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Audit & Accounting Alert Newsletter

Issue 8 | October 2016


Gerry Herter

The far reaching Revenue from Contracts with Customers accounting standard is midway between issuance and the effective date. Having been mutually adopted by both the international and United States accounting boards, the standard will transform revenue reporting on a worldwide basis. As our first article reports, the boards, professional groups and companies are in the midst of resolving and clarifying issues while tackling the daunting implementation process.

Audit quality continues to be an elusive goal, both for measurement and attainment. Resuming the series on audit quality, our second article takes a look at the survey report issued by the Association of Chartered Accountants, comparing and contrasting the views of corporate directors, CFO’s and auditors.

Finally, the realm of non-profit financial reporting has taken center stage in the United States. More than twenty years have passed since standards for financial reporting and accounting have been updated. Our third article highlights the new standard issued by the Financial Accounting Standards Board.

Editor Gerald E. Herter, CPA

In This Issue 

Revenue Accounting Standard Progressing Toward Implementation

Amendments and guidance address issues

Well over two years have passed since the monumental revenue accounting standard was jointly issued by the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) in April 2014. Since then, six amendments have been made to the FASB pronouncement and two to the IASB pronouncement, including deferral by both Boards of the effective date for an additional year to 2018, which provides the better part of four years between issuance and implementation.

The core principle of the global standard is for companies to recognize revenues in a way that shows the transfer of goods and services to customers that reflects the payment to which the company expects to be entitled. To achieve that core principle, an entity shall apply all of the following five 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.  Recognize revenue when (or as) the entity satisfies a performance obligation.

The standard applies broadly across all industries, with exceptions only for some leases, insurance contracts, financial instruments and guarantees (other than product or service warranties), which are specifically covered by other standards.

The amendments by both boards cover mainly clarifications concerning the identification of performance obligations, licensing, principal versus agency considerations, and various narrow scope improvements and practical expedients.

One major challenge, primarily for American companies, is that the standard is “principles” based, as opposed to the past “rules” based standards that have been the norm for those applying FASB standards. Consequently, judgment plays a greater role under the newly converged standard. As a means to bridge the gap, the AICPA established a process to provide specific guidance directed toward individual industries. Task forces for sixteen different industries have been at work identifying implementation issues for consideration in a new Accounting Guide on Revenue Recognition that is under development.

As of August, 2016, 154 potential issues have been identified. Industries with ten or more issues include aerospace & defense, airlines, engineering & construction contractors, gaming, power and utility entities, software entities, telecommunication entities, and timeshare entities. The issues are submitted for due diligence reviews by the AICPA’s Revenue Recognition Working Group (RRWG) and Financial Reporting Executive Committee (FinREC), before being exposed for public comment. Where needed, the FASB’s Transition Resource Group (TRG) is consulted. Twenty-nine issues have reached the exposure draft stage, and nine have been finalized.

Additionally, the FASB on August 31, 2016 tentatively approved a number of items to include in technical corrections updates expected in the fourth quarter. One of those updates will:

  1.  Supersede the guidance on preproduction costs of long-term supply arrangements, except for capitalization of certain molds, tools, and dies;
  2.  Amend the impairment testing guidance for contract costs;
  3.  Amend the guidance for testing the provision for losses on construction- and production-type contracts;
  4.  Exclude all contracts (not only insurance contracts) that are within the scope of the accounting standards on insurance; and
  5.  Align the cost-capitalization guidance in the standard for financial services-investment companies, resulting in capitalization of direct incremental costs, for advisors to both private and public funds.

A separate update will exclude financial loan guarantees, reinstate the guidance on the accrual of advertising expenses, and make minor changes regarding contract receivables and liabilities.

Finally, the Not-For-Profit industry task force referred the issue of grants and contracts to the FASB for consideration. The FASB is exploring ways to improve guidance for distinguishing between conditions and restrictions for contributions, using a “right of return” approach.

The revenue accounting standard is just one of two monumental accounting changes occurring in 2018/2019. Next month, the Audit & Accounting Alert will recap the new standard on leases that is effective in 2019. The IFRS has stated that early adoption of the lease standard is permissible if the revenue accounting standard has also been adopted. With these complicated accounting and timing issues, companies may need to consider a strategy, in order to optimize how and when to implement the standards. One of our Integra International firms has developed a structured approach to proactively address the multi-faceted aspects of effective lease accounting implementation. If you can not wait until the next Audit & Accounting Alert, contact me for the firm name. 

For further information, see  The End of Accounting and the Path Forward for Investors and Managers and Managers and AICPA Revenue Recognition Task Force - Status of Implementation


Perceptions of Audit Quality Attributes

Directors, CFOs and auditors weigh in

Last month, the Audit & Accounting Alert reported on the Federation of European Accountants’ (FEE) paper detailing the state of audit quality initiatives (AQI) internationally. This month, a different approach is explored by the Association of Chartered Accountants (ACCA). In July, in conjunction with Macquarie University, Sydney, ACCA presented results of a survey report: Directors’, CFOs’ and auditors’ perceptions of audit quality attributes: a comparative study.

The ACCA survey looked at the implications of the following ten designated audit quality attributes from the perspective of the three stakeholder groups: directors, CFOs and auditors:

  1.  Audit firm size
  2.  Partner/manager attention to audit
  3.  Communication between audit team and client management
  4.  Audit partner tenure
  5.  Audit quality assurance review
  6.  Provision of non-audit services (NAS)
  7.  Audit firm industry experience
  8.  Partner knowledgeable about client industry
  9.  Senior manager or manager knowledge of client industry
  10.  Very knowledgeable audit team

Some of the attributes, like industry knowledge and assurance reviews, correlate directly with the FEE AQIs, while others, like firm size, have a more indirect relationship.

Survey results revealed some areas of similarity between the three stakeholder groups, while other areas displayed differences. They all felt that firm size was the most important attribute, while partner/manager attention to audit was next in importance. While communication between audit team and client management was considered more important than other attributes, audit partner tenure and audit quality assurance reviews (both internal and external) were considered to be relatively low in importance.

Of the areas of difference, directors and CFOs ranked provision of non-audit services as higher in importance than did auditors. Also, while all three groups ranked the last four (“knowledge”) attributes as having relatively moderate influence compared to other attributes, directors ranked manager industry knowledge as the more important of those, while CFOS ranked partner industry knowledge as the more important, and auditors ranked a very knowledgeable audit team as the more important.

The authors of the ACCA study state that the ranking of audit firm size as the most important attribute is consistent with prior research. Of course, the fact that most of the survey participants are from large audit firms or large companies, may also have something to do with the result. More surprising is the low ranking given to audit partner tenure and audit quality assurance reviews, since regulators have given these areas a lot of attention. Of course, auditors cannot be expected to care for intrusive inspections, while CFOs and directors may not see much direct benefit to them, either. All could be expected to desire audit partner tenure, for the benefit of the extended knowledge and experience that comes with it.

The differences in perceptions of audit quality expressed by the three stakeholder groups in the survey is reminiscent of the differences in emphasis placed on audit quality indicators by regulatory authorities, as described last month in the FEE paper. There is still a long way to go to develop consensus as to the best way to identify and attain a consistently high level of quality in audit performance and results.

Next month, we will look at a newly issued report of Highlights and Progress stemming from the first year results of the AICPA’s Enhancing Audit Quality Initiative. The report expresses encouragement, from what current accomplishments indicate for the prospects of future advances.

For further information, see Directors’, CFOs’ and auditors’ perceptions of audit quality attributes: a comparative study.

New Look Coming for Non-Profit Financial Statements

FASB issues major new standard for US organizations

 When first described as an exposure draft in the June, 2015 Audit & Accounting Alert, the now newly released (August 18, 2016) standard, Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities (ASU No. 2016-14), represented the first major proposed change for reporting in the non-profit arena in over 20 years.

 FASB Statement 117, Financial Statements of Not-for-Profit Organizations (6/93), along with FASB Statement 116, Accounting for Contributions Received and Contributions Made (6/93), had brought standardization to reporting practices at that time. However, just as times are rapidly changing in the realm of for-profit reporting, users of not-for-profit financials are calling for updates here as well.

The length of time from exposure in April, 2015 to issuance almost a year-and-a-half later, is indicative of the comprehensive nature of the deliberations undertaken. Along with 260 comment letters to consider, well over a hundred meetings, workshops and roundtables were conducted with various industry groups, preparers, auditors and other stakeholders.

The first major change to enhance clarity and usefulness for users, such as donors and creditors, impacts the statement of financial condition. The current separation of restricted net assets into temporary and permanent, along with calling the rest unrestricted, apparently has caused confusion. Consequently, those three designations are replaced by two: net assets with donor restrictions and net assets without donor restrictions. The disclosure requirements for describing types, amounts and liquidity of donor restrictions are retained, as well as for board designations, which differ from donor restrictions in that they are self-imposed. Also, capital gifts will be released from restriction once placed in service, rather than over time, unless specified differently by the donor.

 Endowment fund treatment has also caused confusion. When the current fair value of the fund falls below the original donor given amount, the shortfall will now be reflected in the net assets with donor restrictions, rather than in unrestricted net assets, as is the case in the present standard. Also, disclosures are to describe current policies and actions taken.

Liquidity is an important issue with the proposal. Qualitative and quantitative disclosures are designed to help the user ascertain the availability and timing of cash and other assets to fulfil obligations, as they occur generally and specifically for the coming year. Also, the influence of donor restrictions, internal board directed limitations, and the organization’s liquidity management policies are a focus to be emphasized.

The proposed changes in the statement of activities result from a lack of specificity in the current standard. The new rules will require showing the change in net assets for the two new above-mentioned classes. Also, operating expenses will need to be shown, here or elsewhere, both by nature and function. Investment return is to be reported net of related expenses, in order to improve comparability between non-profits, regardless of whether investments are managed internally, externally, or through use of mutual funds or similar vehicles.

One change from the original exposure draft is that either the direct or indirect method will be allowed for the statement of cash flows, similar to the current standard. The proposal initially was going to require only the direct method, which typically takes more work compared to the indirect method. The direct method presents the specific cash flows, such as the amount of cash collected from customers and paid to suppliers, payroll paid to employees, interest received and paid, and income taxes paid. The indirect method generally shows just the net changes in balance sheet accounts. If the direct method is used, the new standard, unlike the old one, no longer requires an additional reconciliation using the indirect method.

The other significant change from the exposure draft involves the operating measure. The FASB decided to conduct further research before requiring the use of an operating measure to report operating versus non-operating activities.

The new standard is effective generally in 2018, with early application permitted. .

For further information, see ASU No. 2016-14, Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities.

Additional A&A News

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

  1. A Sour Surprise for Public Pensions: Two Sets of Books
  2. KPMG Launches Blockchain Service in Canada
  3. Three ways audit executives can increase impact and influence
  4. PCAOB, German regulator to cooperate in oversight of audit firms
  5. Are you getting fair value?
  6. Bogus Audited Statements Are Holding Africa Back

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]