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Audit & Accounting Alert Newsletter

Issue 8 | November 2012


Gerry Herter

While the SEC prolongs a decision on IFRS, progress has been made on other aspects of financial reporting by several professional bodies. COSO enhanced the usefulness of the internal control framework Exposure Draft by adding extensive sets of examples and tools for applying the newly updated principles. The Financial Accounting Foundation has named the members of the new Private Company Council that will be considering the applicability of certain financial reporting standards to private entities. Two AICPA Committees have proposed revisions to standards that will clarify when a compilation report is required with financial statements. Finally, the PCAOB reached an agreement with China that will allow limited access for observational visits to firms that audit Chinese companies.

Editor Gerald E. Herter, CPA

In This Issue 

COSO Expands Guidance

New Internal Control Framework Supplemented by Helpful Tools

In our February issue, we described the newly issued Exposure Draft, Internal Control – Integrated Framework (“Framework”), that is on track to replace its 20 year old predecessor in 2013. During the comment period that ended on March 31, over 21,000 copies of the draft were downloaded and over 200 comments from a wide range of sources were received. Many were supportive of the efforts to modernize and codify the principles, while there was also concern with the scope and the perceived additional efforts that would be required to work with the Framework. After considering the issues over a six month period, an updated draft was issued in September, with primarily cosmetic changes to clarify terminology, the relationship to enterprise risk management, and added guidance for smaller entities.

The depth of effort devoted to this project by COSO was evidenced by the additional issuance in September of two extensive documents providing practical assistance: Internal Control over External Financial Reporting: Compendium of Approaches and Examples (ICEFR) and Illustrative Tools for Assessing Effectiveness of a System of Internal Control (Illustrative Tools).

 As the Framework indicates, the scope of the internal control definition covers objectives relating to operations, reporting, and compliance. The ICEFR addresses a subset of the reporting category. As such, the ICEFR will be helpful to CPAs and their clients in the preparation and scrutiny of financial statements that will be going to outside users.

The structure of the ICEFR follows that of the Framework, so there is a chapter for each of the five internal control components: control environment, risk assessment, control activities, information and communication, and monitoring activities. Each chapter describes the internal control principles relating to that component and lists approaches for each principle. To further assess whether a principle is present and functioning, points of focus are offered. The points of focus were called attributes in the original exposure draft. For each approach, real life examples elaborate ways the approaches have been applied.

For example, under the information and communication component, there is Principle 15: The organization communicates with external parties regarding matters affecting the functioning of other components of internal control. The approaches are:

  1. Communicating information to relevant external parties
  2. Obtaining information from outside sources
  3. Surveying external parties
  4. Communicating the whistle-blower program to outside parties
  5. Reviewing external audit communications

The points of focus are:

  1. Communicates to external parties
  2. Enables inbound communication
  3. Communicates with the Board of Directors
  4. Provides separate communication lines
  5. Selects relevant method of communication

Under approach 4, “Communicating the whistle-blower program to outside parties,” an example is provided that describes the specific steps taken. Here a company has set up a section of its website to receive questions, concerns, or complaints. The internal audit department maintains a process to ensure collecting, documenting evaluating and addressing all reported matters. The website is monitored weekly and secure software is used to summarize new information. The internal audit director develops an action plan for each matter. The CFO or audit committee chair reviews and takes appropriate action.

The ICEFR is designed to be a reference tool as opposed to a document that is read from front to back. The Illustrative Tools are meant to help with assessing the internal control system that is in place. Those that have worked with SOX 404 or the risk assessment SAS’s will find these tools familiar. Though not intended to fulfill any particular regulatory requirement with regards to the appraising the severity of deficiencies, the tools, like the ICEFR, follow the Framework structure in addressing internal control components and principles. A series of templates are provided for overall and specific assessments, followed by five scenarios to show how they can be applied to actual situations.

The scenarios are comprehensive presentations complete with specific purpose, factual background information, and extensive filled-in templates. Issues covered by the scenarios are:

  1. Is a principle and component present and functioning?
  2. Are the five components present, functioning and operating together in an integrated manner?
  3. How does a weakness in a control activity impact principles, components, and internal control?
  4. Are the principles and components present and functioning in a division, operating unit or function?
  5. How are the assessments of multiple locations combined?

The templates and scenarios will prove helpful in assessing a system of internal control, documenting the assessment, and documenting deficiencies that were identified, all in an organized, structured format.

For further information, see COSO Internal Control Guidance

Private Company Council in Place

Financial Accounting Foundation Names Ten Members for PCC

Momentum continues to build for the launch of the Private Company Council (PCC), the Financial Accounting Foundation’s (FAF) answer to the private sector’s call for meaningful financial reporting standards. In September, the FAF appointed Billy Atkinson chairman, along with nine other members, representing a mix of public accounting, financial and industrial companies. Atkinson was an audit partner with Pricewaterhouse Coopers for 39 years prior to retiring in 2011, and has served on various national and state accounting boards and councils.

While the PCC membership embodies a depth of technical expertise and commitment to the profession, the Council’s ability to attain the long sought after objectives may prove challenging. In our July issue, we alluded to AICPA President, Barry Melancon’s cautious support, when he announced simultaneously a separate project for a simplified financial framework for smaller entities that do not need to contend with GAAP. Melancon’s reservations surfaced again in a statement when Atkinson’s appointment was announced, as reported by Ken Tysiac in the Journal of Accountancy: “…We note that the appointed Chair has in the past publicly expressed strong reservations about appropriate significant differences in GAAP for private companies. Since the job of the PCC is to advocate for those differences, we can only assume that during the interview process the FAF reached a point of comfort that Mr. Atkinson now supports meaningful differences. I've known Billy for a long time. He is a competent, passionate professional who has worked hard for the CPA profession during his career. We expect that his commitment to differential standards has evolved and that his actions and those of his council will in fact fulfill the FAF's commitment to at long last address this issue.”

Initial topics to be tackled by the PCC according to Atkinson are:

  1. Accounting for Uncertainty in Income Taxes or FIN 48.
  2. Fair value.
  3. Variable interest entity consolidation, or FIN 46(R).
  4. Complexity of derivatives, including simple interest rate swaps used to convert floating rate debt to fixed.
  5. Accounting for warrants as liabilities.
  6. Elements of business combination accounting such as separately identified intangible assets.

These are topics well worth considering, since they most often are of little concern or relevancy to preparers and users of private company financials.

In our September issue, we described the FASB Exposure Draft that will determine the criteria the PCC is to use for selecting matters that can be considered for private company GAAP exception or modification. The comment period for the Exposure Draft has just expired as of October 31.

Bundled into the Exposure Draft is a separate project deliberating over the definition of a private company (nonpublic business entity), since the Codification of standards currently has several definitions for various situations. The goal of this project is to simplify the definition, address known issues, and indicate which types of entities qualify. Tentative decisions for entities that would not qualify include employee benefit plans and entities whose securities trade in a public market. Entities that would qualify generally include nonpublicly traded entities, including nonpublic financial institutions, subsidiaries of public entities, and nonpublic entities that own consolidated public subsidiaries. Qualified entities in industries that have industry-specific accounting guidance would be required to follow that same industry-specific guidance that applies to public entities. A second phase of this project will consider which not-for-profit organizations are nonpublic entities. After these two phases are complete, a separate exposure draft is expected.

For further information, see Private Company Council

Financial Statements: To compile or not?

Clarification appears to be near

The compilation and review standards were first established in 1979 to clarify and expand upon public accounting services pertaining to unaudited financial statements. While providing much needed guidance in this area, the standards also resulted in lingering confusion over the years about just what constitutes a compiled financial statement. This confusion was only heightened by the advances of technology, to the point where the answer may have depended on who pushed the button on a computer that caused software to print the financials. Some relief was allotted in the year 2000, to exempt certain financials created solely for knowledgeable management.

However, this past June two AICPA committees, the Professional Ethics Executive Committee (PEEC) and the Accounting and Review Services Committee (ARSC) both issued complementary Exposure Drafts that are intended to lay to rest much of the confusion. The PEEC Exposure Draft, Proposed Revised and New Interpretations and Proposed Deletion of Ethics Rulings, would amend Interpretation 101-3 of AICPA Professional Standards Rule 101, to state that financial statement preparation is a nonattest service. Nonattest services do not fall under the independence provisions of Interpretation 101-3.

The ARSC Exposure Draft, Compilation of Financial Statements, would amend AR section 80 to state that a compilation is required only when the accountant is engaged to perform one, while Exposure Draft, Proposed SSARS: Association With Unaudited Financial Statements, would call for the financials to indicate that they have not been audited, reviewed, or compiled when the accountant is associated with them, or else have the accountant attach a disclaimer to that effect.

These revisions should eliminate, for the practitioner, some of the judgmental gray areas over whether various levels of involvement constitute a compilation. A mere annotation is all that is needed on the financials to show that none of the three levels of attest services has been performed. Also, these financials would not be subject to peer review. A compilation engagement is referred to as “read and report,” while an association is characterized as “prepare and present.”

The original comment period deadline of August 31, 2012 has been extended to November 30, 2012. About 60 Comment Letters have been received thus far. While a majority are favorable, many of those appear to be form letters from members of a single accounting organization. Smaller practitioners feel relieved that the compilation burden was being lifted, especially tax-return-only practices that had previously abandoned financial statement work because of the added peer review requirements.

Some of the other respondents, such as the National Association of State Boards of Accountancy, are concerned with the financials going out without an accountant letter. They would make the disclaimer letter mandatory. However, while confusion may be lessened for CPAs, some feel that more confusion may be caused among the users of financial statements. There is a contention that many users do not comprehend the difference between the levels of service, ascribing a level of assurance not intended by the CPA. So regardless of the content of the letter attached to the financials, its presence may give credibility not warranted. So for some, whether the new standard will lower liability exposure remains unclear.

The proposed effective dates for the revised standards would be two years out, at the end of 2014.

 For further information see AICPA White Paper on Preparation as a Nonattest Service

PCAOB Reaches Agreement With China?

Observations of audit firm quality controls to begin

Following intensified efforts over the past year, the PCAOB announced in early October that an agreement had been reached with Chinese regulators, allowing observations of the quality control systems of firms that audit Chinese companies. In our May issue, we highlighted the immense challenges China faces as the country seeks credibility, both with accounting standards which still have a long way to go in achieving IFRS comparability, and with Chinese companies whose records and reports continue to be the subject of questionable integrity.

The new agreement, while not permitting review or access to specific audit workpapers, will open the Chinese audit firms to observational visits, so inspectors can assess overall audit quality control procedures. That step allows both sides to work more closely together and, hopefully, to develop a higher level of trust. Ultimately, PCAOB standards require the review of actual workpapers. But for now, the agreement buys time as negotiations continue in the attempt to achieve that final goal.

China has concerns that any access to audit documents would violate the country’s sovereignty. Also, there is a perceived risk that state secrets would be disclosed, especially for audits of state-owned entities. If the differences between the PCAOB and the Chinese government are not resolved, the consequences could be far-reaching. The PCAOB could disqualify audit firms whose workpapers are not opened for inspection. The SEC could delist companies whose auditors are not in compliance. With the huge and expanding presence of Chinese companies on the world market, such an outcome would be regrettable.

 For further information see China Agrees to “Observational Visits” by PCAOB

Additional A&A News

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

  1. Going Concern SAS 126 Arrives
  2. ASB weighs in on IAASB “auditor commentary” requirements
  3. PCAOB and China Reach Agreement on Audit Observations 
  4. Cloud Computing for CPAs: Beware the Risks
  5. FASB Decides on New Exposure for Impairments
  6. Big Four alumni's influence could restrict competition in UK

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]