

  1. Financial Reporting Brief: Roadmap to Understanding the New Revenue Recognition Standards -provides guidance that follows the five step process of the revenue recognition model, and describes the minor differences from IFRS 15.
  2.  New Revenue Recognition Accounting Standard—Learning and Implementation Plan - is a detailed roadmap of what needs to be accomplished, and when, along with references to other resources that can be employed.
  3.  Brief: Revenue Recognition Primer for Audit Committees - is a short summary of considerations for audit committees.
  4.  Financial Reporting Brief: Tax Effects of ASU 2014-09 - while not having all the answers yet, provides a list of questions and areas that companies should be looking at, as well as the possibility of requesting a change in the tax accounting method to conform more closely with the standard.

Meanwhile, the TRG will seek out, consider and discuss implementation issues, but will not release authoritative interpretations on its own. If needed, the FASB and IASB will act on implementation matters requiring additional attention.

The TRG held its first meeting on July 18, 2014. The four main issues presented at this meeting were:

  1.  Gross versus net revenue
  2.  Gross versus net revenue: amounts billed to customers
  3.  Sales-based and usage-based royalties in contracts with licenses and goods or services other than licenses
  4.  Impairment testing of capitalized contract costs.

Discussions on these topics centered around the following:

  1. The gross versus net revenue issue has to do with whether the entity is a principal or agent with regards to the goods or services provided. For items such as gift cards or video gaming, questions arise as to what extent the principal or agency relationship applies, how to allocate the transaction price in mixed situations, and how to gross-up net amounts.
  2.  Certain amounts billed to customers, such as shipping and handling fees, reimbursements of other out-of-pocket expenses, and taxes or other assessments, may or may not be included in the transaction price, depending on whether they are collected on behalf of third parties.
  3.  Royalty contracts that bundle licenses with other goods or services, such as training, support or equipment, need clarification as to when and how to apply the royalty revenue.
  4.  Where renewal or extension periods are part of a contract, the question was presented as to whether the revenue expected from such periods should be considered in the impairment testing of the capitalized costs.

The next meeting of the TRG is scheduled for October 31, 2014. Between now and then, the FASB and IASB will be informed of the discussions on the above issues, and may or may not have further input on them at that time. Other issues that have arisen in the meantime will also be considered for discussion at the October meeting.

For further information, see FASB and IASB Joint Transition Resource Group for Revenue Recognition and AICPA Revenue Accounting Resources


Leasing and Financial Instruments: Where Convergence Failed

Conceptual agreement thwarted by methodology

As was the case with revenue accounting, the IASB and FASB struggled for years to work out their differences when reforming lease and financial instrument accounting. But while consensus triumphed in the former, frustrating divergence has been the result with the latter. However, since both boards agree on the overarching goals in each case, that commonality may prove beneficial in the long run, despite the impact of the differing methodologies.

A key objective in lease accounting reform was to reflect most leases on the balance sheet, showing both the asset and the related liability, rather than have this information relegated to the footnotes, as is currently done. Both boards will accomplish this goal, while also agreeing to exempt lease of 12 months or less. But their currently proposed models for achieving the objective, and the corresponding profit impact, will differ.

The FASB has thus far retained the proposed two model approach for lessees that both boards had embraced in the 2013 exposure draft. Under this approach, leases, which current accounting considers capital or purchase leases, would have the right-of-use portion of the balance sheet asset amortized as an expense using a straight line basis. The financing portion of the balance sheet liability would produce a separately reported interest expense. Leases currently considered operating leases would have the periodic lease costs amortized as a single expense using a straight-line method.

The IASB approach considers all leases the same, using a one model approach. The lease costs would all be reported in a similar fashion as the FASB capital or purchase leases with both amortization and interest expenses reported on the income statement.

For financial instrument accounting, the recent financial crisis spotlighted the need to report expected loan impairment losses sooner. That objective differed from the prevailing standard, which required loan losses to be recorded only when incurred and measurable. The old standard, while taking longer to report losses, did serve to deter the practice of smoothing earnings. Using that practice in good years, some companies would be tempted to overstate loan loss reserves, so that in bad years loan losses could be understated by merely reducing the prior established reserves, thereby distorting the true earnings picture in any given year.

The new loan loss proposals by both boards would accelerate the reporting of the impact of problem loans. However, the methodologies differ.

The FASB model would record, at the start of the loans, the expected loan losses for the whole life of the loans. Since the precise future results would not be known when loans were originated, past experience could be considered, such as the kind employed when an operating company evaluates the anticipated proportion of bad debts on accounts receivable. Such experience would be tempered with a forward looking approach that considered differing current economic conditions or other future dynamics that could be expected to have an effect.

The IASB model, which was finalized with the issuance of IFRS 9, Financial Instruments, on July 24, 2014, would require recording initially, only the proportion of anticipated losses on loans that would relate to the first twelve month period. However, if future conditions indicated a deterioration of certain loans, then at that time, the loan loss expectation for the entire life of the loan would be recorded.

While the approaches to the two standards will require an element of discernment for both boards, the financial instruments proposals will require a significant exercise of judgment under either scenario, considering the uncertainty involved in future estimations.

For further information, see Leases see Financial Instruments


Enhancing Audit Quality of Private Entities

AICPA discussion paper weighs in

The PCAOB and the Center for Audit Quality, as well as international bodies, have been seeking a formal approach to address the need for better public company audit results, as reported in our May and June issues of the Audit & Accounting Alert. Now the AICPA, on August 7, 2014, has issued a discussion paper, Enhancing Audit Quality, Plans and Perspectives for the U.S. CPA Profession, that focuses on audits of privately owned entities.

With release of the discussion paper, AICPA President Barry Melancon stated “EAQ is a holistic effort to consider auditing of private entities – including private companies, not-for-profit organizations, employee benefit plans and governmental entities – through multiple touch points, especially where quality issues have emerged. Many AICPA committees, boards and staff contributed to the EAQ. The goal is to align the objectives of all audit-related AICPA efforts and collectively improve the quality of audit services delivered by the profession.”

The paper proposes a near-term and longer term approach. In the near term, initiatives already approved or planned will immediately address areas of the current peer review and practice monitoring standards that need improvement. In the longer term, the paper seeks a “transformation of the current peer review program for firms’ accounting and auditing engagements into a practice monitoring process that marries technology with human oversight, and makes a closer, more real-time connection among a firm’s accounting and auditing engagements, the AICPA and the individuals performing the practice monitoring.”

The paper organizes the efforts into five areas, as more fully described below:

  1. Competence and Due Care
  2.  Auditing and Quality Control Standards
  3.  Guidance, Tools, Learning and Resources
  4.  Practice Monitoring (Peer Review)
  5.  Ethics Enforcement

1. Competence starts with continually evaluating and updating the CPA exam, so that it retains relevance and responds to the quickly changing business environment. For practicing CPAs, the AICPA Code of Professional Conduct stresses integrity and excellence as guiding virtues for maintaining competence and exercising due care, including recognition of the limits of one’s capabilities.

2. The usage of the auditing standards will be monitored and necessary revisions and additional assistance will be provided. Audit deficiencies will be identified and better understood. Added specificity of quality control standards will also be considered.

3. All aspects of instruction will be upgraded, with an emphasis on areas where difficulties are experienced. A robust competency framework will be issued. Additional resources will be developed in response to peer review concerns.

4. The peer review process will be overhauled to be more preventative of audit problems, by responding on a continual basis rather than after the fact. In the near term, several initiatives will be pursued. Peer review procedures will be beefed up for risky and complex areas. Low-volume auditors with material deficiencies in these areas will be required to have pre- or post-issuance reviews and closer supervision by a new body. Evaluations between peer reviews will be called for when new industries are entered. A credible system for identifying the population of firms and engagements subject to peer review will be developed. Peer review reports will be more meaningful. Qualifications for peer reviewers will be strengthened, and speedier discipline will be initiated for sub-standard peer reviewers.

5. Enforcement measures will be enhanced by employing various accessible resources for detecting deficient audits, requiring corrective actions, and disciplining firms that circumvent the process of selection for engagements that fall under the purview of peer review.

Feedback is requested by November 7, 2014 to EAQ@aicpa.org.

Despite the significant changes that have already taken place in audit processes and techniques, spurred on by Enron and the financial crisis, the culpability of the auditors is still up for question by some. (See Holding Auditors Blameless, in our Additional A & A News below). The public company auditor initiatives hope to achieve better results by focusing on more in depth content and transparency in audit reporting, while the European Parliament has even gone so far as to enact harsh auditor rotation and service restriction legislation The AICPA proposals for private company auditors are also specific in nature, which should facilitate implementation and scrutiny.

For further information, see Enhancing Audit Quality Initiative


Additional A&A News 

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

  1. Holding Auditors Blameless
  2. PCAOB: Deficiencies Continued in 2013 Broker-Dealer Audits
  3. Ethics Board Aims to Strengthen Auditor Independence during Long Client Associations
  4. UK - One in seven FTSE 350 companies to tender audit in 2014
  5. Alibaba unit finds possible accounting irregularities
  6. PwC Fined $25 Million for Altering Client Bank Report to Regulators

 

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