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Audit & Accounting Alert Newsletter

Issue 6 | July 2015


Gerry Herter

Integra International‘s place in the forefront of worldwide accounting standards was evident again this past month. While in Brussels for the June Conference, Integra leaders met with European Commission officials. As recounted in our first article, the EC officials presented a briefing on the process for accepting International Financial Reporting Standards into the European Union. Following the briefing, Integra became among the first to receive a copy of a new report evaluating the effectiveness of IFRS since placed into law ten years ago.

Speaking of accounting standards, who would not be in favor of reducing the complexities of financial reporting standards? Apparently the trend toward simplification, covered in last month’s Audit & Accounting Alert, has not been universally embraced. Our second article describes negative consequences that diverse groups have pointed out.

Finally, the latest round of audit quality inspections has been completed. Though there is always room for improvement, the news is better for the United Kingdom than it is for the United States, as our third article reports.

Editor Gerald E. Herter, CPA

In This Issue 

Integra Meets With European Commission in Brussels!

EC Officials brief Integra leaders on newly released IFRS evaluation report

In conjunction with the Integra International June 2015 Conference in Brussels Belgium, Integra CEO Maria Nazario and Integra Global Board member Steve Austin met with Zbigniew Zach, IFRS Policy Officer, and Christelle Fontbonne Proniewski, Policy Officer, for the Accounting and Financial Reporting Office of the Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA) of the European Commission (EC).

The EC officials apprised the Integra leaders of the European Parliament’s acceptance process for International Financial Reporting Standards (IFRS), just before release that same day of the new EC report that evaluated the process. The evaluation comes ten years after enactment of the law that put IFRS in place for European Union (EU) members.

The press release accompanying the report’s release stated: “The adoption of IFRS in the European Union was designed to improve the efficiency of EU capital markets by increasing the transparency and comparability of financial statements…The Commission's evaluation of the IAS Regulation assesses whether:

  • The Regulation achieved its objective in an efficient and effective manner;
  • The criteria that all new IFRS should meet to become EU law are appropriate and whether the process for adoption of standards works properly;
  •  The governance structure of the bodies developing the standards and advising the Commission is appropriate.”

The report was quite favorable as to the efficiency and effectiveness of the adoption process, noting the enhanced transparency of financial statements by virtue of “improved accounting quality and disclosure and greater value-relevance of reporting” and “greater comparability between financial statements within and across industries and countries.” There is still room for improvement, but the progress is encouraging.

As the EC officials explained to the Integra leaders, processing time for recent International Accounting Standards Board (IASB) pronouncements has averaged only about eight months from the IASB date of issuance to final acceptance by the EU. Considering that the proposed standards have to pass through the European Financial Reporting Advisory Group (EFRAG), the EC, and the European Parliament with its 28 members, that timeframe is commendable. Also noteworthy is that only one of those pronouncements required any modification from the IASB version.

Nevertheless, the report calls for further improvement of the endorsement process. EFRAG provides technical advice to the EC and weighs in on endorsement. A more interactive working relationship between these groups, along with an EFRAG that is more balanced in membership between public and private interests, is expected to facilitate efforts toward the common goal.

There also was concern expressed about the complexity of IFRS standards, even though the cost and effort of adoption was generally felt by companies to be worthwhile. Even so, while the desire for simplification may seem universal, the reality is that simplification is not always considered feasible or desirable. For contrary views on simplification, see the next article in this Alert.

While enforcement of IFRS was found adequate, differences in implementation by various EU members need further refinement. Further interpretive material would enhance consistency.

While the EU’s adoption of IFRS goes a long way toward establishing IFRS as the global standard, the failure of the United States to embrace IFRS is stated as a definite impediment in that regard. The report encourages the US SEC to adopt IFRS, and calls for a requirement that members of the IFRS Foundation and IASB use IFRS and provide financial support.

The Integra leadership has extended an invitation for the EC officials to share further about the Commission’s endeavors at a future Integra conference. Details will be announced when a date and location are formalized.

For further information, see The European Commission adopts report on use of International Financial Reporting Standards in the EU.

Pushback on Simplification?

Challengers lay out concerns

Last month, the Audit & Accounting Alert applauded the ongoing progress shown by the United States and Europe toward the goal of accounting and reporting standards simplification. The Financial Accounting Standards Board (FASB) and related Private Company Council (PCC) have made substantive inroads, for example, with measures easing the treatment of deferred taxes, variable interest entities, and eliminating the extraordinary item concept altogether. The Financial Reporting Council of the United Kingdom (FRC) implemented European Union directives, greatly reducing the volume of standards governing SMEs.

While many private companies and their stakeholders welcomed the practical measures, not everyone was pleased. The concerns differ between the United States (US) and Europe. In most of Europe there are two distinct standards: International Financial Reporting Standards (IFRS) generally for large and/or public companies and IFRS for SMEs for smaller private companies. In the US, there is just one authoritative standard: US Generally Accepted Accounting Principles (US GAAP), as promulgated by the FASB, for all companies. However, now that some private company alternative accounting standards are being approved as a part of US GAAP, users may not be aware of the double standard that exists, potentially leading to confusion.

The CFA Institute, an organization of investment professionals, found that its members questioned the need for double standards. Also, others like Edward Trott, former FASB member, believe that allowing accounting alternatives “dilutes the GAAP brand and creates unnecessary complexity for the statement preparer, auditor and financial statement user.” Both the CFA and Trott contend that the existing option, for private companies to take an exception in the audit report as a means of avoiding unwieldy standards, is the proper means of dealing with the situation. In this way, users are at least put on notice of the differing accounting treatment. Unfortunately, some users automatically attach a stigma to qualified opinions.

Trott’s opinions were contained in his comment letter responding to the Financial Accounting Foundation (FAF). In February 2015, the FAF issued a Request for Comment (RFC) document to assist in assessing the effectiveness of the Private Company Council (PCC) over the three years of its existence. With ten questions, the RFC asked generally if the PCC had accomplished its goal of private company alternatives, if that job was essentially done, if the PCC should now function solely as an advisory body on future issues, and whether other suggested structural changes were warranted.

The FAF received more than 50 comment letters. The comment period ended May 11, 2015, so the FASB is now in the evaluation process. From a brief scan of the comment letters, most feel that the work of the PCC with the FASB has been a clear success. A general sense is that while the largest, national, firms tend to feel that the “look-back” work is essentially done and that the PCC can assume an advisory role, the smaller firms more strongly feel that there is more work to be done. In that regard, the American Institute of Certified Public Accountants (AICPA) emphatically stated that there is certainly more work to be done. Also, the tenor of the AICPA and most other respondents calls for a continued prominent voice for the PCC in the FASB’s work, with substantive interactions, scheduled meetings and transparency of actions.

In Europe, with two clearly different, but related standards (IFRS and IFRS for SMEs), the user knows which is in effect for a company, and can act accordingly. The concerns lately are more with the size of companies required to use IFRS as opposed to IFRS for SMEs. In an effort to extend the benefits of simplification to more companies, the revenue and asset thresholds for requiring IFRS use have been increased by 60%. In the United Kingdom (UK), companies falling below the new thresholds will only be required to provide a balance sheet and income statement, as well as a more limited number of footnotes.

Smaller accounting firms in Europe are concerned, since most of their clientele are private companies that no longer have the rigors of full IFRS to contend with. Also, they may be freed of the audit requirement if that measure is finalized in the UK. Consequently, a significant amount of client work may be lost. In order to replace that work, the accounting firms will need to adjust their offerings, for example, to encompass more advisory assistance or other services. 

For further information, see Addressing Financial Reporting Complexity: Investor Perspectivess and Accounting threshold shifts risk lasting damage to audit profession.

Mixed Results for Latest Audit Inspections

British fare better than Americans

This past month, the Financial Reporting Council of the United Kingdom (FRC) issued its annual report on inspections of audit quality. At the same time, the United States Department of Labor (DOL) released the fourth study of employee benefit plan audit quality since the creation of its Office of the Chief Accountant in 1988. While the FRC reported improvement in the overall quality of auditing in the UK, the DOL study disclosed a disturbingly negative trend in quality since its last study in 2004.

The FRC inspected 126 audit engagements. The engagements selected were primarily from listed companies, and the majority of those were audited by Big 4 firms. 67% of the engagements were assessed as good or only requiring limited improvements. This result compares to 60% in the prior year and even lower percentages in the two years before that. Nevertheless, the FRC still expressed concern over the 33% percent that require improvements.

The three overriding themes noted for the shortcomings were:

  1.  Insufficient skepticism in challenging the appropriateness of assumptions in key areas of audit judgment such as impairment testing and property valuations;
  2.  Insufficient or inappropriate procedures being performed. This is common to many audit areas including revenue recognition;
  3.  The failure to adequately identify the threats and related safeguards to auditor independence and to appropriately communicate these to audit committees.

Of the 255 specific matters of concern identified that the FRC expects auditors and audit committees to address in future audits, over 50% related to four areas:

  1.  Fair value measurements (especially impairment testing and investment property valuations);
  2.  Audit of allowance for loan losses and loan impairments (for banks);
  3.  Reporting to audit committees (inadequacies regarding planned audit approach and issues raised);
  4.  Revenue recognition.

In an effort to increase favorable audit results, the FRC is requiring firms “to develop action plans to address the weaknesses identified in individual audit engagements and firm-wide procedures.” Also required are root cause analyses to identify the sources of the shortcomings and remedial actions to correct major issues.

As expected, audits of the largest companies resulted in the lowest number requiring significant improvements, while audits of smaller companies contained more deficiencies. This condition was cause for even more concern since, as the FRC pointed out, investors “rely particularly heavily on the quality of reporting in smaller listed companies given the absence of other analysis.”

Turning to the United States, the Department of Labor reviewed 400 employee benefit audits performed by 232 different CPA firms. 61% of the engagements complied with professional auditing standards or only had minor deficiencies. That means 39% had major deficiencies that were unacceptable. Since the 1988, 1997 and 2004 reviews produced 23%, 19% and 33% major deficiencies, respectively, the trend and current 39% result are understandably troubling to the DOL.

 The overall findings of the DOL study were that:

  1.  There is a clear link between the number of employee benefit plan audits performed by a CPA and the quality of the audit work performed;
  2.  The accounting profession’s peer review and practice monitoring efforts have not resulted in improved audit quality or improved identification of deficient audit engagements;
  3.  CPA firms that were members of the American Institute of Certified Public Accountants’ (AICPA) Employee Benefit Plan Audit Quality Center (EBPAQC) tended to produce audits that have fewer audit deficiencies;
  4.  Training specifically targeted at audits of employee benefit plans (EBPs) may contribute to better audit work;
  5.  Of the 400 plan audit reports reviewed, 67 (17%) of the audit reports failed to comply with one or more of ERISA’s reporting and disclosure requirements.

In drawing conclusions from the study, the DOL acknowledged that employee benefit plans have their own special characteristics not found in other entities. Consequently, if an auditor has not been specifically trained and is not familiar with the distinctive issues involved in this niche, flawed audits are more likely to occur. Similarly, if a firm conducts only one or just a few plan audits, the likelihood of deficiencies is much greater. Specialized training and repetitive experience are a necessary combination for optimal results.

The unfortunate quandary in the US is that efforts have been implemented in recent years explicitly to reverse the trend of substandard audits. Peer reviews are required to include reviews of plan audits. Also, the AICPA established the EBPAQC for the express purpose of enhancing audit quality by providing targeted resources and requiring fundamental accountability. Though audits of EBPAQC members did contain fewer shortcomings, the overall results were still disappointing.

The DOL’s recommendations included:

  1.  Enforcement – focusing on firms with a smaller number of plan audits, and working with authorities to strengthen disciplinary measures;
  2.  Regulatory/Legislative – tightening qualification restrictions for plan auditors, eliminating the limited-scope audit exception, and providing standard making authority to the DOL;
  3.  Outreach – working with states to stiffen licensing requirements, and expanding distribution of relevant information to plan administrators, state boards of accountancy and state CPA societies, to better inform them about problems and to encourage training programs.

The AICPA has not hesitated to address the DOL concerns. The Enhancing Audit Quality (EAQ) Initiative launched in May 2014 (see September 2014 Audit & Accounting Alert for details) called for renewed efforts on competence, quality control, resources, peer review, and ethics. Then in May 2015, the Six Point Plan to Improve Audits was released, incorporating broad-based feedback to the EAQ from stakeholders and profession leaders. The points of the plan are:

  1.  Pre-licensure – Accounting education and the CPA Exam are addressed to relate closer to real world working conditions;
  2.  Standards and Ethics – Monitoring and evaluation of the implementation of auditing and quality control standard updates and audit report revisions, along with the newly revamped ethics code;
  3.  CPA Learning and Support – Competency assessment models developed with the Chartered Institute of Management Accountants (CIMA), modernized experience and training tools, and new initiatives from the Audit Quality Centers and the Center for Plain English Accounting;
  4.  Peer Review – enhancing the quality of peer reviewers, targeting firm quality and accountability, and improving engagement and firm tracking;
  5.  Practice Monitoring of the Future - Developing new technology to promote an “ongoing, near real-time practice monitoring program;”
  6.  Enforcement – A more robust and inter-agency-coordinated investigation and disciplinary process to deal with deficient audits and auditors.

 For further information, see U.K. Financial Reporting Council - Audit Quality Inspections: Annual Report 2014/15 and AICPA releases 6-point plan to enhance audit quality.

Additional A&A News 

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

  1. High Tech, Fantasy Accounting
  2. Irish and Nigerian Accounting Organizations Sign Deal
  3. Companies Pause on New Discontinued Operations Rule
  4. The top 5 cybersecurity risks for CPAs
  5. New India Accounting Standards are Set
  6. Four Signs the Uberization of Accounting Has Already Begun

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]