At-A-Glance
With the ongoing global financial
turmoil, a number of governmental and industry bodies have
been weighing in with proposals and actions intended to
strengthen the quality of accounting and auditing. In this
issue, we look at four of them. COSO, the American based
author of the industry standard for designing and assessing
internal controls, has an update in the works for its 20
year old framework, while the international accountancy
body, IFAC, is producing a guide focused on evaluating and
improving organizational controls. Meanwhile, the European
Commission has issued controversial proposals directed at
auditors, and the PCAOB continues to find audit failures
in Big 4 inspections, while it considers responses to its
Concept Release on Auditor Independence and Audit Firm Rotation.
For a summary of other accounting highlights from 2011,
see
CFO.com�s Best of 2011: Accounting
Editor Gerald E. Herter, CPA
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In This Issue
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Welcome to the initial edition
of the Integra International Audit & Accounting Alert. This
new newsletter will 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. We encourage
your suggestions and comments as we proceed. Let us know
how to make this communication as useful as possible.
COSO Internal Control Update
Twenty Year Old Benchmark Modernized
The Committee on Sponsoring Organizations of
the Treadway Commission (COSO) is an American private
sector group providing leadership and guidance to
help organizations reduce fraud and operate more
efficiently through the issuance of formal frameworks
for internal control and risk management. The five
members are the AICPA, AAA, FEI, IMA and IIA. The
original internal control framework was issued in
1992. Since then, there have been monumental changes
in organizational, technological and global complexities.
The aim of the Exposure Draft, Internal Control
� Integrated Framework, is to clarify concepts and
facilitate the development of internal controls
in light of the current environment, while retaining
the still pertinent core definition and five overall
components of internal control: control environment,
risk assessment, control activities, information
and communication, and monitoring activities. The
more generalized components are codified into specific
principles and attributes to make them more accessible,
both for design and development purposes, as well
as for assessing effectiveness.
Organizational objectives are presented in the
three categories of operational, reporting and compliance
to offer further focus for applying the seventeen
principles underlying the components. The principles
are fleshed out in the more than eighty attributes
that detail explicitly what is needed. For example,
the first principle under Control Environment is:
The organization demonstrates a commitment to integrity
and ethical values. The four attributes called for
under this principle in the internal control design
are:
- Sets the tone at the top;
- Establishes standards of conduct;
- Evaluates adherence to standards of conduct;
and
- Addresses deviations in a timely manner.
The first attribute �Sets the tone at the top�
is delineated with several paragraphs elaborating
on leading by example, expectations, behavior, guidance
and direction, as well as listing types of documents,
such as mission statements and codes of conduct,
where the attribute can be addressed. Judgment is
still of prime importance in the establishment and
evaluation of the internal control system, as is
the heightened expectation in recent times of knowledgeable
and attentive governance oversight and formalized
management accountability. While current developments,
such as technological advances are addressed in
detail, the framework strives to avoid getting overly
tied to current applications that may soon become
outdated. Comments on the Exposure Draft are encouraged
for submission by March 31, 2012.
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IFAC Good Practice Guidance
Evaluating and Improving Internal Control in Organizations
The International Federation of Accountants (IFAC) is
the global organization for the accountancy profession,
whose membership consists of the national accounting bodies
from countries throughout the world, and which established
the independent International Auditing and Assurance Standards
Board (IAASB). IFAC promotes the furtherance of high quality
standards, as well as the leadership role and value of the
accountancy profession.
The aim of the Exposure Draft, Evaluating and Improving
Internal Control in Organizations, �is to establish a benchmark
for good practice in maintaining effective internal control�
and for �continuous improvement.� It is geared to �good
practice principles� rather than �specific internal controls.�
IFAC recognized the need for such guidance as a result of
recent financial failures that pointed out flawed practices,
misplaced emphasis, and too narrow a scope. Risk management
and internal control need to be better integrated and applied
on a broader perspective to an organization�s overall governance
process.
The Guide sets out nine principles, and then recasts
them in the form of questions, followed by two to sixteen
examples under each one, describing where shortcomings are
often found. These are not meant for designing and implementing
an internal control system, but for evaluating and improving
existing internal control systems. These are the principles
and the related questions:
- Supporting the Organization�s Objectives. What should
the scope of internal control be?
- Determining Roles and Responsibilities. Who should
be responsible for internal control?
- Linking to Individual Performance. How could management�s
genuine attention to internal control objectives be
obtained?
- Ensuring Sufficient Competency. How should those
in the internal control system live up to their responsibilities?
- Supporting Organizational Culture. What else, beyond
their formal responsibilities, should be expected from
the governing body and management with respect to internal
control?
- Responding to Risk. How should internal controls
be selected, implemented, and operated?
- Communicating Regularly. How can internal control
be better ingrained into the DNA of the organization?
- Monitoring and Evaluating Controls. How should internal
control be monitored and evaluated?
- Providing for Accountability and Transparency. How
should the organization report on internal control performance?
The Guide provides numerous sources and definitions,
and encourages comments for submission by February 29, 2012.
For more recent IFAC guidance, see
IFAC Offers Alerts on Tough Audit Issues
European Commission Audit Reforms
Far-Reaching Proposals Fuel Debate
Stating that the financial crisis of 2008 revealed serious
failings in audits, the European Commission recently proposed
major changes in the laws governing auditors and audit performance
in Europe. Already reflecting significant changes since
the original ideas were floated a year earlier in a green
paper, the current proposals may take years to gain approval,
if the already withering criticism is any indicator.
The goals of the legislation are to improve audit quality
by strengthening independence between auditor and client,
fostering competition among auditors, and promoting better
regulatory oversight of audit firms. The latter two goals
have found a more receptive audience. Provisions in these
areas include liberalizing ownership restrictions on audit
firms, prohibiting �Big 4 only� clauses in third party contracts,
requiring an open bidding process including smaller firms,
coordinating EU and international supervision of audits,
and allowing auditors with a license in one member country
to perform audits in all European Union countries. This
last proposal, creating a �Single Market,� would be similar
to the practice mobility movement in the United States.
According to the AICPA, all states except for California
and Hawaii now have laws enacted permitting CPA practice
reciprocity.
The more problematic proposals focus on mandatory rotation
of audit firms and a ban on audit firms from providing non-audit
services. The maximum engagement period would be six years,
with a four year break before being rehired. If the audit
is carried out by two firms jointly, a nine year engagement
period is allowed. Criticisms of mandatory rotation range
from too short an engagement period, to increased cost for
the client and lessened impetus for developing industry
expertise. Also, firms feel that the ability to provide
non-audit services enhances the effectiveness of audits,
since the audit firm becomes more familiar with client operations
from the other areas of involvement. Some critics go so
far as to say the proposals would be worse than no changes
at all, and Steve Haddrill, CEO of the UK �watchdog,� Financial
Reporting Council, stated �Many of the proposals are extremely
damaging and threatening to the quality of audit and would
do no more than add cost.�
For alternative measures, more attention to and strengthening
of the audit committee role is seen as a better approach.
Also, the Competition Commission of the UK is currently
conducting an inquiry of the audit market to assess issues
of competition.
For parallels to similar concerns in the United States,
see the related article on audit failures and PCAOB proposals.
Audit Failures Prompt PCAOB Appeal
Increases Seen in Big 4 Shortcomings
Responding to unsatisfactory results in ongoing 2010
inspections of Big 4 audit practices, and similar concerns
expressed by regulators around the world, the PCAOB issued
a Concept Release on Auditor Independence and Audit Firm
Rotation in August 2011 (PCAOB Release No. 2011-006). Reporting
to Congress earlier in the year, PCAOB Chairman, James R.
Doty, stated that ��inspectors have continued to identify
significant deficiencies related to the valuation of complex
financial instruments, inappropriate use of substantive
analytical procedures, reliance on entity level controls
without adequate evaluation of whether those processes actually
function as effective controls, and several other issues.
PCAOB inspectors have also identified more issues than in
prior years.�
The inspection results, released in November and December
2011, found failure rates of 20% to 45% of the audits selected
for examination by the PCAOB. Those results contrasted with
rates ranging from 9% to 22% in the prior year. Regarding
financial instruments, examples of the shortcomings included
failing to gain sufficient understanding of valuation methods
and assumptions, failing to update and evaluate interim
to year end results, and failing to test or otherwise validate
external sources that were relied upon. In various areas,
there appeared to be too much reliance on management representations
and an inadequate level of skepticism. This concern was
so prevalent with respect to one firm that its overall audit
process and culture were called into question. Consequently,
the PCAOB made public portions of the prior year�s inspection
report that were previously non-public, where satisfactory
resolution of issues had still not been made. In some cases,
audit documentation was insufficient to determine if a claimed
procedure had been performed.
The Concept Release requests input on the desirability
of mandatory audit firm rotation, as a means of improving
audit quality. The PCAOB theorizes that audit firms may
be less likely to succumb to management pressure, if there
tenure as auditors is limited to just a few years. Also,
possibly a fresh look every few years by a new auditor would
produce better results.
The AICPA and numerous other sources strongly oppose
the idea of mandatory audit firm rotation. Similar to responses
to the European Commission proposals (see separate article),
the AICPA notes the expectation of increased costs and the
reduction of client and industry expertise that could actually
increase audit risk. The PCAOB Release is more of a collaboration
seeking effort, as opposed to the EC proposal which is a
legislative directive.
The comment period for the PCAOB Release has now closed,
but a public roundtable is scheduled for March 2012.
See also
PCAOB Seeks More Feedback on Communication With Audit Committees
Additional A&A News
The following links provide a selection of current articles
devoted to highlighting other A&A topics currently making
news.
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What�s the Future of IFRS in the U.S.?
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Time to Test-Drive the Revenue Recognition Proposal
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FASB Seeks Comment on Revenue-Related Amendments
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IAASB: Going Concern Assumption Must Remain in Auditor
Focus
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IAASB Issues Standard on Pro Forma Financial Info for
Prospectuses
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FASB, IASB Find Common Ground on Impairments
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