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Audit & Accounting Alert Newsletter

Issue 1 | January 2013


Gerry Herter

With the onset of 2013, public accountants once again prepare for their busiest time of the year. In our first article, we welcome the New Year with a few reminders. The Auditing Standards Board’s recently completed Clarified Auditing Standards are now in effect, to smooth the way and hopefully not to trip up the unwary. Also, the PCAOB re-emphasizes the importance of professional skepticism in upcoming audits, while British accounting bodies look further ahead, exploring how the auditor of the future will need to adapt to remain relevant in a rapidly changing world.

Next, we look behind the scenes of the huge write-down taken by HP on the Autonomy acquisition, and consider the alleged accounting improprieties, the roles played by each of the Big Four accounting firms, and whether IFRS may have played a part.

Finally, we look at “The Future of IFRS,” a new report by the British Chartered Accountants Institute that highlights the accomplishments and shortfalls of IFRS in its first decade, while making a strong case for IFRS’ ultimate success, providing the right steps are taken. 

Editor Gerald E. Herter, CPA

In This Issue 

Auditing in the New Year and Beyond

The Audit Season is here with Reminders and Concerns

As the New Year begins, auditors gear up for the hectic months ahead, fine-tuning policies and procedures, as they implement the latest standards and directives. Meanwhile, the profession seeks direction in the pursuit of future relevance, amidst troubling fallout from an increasingly complex and demanding world.

On the immediate horizon, the Clarified Auditing Standards (CAS), produced by the AICPA’s Auditing Standards Board, are now in effect for December year end audits. The Statements on Auditing Standards (SAS) have each been redrafted in a standardized format with the goal of making them easier to read, understand, and apply. However, they were also converged with the International Standards on Auditing (ISA), so there are more than cosmetic changes to consider. Among other things, the auditor’s report has been reworded, procedures to detect noncompliance with laws and regulations are required, and opening balances on initial audits require more than just reviewing the predecessor’s work papers. For assistance in dealing with the new clarified standards, the AICPA has a number of resources available for download from their website.

In the public arena, The PCAOB is speaking out in an effort to stem the increase of deficiencies that continue to be found from inspections of audit firms. In a recent speech at Baruch College, PCAOB Chairman, Jim Doty, noted that in an environment where accounting firms’ “audit fees have stagnated” and the audit has “become a commodity to be contained with other compliance costs,” consulting fees have been growing “rapidly.” He stresses that “we are in a high risk period that merits more attention to the audit, not less.” Interestingly enough, just four days later, AICPA chairman Richard Caturano commented at an AICPA conference that “Just a few years ago, auditing was being called a commodity. You don’t hear that any more. Auditors are being scrutinized more closely than ever, and are taking on more responsibility.” There are clearly different perspectives when seen through the eyes of the entrepreneurial audit firm wanting to spur growth, as compared to the regulator concerned that ongoing deficiencies result from the distractions of that aggressive growth mentality.

In a more formal way, the PCAOB in December issued Staff Audit Practice Alert No. 10: Maintaining and Applying Professional Skepticism in Audits. The issuance of a Staff Audit Practice Alert by the PCAOB is a major occurrence to which all firms, PCAOB registered or not, should give serious thought. This one is a practical sixteen page guide that is useful for public and private entity auditors alike, with specific examples of shortcomings observed in inspections. The alert reiterates that “PCAOB standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence.” Fundamentals covered include:

  1. A discussion of due professional care that emphasizes that professional skepticism a) is required throughout the audit, b) is particularly important with regard to significant management judgments or transactions outside the normal course of business, and c) is needed in the consideration of fraud;
  2.  The alert warns against impediments that can cause undue pressure, such as unconscious human biases, filing deadlines, fee level concerns, desires to cross-sell other services, long-term client relationships, scheduling and workload demands;
  3. The elements and importance of the auditor’s system of quality control are itemized;
  4.  Supervision by the engagement partner and senior team members set the tone and provide direction; and
  5. Application throughout the audit by each team member with regards to risk assessment, control tests and substantive procedures, and evaluation of audit results.

Looking further ahead, while legislation affecting the audit profession works slowly forward in Europe and the US, the debate continues as to how best to reform the audit function. In the aftermath of the financial crisis and high profile corporate downfalls, the investment community cannot be faulted for questioning the accounting profession’s role as the public watchdog.

The UK regulator, the Financial Reporting Council, and the Institute of Chartered Accountants of Scotland are having a study performed to answer the question: “What mix of attributes, competencies, professional skills and qualities need to be combined in an audit team in order for it to perform a high quality public interest audit in a modern and complex global business environment?” Not intended to be a mere revision of procedures and rules, the goal is to step back and take a “philosophical perspective.” In other words, start from the beginning, look at the world as it exists today and in the future, and re-visualize what users of financial reports need and how the auditor can effectively provide that information. For instance, how should training change, what areas of specialized knowledge are required, how is the audit process carried out, what information should be presented, and how can that information be presented in a way that gives the user what is needed to make informed decisions? The study is expected to be completed later in 2013.

For further information, see Clarified Auditing Standards—Learning and Implementation Plan, Maintaining and Applying Professional Skepticism in Audits, and Competencies and Professional Skills of Auditors

HP Write-down of Autonomy Acquisition: Implications for IFRS?

Bad Press for Big Four and all of Accounting Profession

HP’s vastly overpriced purchase of Autonomy may renew the debate of the relative value of principles based versus rules based accounting standards. In the wake of a multi-billion dollar write-down of goodwill from the acquisition, HP is claiming intentional accounting misdeeds by the Autonomy accountants that allegedly were missed by Deloitte, Autonomy’s auditors, Ernst & Young, HP’s auditors, and KPMG, brought in to perform due diligence on the acquisition. Of the Big four accounting firms, that left PricewaterhouseCoopers, who uncovered the supposed improprieties when called in to do “after the fact” forensic work on the fiasco.

Accounting issues raised by HP include 1) hardware sales classified as software sales, with some of the costs reclassified as marketing expenses, 2) sales recognized to resellers where the reseller had no corresponding sale to an end user, and 3) multi-year software license agreements where all revenue was recognized in the initial year.

An intriguing aspect of the debacle is that Autonomy is a British company whose financial reporting falls under IFRS, while HP is an American company that reports using US GAAP. The former owner of Autonomy, Mike Lynch, in interviews with Reuters and others, contended that the Autonomy accounting was properly reported under IFRS, and that HP’s allegations are mistaken because they are applying US GAAP, which is different than IFRS.

Revenue recognition with regards to technology is a highly complex area, where hardware, software, licensing, maintenance, and programming modifications are often bundled into major contracts. As discussed in our May 2012 issue, the FASB and IASB have been trying for over ten years to converge the differing standards of IFRS and US GAAP. Interestingly enough, the principles-based IFRS covers revenue recognition primarily in the 12 page IAS 18, whereas the rules-based US GAAP draws from over 150 areas of guidance and hundreds of pages of material, much of which is now consolidated in the FASB Standards Codification and SEC releases.

The question with regards to the first issue was whether the hardware bundled with software should have been reported separately, and whether the customer’s agreement to assist with marketing as part of the bundled sale, justified reclassifying part of the cost as marketing expense. The result was a higher reported gross margin on sales.

The second issue, involving resellers, was at what point did Autonomy have a completed sale. Did the sale occur when the product was provided to the reseller, or when the reseller sold the product to the end user?

 The third issue concerned at what point revenue from long term software hosting agreements should be recognized.

Only time and further revelations will divulge whether these are the actual issues that caused HP to overvalue the price paid for Autonomy, and whether they were the result of improprieties, oversights by the accounting firms, and/or conflicting interpretations of the standards. But the long and protracted efforts to synchronize global standards, as exemplified by the still unresolved revenue recognition differences between IFRS and US GAAP, can’t be helping.

On a broader scale, questions remain and may be growing as to the adequacy of a principles based IFRS to address these issues, or whether too much flexibility defeats the goal of uniform standards. On the other hand, while a rules based US GAAP may provide more clarity for the specific issues raised here, does that clarity come at too big a price, where the rules can give way to manipulation? Possibly a middle ground is needed. See what a British group has to say, in the next article.

For further information, see Trustees publish IFRS Foundation Staff Analysis of SEC Final Staff Report on IFRS

The Future of IFRS

British accountants’ society weighs in strongly

Though the British may have wanted to keep America in the fold a couple of centuries ago, now when it comes to joining forces for current day International Financial Reporting Standards, they appear to be having second thoughts. The Institute of Chartered Accountants in England and Wales (ICAEW) on December 12 published a report, “The Future of IFRS,” that calls for the cause of IFRS to move forward, with or without the US.

The ICAEW, the British counterpart to the AICPA, issued “The Future of IFRS” as part of its ongoing program on thought leadership, known as the Information for Better Markets Initiative. Through periodic papers and conferences, the program “subjects key issues in financial reporting to careful and impartial analysis, and focuses on three broad themes: disclosure, measurement and regulation.” A recent example of the program’s work is the 2011 study “Reporting Business Risks: Meeting Expectations,” which explored why risk reporting was inadequate leading up to the financial crisis, and offered concrete suggestions for improvement.

With IFRS the law of the land in the European Union for ten years now, the ICAEW felt it was time to “step back, to put things in perspective.” As alluded to in our preceding article, the protracted march toward global accounting standards has encountered some resistance, stalling momentum. That resistance is personified primarily by the US SEC’s recent staff report issued on July 13, 2012, which is long on concerns, but lacking in a decisive recommendation.

“The Future of IFRS” points out the accomplishments of the past decade: over 100 countries require or allow use of IFRS, academic studies have revealed substantial benefits, and increasing international trade and investment advocate for the uniformity of IFRS. Remaining concerns are also considered: excess complexity, compromise of quality from convergence, inconsistent implementation, national differences, financial crisis implications, and the hesitancy of the US, which countries like Japan and India tend to follow.

“The Future of IFRS” acknowledged shortcomings in financial instrument accounting, but found no evidence implicating IFRS in the global financial crisis. The delay by the US was seen as beneficial, by allowing the IASB time to digest the achievements of the past ten years, while making needed reforms, before tackling the formidable task of integrating the US with the rest of the IFRS world. Differences in how countries implemented IFRS were seen as minor and not inhibiting to the overall goal. The move to IFRS will prove to be an improvement, with differences diminishing in time.

“The Future of IFRS” respects that the move to IFRS will be difficult for countries with already strong standards like US GAAP. However, the position is clearly stated that IFRS is now a highly respected set of standards in its own right, and consequently the time has come to step away from any dependency on US GAAP. A call is made for the IASB to end the convergence process, acknowledge the good that it has done, and move ahead in the future, focusing its work on the needs of the 100 plus countries that have adopted IFRS. Even so, the United State should be encouraged to continue participating on the IASB boards, at least for now.

Finally, “The Future of IFRS” gives the IASB advice for managing an organization that now has over a hundred diverse constituents. Governments are called upon for greater support, regulators for more active enforcement, and the IASB to proceed as “an organization that listens and learns as well as leads.” Principles-based standards are strongly affirmed, with little interest shown for industry-specific information, application guidance, or interpretations, for that matter. Professional judgment reigns supreme, while detailed rules are disdained for their danger of manipulation. Only time will tell if the next decade matches the progress made in the past ten years.

 For further information see The Future of IFRS

Additional A&A News

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

  1. Barry Melancon, AICPA President, looks ahead
  2. Audit needs to adapt or risk becoming irrelevant
  3. U.S.-China Audit Clash Could Have Broad Reach 
  4. Private Company Council Initial Issues
  5. Hedge standard unlikely to be adopted
  6. PCAOB Finds Problems with Audits of Internal Controls

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]