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Audit & Accounting Alert Newsletter

Issue 9 | November 2016


Gerry Herter

The new lease accounting standard is slowly working its way toward implementation over the next two to three years. Along with the imminent new revenue accounting standard, these two epic pronouncements will form a virtual one-two punch of major reform in financial reporting. Our first article emphasizes the importance of planning ahead, in order to avoid any unexpected last minute effects with leases that can produce unfavorable results.

Time and time again over the last several years, we have reported on concerns and shortcomings in audit quality, along with calls for transformational change. In 2014, the American Institute of Public Accountants (AICPA) took up the challenge, announcing a robust, comprehensive plan to turn things around. Now that two years have passed, as our second article reports, the AICPA details tangible progress that is being made.

Though the bitcoin cryptocurrency has experienced a volatile reputation in recent years, the underlying blockchain technology has received increasingly more attention and investment. The Big Four accounting firms are collaborating on joint approaches, while the Untied States Congress has even formed a Blockchain Caucus. Our third article describes current developments and potential applications.

Editor Gerald E. Herter, CPA

In This Issue 

Leases to Take Center Stage on Balance Sheets World-Wide

Financial implications can be substantial

“I don’t think anyone is ready for this,” commented Simon Terry-Lloyd, principal with real estate firm, Cresa San Diego, while addressing the upcoming new standard on leases, at Integra member Swenson Advisors’ Hot Topics Seminar in September. Terry-Lloyd was referring to the far reaching impact of the 2-3 trillion dollars of lease related assets and liabilities anticipated to collectively appear on balance sheets across the world within the next three years or so.

Cresa is one of the newest members of Integra International, as recently announced at the association’s annual world conference, held at Cape Town, South Africa, in October, 2016. Cresa is the world’s largest tenant-only commercial real estate firm.

Along with the monumental changes coming from the new Revenue Accounting standard, recapped in last month’s Audit & Accounting Alert, the near future is shaping up to be “the most exciting time for accountants in years,” as Swenson managing partner Steve Austin characterized it. The speakers emphasized that though the lease standard does not officially go into effect until 2019, the potential effect is so significant that companies need to plan far ahead to avoid unexpected consequences.

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), with the issuance of their corresponding standards in early 2016, have both agreed to the overall concept of reporting leases on the balance sheet as assets with corresponding liabilities. However, the boards differ as to the model for accomplishing that goal.

The FASB retains a two model approach for lessees. Under this approach, finance leases, which current accounting considers capital or purchase leases, will have the right-of-use balance sheet asset amortized as an expense using a straight line basis. The balance sheet lease liability will produce a separately reported interest expense. Operating leases will have the periodic lease cost amortized as a single expense using a straight-line method. Leases meeting any one of five criteria will be considered finance leases. All other leases will be considered operating leases. The criteria generally provide that the lessee receives the bulk of the value of the asset over the lease term, considering the nature and expected life of the asset, purchase options, and present value of payments. However, the old rules-based measures are replaced with principles-based determinations, so that leases cannot be cleverly structured to avoid the standard.

The IASB approach will consider all leases the same, using a one model approach. The lease costs will all be reported in a similar fashion as finance leases, with both amortization and interest expenses reported on the income statement.

Lessor lease accounting under both boards will be similar to the current standards, which already use an approach that corresponds to the finance and operating models above. Also, leases with terms of a year or less will be exempt from the standard, and groups of leases with comparable characteristics can be reported collectively as a portfolio.

According to the standards, “a lease is defined as a contract, or part of a contract, that conveys to the customer the right to use an asset for a period of time in exchange for consideration…A lease exists when the customer controls the use of the identified asset throughout the period of use. This is when the customer has the right to: 1) obtain substantially all of the economic benefits from use of the identified asset throughout the period of use, and 2) direct the use of the identified asset throughout that period.”

The new standard will change the way leases are looked at. As Don Mitchell, managing principal of Cresa San Diego put it, “it’s not about cash flow any longer, it’s about the impact on the balance sheet and profit & loss.” Consequently, companies should be planning now and not wait. Systems will need to be updated, along with proper controls, to accommodate the new standard. Some retrospective reporting will be required. With the new revenue accounting standard coming into place as well, consideration needs to be given to whether the two standards should be implemented together or in separate years. Also, the year of adoption will determine the interest rate used in asset and liability calculations, so the impact could be different depending on the year chosen. In addition, upcoming lease expiration dates and the potential for restructuring should be assessed while there is ample time for negotiating desirable terms.

Recognizing the need for a solution that combines accounting and real estate expertise to successfully maneuver through these potentially significant and complex issues, Swenson Advisors has teamed up with Cresa to develop AccountLease, an integrated service to assist clients with their lease planning process. Further details can be found at the Swenson Advisors website and the AccountLease Press Release

For further information, see  FASB In Focus on Leases and IASB shines light on leases by bringing them onto the balance sheet

Making Headway Toward Heightened Audit Quality

Progress report two years into AICPA’s enhancement initiative

In May, 2014, the AICPA announced a bold new plan to address the multiple challenges faced by auditors: the Enhancing Audit Quality Initiative (EAQ). The EAQ came three months after the release of the International Auditing and Assurance Standards Board’s (IAASB) Framework for Audit Quality (February, 2014). The impact of the IAASB framework was the subject of articles in the last two issues of the Audit & Accounting Alert, covering the perspectives of two European based studies.

Looking back over the first two years of the EAQ, the AICPA has reason to be encouraged with the results thus far, as described in their new report: Highlights and Progress 2016. The first step, issued in May, 2015, was A Six Point Plan to Improve Audits, the U.S. CPA profession’s answer to quality financial statement audits of private companies, employee benefit plans and governmental entities. The Plan introduced a roadmap for moving forward, focused on the six critical areas:

  1.  Pre-licensure
  2.  Standards and Ethics
  3.  CPA Learning and Support
  4.  Peer Review
  5.  Practice Monitoring of the Future
  6.  Enforcement

The progress report highlights accomplishments according to the six areas.

Pre-licensure - A pipeline covers various levels to stimulate entry to the profession for a wide diversity of qualified students. A successful four-state, pilot high school program partnering with the NAF Academy of Finance was recently launched nationwide, offering multiple learning platforms and a rigorous achievement program, coupled with accounting profession familiarization and career guidance. At the college level, a pilot program with seven state CPA societies is working to identify and support accounting students, while expansion of accounting doctoral programs and community college initiatives have reached more students with increased funding and scholarships. Also, the CPA exam is being revamped for use early in 2017 to enhance “testing of higher-order cognitive skills, incorporating critical thinking, problem-solving, analytical ability and professional skepticism.”

Standards and Ethics - The AICPA is committed to supporting practitioners with clear, practical standards on an ongoing basis, through the Auditing Standards Board. Also, the Assurance Research Advisory Group (ARAG) was established to tackle pressing issues. Working through a group of practitioners, academics and the American Accounting Association, ARAG focuses on challenging aspects of auditing, to offer helpful insights to auditors and the standard setting process.

CPA Learning and Support – Employing the new venture with the Chartered Institute of Management Accountants (CIMA), the AICPA established The AICPA | CIMA Competency and Learning Website, drawing together a wide range of audit and assurance educational opportunities, emphasizing the new approach toward programs that develop and improve competency, rather than just require compliance with completion of a certain number of hours.

Peer Review – Efforts during the first two years determined that effective methods for detection of deficiencies, and assurance of their remediation, topped the list of needed reforms. Resulting changes include new peer reviewer training requirements, new procedures for removal of poor performing firms, and closer focus on high-risk areas and industries, such as employee benefit plans and governmental single audits.

Practice Monitoring of the Future – In December, 2014, the AICPA issued a concept paper, Evolving the CPA Profession’s Peer Review Program for the Future . The paper envisioned an ongoing process of internal and external monitoring of audit firms, encompassing the following functions:

  1.  Continuous analytical evaluation of engagement performance
  2.  Human review when system-identified concerns are raised
  3.  Involvement of external monitors when necessary
  4.  Periodic inspection of system integrity
  5.  Oversight of the system’s operating effectiveness

The paper has stirred substantial discussion of what direction practice monitoring should take. The discussion continues, as well as pilot testing of a self-monitoring tool to assess how the new concept approach could be implemented.

Enforcement – Enhancement of this area includes the AICPA working with the National Association of State Boards of Accountancy and the U.S. Department of Labor to develop ways of sharing files to facilitate investigations.

Considering the comprehensive nature pf the above proposals, the AICPA has demonstrated a clear acknowledgement of the critical importance of attaining and maintaining the highest possible audit quality now and going forward. 

For further information, see  Enhancing Audit Quality - Initiative Highlights and Progress

Blockchain Technology Advances

Underlying technology for bitcoin has potential for wide range of activities

When bitcoin was last covered in the Audit & Accounting Alert about a year and a half ago, the market capitalization of the cryptocurrency had bottomed out at about $3 billion, the price was about $225 per bitcoin, and the daily trading volume was around $20 million. Despite lingering security concerns, the market cap, price, and volume in early October, 2016, were in the ranges of $10 billion, $600 and $60 million, respectively. That was despite news of the early August hack of the Bitfinex exchange where 120,000 bitcoins were stolen for a loss of $65 million. Of course, that loss paled in comparison to the Mt. Gox exchange collapse in 2014 that cost investors $500 million. Undoubtedly, improvements implemented since that episode will be supplemented with further tightening of controls in the wake of the more recent theft.

Apparently, one of the major concerns with bitcoin security lies with the safeguarding of the private keys used to access the bitcoins, rather than the underlying blockchain technology on which it is built. Two keys are required to access bitcoins, something like a virtual safe deposit box. When these keys are maintained online, the possibility of hacking is always a threat. In fact, exchanges, like Bitfinex, have even employed low-tech techniques, such as storing keys offline on hard drives placed in actual safe deposit boxes, to strengthen security.

Though bitcoin is the most popularly known use of blockchain technology, a number of other applications have been developed, or are the focus of substantial investment dollars. For example, the tiny country of Estonia utilizes blockchain with its X-Road and e-Residency programs. The distributed public ledger system allows citizens through X-Road to obtain their personal information from all governmental sources through a single entry point, while e-Residency provides a transnational digital identity for establishing and administering location-independent businesses online. Also, Estonia is working with NASDAQ on an e-voting process that will authenticate and record shareholder votes. The security features and speed of blockchain are desirable aspects. The small size of Estonia makes the country a manageable testing ground for these forward-looking technologies, prior to their expected launch on a larger scale.

Some other applications where blockchain technology is emerging involve electronic medical records and healthcare payment administration, organization of electricity microgeneration from home sources into energy markets, and legal “smart contracts” that are continually and validly updated. Countries in Africa that have faced challenges catching up with the rest of the world in various ways, may reap benefits. Just as the wireless cell phone has enabled countries to rapidly upgrade communication systems by bypassing the need for extensive cable infrastructure, blockchain technology can facilitate cross border payment transaction structures between disparate banking systems that are common in Africa.

As a refresher, here is a description of blockchain from the earlier Audit & Accounting Alert article:

“Virtual currencies, such as bitcoin, offer a triple entry approach, signified by an underlying technology known as the “blockchain.” The blockchain is described by Ryan Lazanis of Xen Accounting in a recent Techvibes article:

The blockchain is a public, decentralized, distributed ledger that is capable of storing and confirming the transactions that pass through it. This means that the ledger is not owned nor controlled by any one party. Instead the control of the network, or protocol, is distributed among the network’s users. As transactions hit the blockchain, they are confirmed as true and accurate by the network’s users, called miners. If you see a transaction on the blockchain, the transaction has been confirmed and it cannot be reversed.

When two parties enter into a virtual currency transaction, the blockchain becomes the third party, independently holding a copy of the entry, thus completing the triple entry.”

Lazanis predicted that blockchain would replace the current “third party,” the auditor accountant. The reality may be more of a shift in emphasis to real-time auditing and a different level of oversight. Nevertheless, as blockchain matures over coming years, accountants need to prove agile enough to adapt. Indeed, a consortium from the Big 4 accounting firms is collaborating over a process for developing blockchain standards, as well as ways to assist clients moving into this arena. Meanwhile, the U.S. Congress has established a Congressional Blockchain Caucus that will “work to raise awareness, promote policies and safeguard consumers.”

For further information, see  How blockchain will impact accountants and auditors

Additional A&A News

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

  1. Will Artificial Intelligence And Cloud Accounting Replace The Accountants Of Tomorrow?
  2. Invigorate the Focus on Quality Toolkit
  3. Adding Up 'The Accountant' Toolkit
  4. US Federal Reserve sees blockchain as revolutionary, but still to prove itself'
  5. Audit Leaders Focus on Emerging Risks
  6. Earnings Management Just as Bad under IFRS as U.S. GAAP

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]