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Audit & Accounting Alert Newsletter

Issue 6 | June 2014


Gerry Herter

Though universal adoption of International Financial Reporting Standards has stalled in the United States, a major milestone of mutual cooperation is about to transpire. As we go to press, the joint release by the IASB and FASB of a major new standard for revenue recognition accounting is expected any day. In fact, it may have already been released as you read this issue. In our first article, we highlight this monumental effort.

The new revenue recognition standard will only become a household word among accountants. But before long everyone will be talking about Alibaba Group Holdings, Ltd., the emerging Chinese internet company. Alibaba is about to launch possibly the largest initial public offering in US history. An ongoing dispute between the SEC and Chinese regulators has put auditors in the spotlight. Our second article describes the difficulty the SEC and US auditor watchdog, PCAOB, are having with Chinese auditors. Concerned about revealing state secrets, China has erected roadblocks, preventing access to audit workpapers for inspection. Consequently, the SEC is faced with a tough decision.

Our third article continues our coverage of the search for audit quality improvement. This past month, the AICPA-affiliated Center for Audit Quality issued a proposal of specific measures for use in evaluating and comparing auditors on a quantifiable basis. These audit quality indicators would reveal heretofore private data, spelling out details of the audit process, competency and reputation of the auditors and the audit firm. The CAQ plans to pilot test this new approach over the coming year. 

Editor Gerald E. Herter, CPA

In This Issue 

Long Overdue Revenue Recognition Standard Becomes a Reality

One size fits all will cause challenges for some

The overhaul of the revenue recognition accounting standard has been on the convergence agenda of the FASB and the IASB since 2002. When we first wrote about the protracted journey of this process two years ago, the final standard was hoped for by the end of 2012. At that time, a Discussion Paper and two Exposure Drafts had already been issued and debated extensively. Now at last, the final standard, Revenue from Contracts with Customers, is at hand.

The deliberate nature of the process has proved beneficial in providing sought after clarity and more specific criteria for making the determinations required by the standard. Respondents presented unique aspects of their contracts to enable further delineation of how the standard would be applied.

Considering that various aspects of revenue recognition have been addressed previously in over 100 pronouncements, the goal of “one standard fits all” has been a monumental undertaking, justifying the time taken. Though new definitions and terms of measurement will need to be considered in the standard’s five step approach, some industries, such as software and construction are already used to dealing with the determination of multiple elements or phases in their revenue recognition models. Even so, some industries, such as telecommunications, questioned the benefit of a single standard over the value of industry-specific accounting. For example, sellers of cell phones bundled with service contracts will have to change their revenue recognition allocation practices from prior methods which they felt were a better fit.

Following is the fundamental crux of the new standard, as described in the introduction to the IFRS version:

“The core principle of this IFRS is that an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

To achieve that core principle, an entity shall apply all of the following steps:

  1. identify the contract with a customer;
  2. identify the separate performance obligations in the contract;
  3. determine the transaction price;
  4. allocate the transaction price to the separate performance obligations in the contract; and
  5. recognise revenue when (or as) the entity satisfies a performance obligation.”

The IFRS and FASB versions parallel each other, varying only in minor technicalities. For instance, the required threshold for probable collectability of revenue is lower in the IFRS than the FAS. Also, the FAS does not permit early adoption, while the IFRS does. The effective date starts generally with the 2017 calendar year, with non-public companies having the option of waiting until 2018.

Some companies have expressed concern that the impact of the effective date comes even sooner than it appears, since those that decide to apply the desirable full retrospective transition need to start accumulating data at the start of 2015. Anticipating this and other challenges, with such major changes in the standard, the FASB and IASB have planned to form a Revenue Recognition Joint Transition Resource Group to assist with issues that arise.

Though much guidance and discussion are sure to follow in coming months and years, the attainment of this joint effort of the FASB and IASB is a major milestone in international cooperation.

For further information, see Revenue Recognition—Joint Project of the FASB and IASB


Paul Beswick, Chief Accountant for the SEC, recently announced his resignation, with plans to return to the private sector. Over his six year tenure with the SEC, Beswick has been heavily involved in the Commission’s efforts to consider IFRS. He has spoken in the past year on the impact that IFRS already has on United States capital markets. A successor to Beswick has not yet been named. For further information see SEC.

Alibaba Spotlights SEC Dispute with Auditors in China

Will the massive IPO reward investors with a treasure trove or a band of thieves?

Until recent times, the name Alibaba conjured up one of two images: a cave filled with treasure, exposed by speaking the words “Open Sesame,” or else a band of forty thieves, conspiring to kill the humble woodcutter who had learned their secret. Jack Ma, founder of Alibaba Group Holdings, Ltd., displayed prophetic vision when naming the privately owned Chinese behemoth. Talking with people from all over the world, he found that everyone recognized the name Alibaba. And it was easy to spell. His original vision of an “Open Sesame” for small businesses has grown into an international conglomerate of internet trade.

So where do the auditors and the SEC come in? With what could be the largest Initial Public Offering in history, financials audited by a Chinese firm are on display. The problem is that Chinese audit firms have been recommended for suspension by the SEC, for failing to subject their workpapers to inspection, as is required of all firms that audit companies trading in the US. The suspension is currently under appeal. The auditors’ defense is that the government of China prohibits the release of the workpapers.

The SEC and PCAOB have been in conflict with the Chinese Securities Regulatory Commission (CSRC) for years over this issue. The controversy started to soften in 2012, when the PCAOB reached an agreement with the CSRC that allowed observational visits of the Chinese audit firms’ quality control systems. However, review of specific audit workpapers was not permitted.

Then in May, 2013, a Memorandum of Understanding provided for workpapers from audits to be sent to the PCAOB and SEC for review. Nevertheless, onsite review of workpapers was still off limits, and there was no telling what manner of redaction would be performed before the workpapers were sent for review.

 The final blow came in January, 2014, when an SEC administrative law judge suspended the Big 4 accounting firms’ Chinese affiliates, calling their non-compliance regarding audit workpapers “egregious” and acting “willfully and with a lack of good faith.” The audit firms have been able to continue their work pending the appeal.

On May 9, 2014, the SEC issued its decision to hear the appeal. Still, final resolution could take months and years. Consequently, Alibaba included a risk warning in its offering documentation, disclosing the uncertainty regarding the audit of the financial statements that are included. A further complication is that the Alibaba auditors are based in Hong Kong. While they fall under China’s rules, the suspension is not against them, but against the mainland offices of the audit firms. Even so, since substantial operations of Alibaba take place in mainland China, significant amounts of the audit work may be performed by the mainland offices. Since the files have not been made available, that issue has not been resolved. Interestingly enough, Alibaba had originally planned to have the stock offering in Hong Kong. However, regulatory restrictions were not as strict in America, so the planned offering was moved to a US stock exchange.

For further information, see Does the SEC Have the Guts to Tank Alibaba's IPO?

Quality Indicators Seek to Advance Audit Effectiveness

Audit assessment evolves with the times

Last month we described persistent auditor deficiencies, as well as current legislative and regulatory measures designed to reduce the frequency of audit failures. This month we cover an approach by the profession to strengthen audit quality using quantitative measurements.

In February, 2014, the International Auditing and Assurance Standards Board (IAASB) issued A Framework for Audit Quality: Key Elements that Create an Environment for Audit Quality. This document details factors, organized by inputs, outputs, interactions and context, that impact audit effectiveness at the engagement, firm, and national levels.

Also, the PCAOB in November, 2012, launched a project to develop audit quality measures focused around a framework of inputs, processes and results. A Concept Paper is expected later in the year.

Drawing upon these and other efforts, the AICPA-affiliated Center for Audit Quality has provided input to the PCAOB and, in April, 2014, issued its own paper, the CAQ Approach to Audit Quality Indicators. Noting a lack of consensus on several aspects, including the definition of audit quality, an audit quality framework, the specific indicators, and communication, the CAQ offered an approach for moving forward.

The paper identifies four thematic elements of audit quality to use in categorizing the audit quality indicators (AQI):

  1. Firm Leadership and Tone at the Top
  2. Engagement Team Knowledge, Experience, and Workload
  3. Monitoring
  4. Auditor Reporting

The CAQ’s approach is to supplement current communications to the audit committee, by providing the AQI on an annual basis, in order to broaden understanding, facilitate evaluation, and stimulate further discussion on audit matters. With an emphasis on engagement-specific measures, the AQI may help the audit firm to improve quality as well.

The CAQ further delineated the thematic elements into the following categories:

I. Firm Leadership and Tone at the Top:

  1. Overview of how the audit firm’s leadership, through its tone at the top, emphasizes audit
    quality and holds itself accountable for the audit firm’s system of quality control

II. Engagement Team Knowledge, Experience, and Workload:

  1. Knowledge and Experience of Key Engagement Team Members
  2. Audit Firm Training Requirements
  3. Trends in Engagement Hours and Related Timing
  4. Allocation of Resources by Significant Risk Areas
  5. Specialists and National Office Personnel Involvement by Significant Risk Areas
  6. Key Engagement Team Members’ Workloads

III. Monitoring:

  1. Internal Quality Review Findings
  2. PCAOB Inspection Findings

IV. Auditor Reporting:

  1. Reissuance Restatements and Withdrawn Auditor’s Reports

For many of the categories, the CAQ proposed readily quantified indicators that could be useful in the audit oversight process. For example, the “knowledge of the engagement team members” category includes the number of years 1) with the firm, 2) at the current level, 3) on the engagement and 4) of industry experience. The “trends in engagement hours and related timing” category includes planned and actual audit hours for the current and prior year at each level, as well as the allocation between planning and execution. For monitoring and reporting categories, the numbers and types of occurrences are indicated.

The CAQ will pilot test the proposed AQI with selected auditors and audit committees through the 2014 audit cycle.

Separately, in breaking news, the AICPA recently announced a new Enhancing Audit Quality Initiative. The initiative plans to monitor execution of Auditing Standards Board standards, create new resources, and reform the peer review process. More information and a discussion paper are expected in coming months.

For further information, see Center for Audit Quality Leads First Effort in U.S. to Pilot Test Audit Quality Indicators

Additional A&A News 

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

  1. UK FRC publishes amended accounting rules for micro-entities
  2. IAASB Proposes Changes in Auditing
  3. Accounting for natural capital: the elephant in the boardroom
  4. Going Concern Looks Out One Year, Starting in 2016 for FASB
  5. ISACA releases white paper on Big Data
  6. Reconciliation of Accounts Still Mostly Done by Hand


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]