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Audit & Accounting Alert Newsletter

Issue 7 | September 2012


Gerry Herter

Change continues to be one of the few constants in the accounting profession, like the rest of the world. The diversity of stakeholders calling for a whole new world of content in company reports is growing rapidly, as our first article on integrated reporting points out. Meanwhile, the requested changes in the American private company reporting standards process, covered in our July Issue, took a step forward with a newly released FASB Invitation to Comment. The Discussion Paper lays out criteria for determining exceptions to US GAAP for non-public entities, as described in our second article. Finally, change continues to bring new opportunities for fraud and wrong doing. But, ironically, the underlying behaviors and motivations are surprisingly familiar. Our third article describes a recent example.

Editor Gerald E. Herter, CPA

In This Issue 

Sustainability Accounting

Integrated Reporting adds the environmental and social perspective

At the annual AICPA Practitioners Symposium in June, AICPA President, Barry Melancon, and Chairman Greg Anton, addressed current items impacting the accounting profession as well as emerging issues and potential service opportunities on the horizon. During his comments, Anton made a prediction: “I truly believe that private companies and our staff are going to be working in an integrated reporting space in the future. I can’t tell you whether it is two, three, four, five years out, but there will be private companies that will want to start using integrated reporting.”

For a lot of accountants, integrated reporting is not yet on their radar. But several recent announcements shed some light on endeavors already well under way. According to a September 2011 discussion paper exposed for comment by the International Integrated Reporting Committee (IIRC),

Integrated Reporting brings together material information about an organization’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It provides a clear and concise representation of how an organization demonstrates stewardship and how it creates and sustains value, now and in the future.

Integrating sustainability into capital markets is the core mission of Ceres, originally known as the Coalition for Environmentally Responsible Economies. Ceres, founded in 1989, the year of the Exxon Valdez oil spill, was an originating point for integrated reporting. Ceres launched the Global Reporting Initiative (GRI) in 1997. According to its website, “GRI works towards a sustainable global economy by providing organizational reporting guidance.” GRI’s first Sustainability Reporting Guidelines were published in 1999 to establish an initial context. On June 25, 2012, GRI issued the second draft of G4, its fourth generation of guidelines, to further refine and harmonize with other international standards.

The guidelines have assisted organizations in evaluating how their early sustainability reporting efforts have measured up, while also providing a process for determining how and what to report. Categories for disclosure are economic, environmental and social. The reporting assesses both how effectively an organization will function going forward considering the current and impending realities in these categories, as well as the impacts the organization will have on them in return. For example, maintaining market presence would be an aspect of the economic category, whereas availability and means of acquisition of key resources would be an aspect of the environmental category. The social category is further subdivided into labor practices, human rights, society and product responsibility.

Taking the final step toward creating a fully integrated reporting framework that could gain worldwide authority, GRI, along with the International Federation of Accountants (IFAC) and the British Prince’s Accounting for Sustainability Project, created the IIRC in 2010. Seeking input internationally from a wide range of stakeholders, the IIRC summarized the responses to its 2011 paper in a May 2012 report, followed in July by a draft outline of the reporting framework that hopefully can lead to a formal exposure draft in 2013.

Though wide support was expressed for the general idea of an international integrated reporting framework, respondents voiced substantive difficulties in achieving that goal. This mindset is reminiscent of the reaction when the prospect of international financial reporting standards was first broached. Attainment for integrated reporting may well take as long as globally accepted IFRS has taken.

Current document drafts acknowledge the need to address concerns such as materiality and timing while fleshing out more specifics and flexibility for various industries and stakeholders. Before proceeding much further, results will be analyzed from a pilot program that 70 organizations from 22 countries will be participating in this year to experiment with integrated reporting and to test concepts.

Even so, advances are being made globally and locally. The South African stock exchange has required a type of integrated report since 2010, while the Brazilian and Singapore exchanges require or recommend inclusion of environmental and social data in reports. In the United States, the recently formed Sustainability Accounting Standards Board (SASB) plans to design industry-specific ESG (environmental, social and governmental) information that can be adapted for inclusion in the risk factors section of SEC 10-k reports. Finally, the IAASB in June issued ISAE 3410: International Standard for Assurance Engagements on Greenhouse Gas Statements. This statement appears to be none too soon, since the United Kingdom also in June announced a requirement for large listed companies to report on greenhouse gas emissions starting next year.

For further information, see International Integrated Reporting Committee and Global Reporting Initiative 

FASB Seeks Input on Private Company Reporting Framework

Results to be deliberated with new Private Company Council

The May 30, 2012 report of the Financial Accounting foundation, Establishment of the Private Company Council, restored a sense of hope in the private sector that financial reporting standards could finally be attained that are both practical and relevant in the non-public arena.

In our July Audit & Accounting Alert, we pointed to two provisions that could determine whether the Private Company Council (PCC) is successful: agenda setting and FASB endorsement. While the effectiveness of FASB endorsement will come further down the road, agenda setting is now under way. According to the May report, the PCC and FASB are to jointly agree on criteria for determining whether and when exceptions or modifications to GAAP are warranted for private companies. When agreed upon, these criteria are to be exposed for public comment before finalizing. The PCC is then to use these established criteria for setting their agenda.

On July 31, the FASB took the first step, issuing the Invitation to Comment-Private Company Decision-Making Framework: A Framework for Evaluating Financial Accounting and Reporting Guidance for Private Companies (ITC). While waiting for the new PCC to be formed, which is anticipated by the end of the year, the FASB had its staff prepare the ITC with the staff’s initial recommendations, based on input received over the past two years from users, preparers and auditors of private company financial statements. Once the comment period ends on October 31, and the PCC is formed, the FASB and PCC will jointly deliberate on the comments and make the final decision on what the criteria will contain.

The ITC emphasizes that the process is not seeking a completely new conceptual framework for private company reporting, but just a formal means for determining when differences in the application of GAAP are appropriate. The ITC lays out for comment six significant factors that differentiate the financial reporting considerations of private companies from public companies:

  1. Types and number of financial statement users
    Private companies control who financials are given to, and tend to have a smaller number of users, usually creditors and owners with specified needs, such that relevance and cost effectiveness of information are considerations.
  2. Access to management
    Private company users have direct access to management for further information, which can be tailored to their specific requests, reducing the need for detailed disclosures.
  3.  Investment strategies
    Private company investors tend to be longer term and look for a sale or buyout of the company as opposed to selling shares on the stock market, making disclosures of cash flow and EBITDA most relevant.
  4.  Ownership and capital structures
    Private company structures deal with tax ramifications and succession as opposed to sophisticated equity instruments, signifying a need for a different accounting and disclosure focus.
  5.  Accounting resources
    Private companies have less accounting personnel and resources, indicating that cost-benefit analysis of reporting standards should be a consideration.
  6.  Learning about new financial reporting guidance
    Private company preparers need more time to learn about and assimilate new guidance, such that deferred effective dates are appropriate.

Also, five areas where financial accounting and reporting guidance might differ for private and public companies are specified for consideration when assessing issues such as relevance, cost complexity, and special industry needs:

  1. Recognition and measurement
  2.  Disclosures
  3.  Display (presentation)
  4.  Effective dates
  5. Transition methods

Illustrative flowcharts are incorporated to assist in visualizing the decision making framework for these issues.

Additionally listed in the ITC are thirteen financial statement categories typically focused on by users that the staff feels should not be subject to exceptions or modifications.

A separate FASB project is working on a definition of a nonpublic entity, which will determine who will fall within the scope of the new framework. An appendix in the ITC covers the status and tentative decisions reached.

For further information, see Private Company Decision-Making Framework

Frauds are a Continuing Menace

“Those who don’t learn from the past…”

One of the worst nightmares for auditors and their malpractice insurance carriers is when a subsequent fraud is discovered at a company where the auditor had issued a clean opinion. While auditors are well aware of the limitations for audits to detect defalcations, the average public has much higher expectations..

No matter how stringent standards and procedures become, the complete elimination of fraud is not realistic as long as human beings are involved. Nevertheless, despite the increasing sophistication in areas, such as electronic systems, which may take experts to assess the adequacy of controls, many present-day frauds involve classic techniques that can be detected by traditional internal controls and professional skepticism, if they are in place and effectively employed.

In a recent example, with a perpetrator that could have come “straight out of Central Casting”, over $200 million in cash was proven to be missing from the bank account of Peregrine Financial Group’s PFGBest unit, a commodities trading firm. While the company’s founder and chairman, Russell Wasendorf, Sr., was inhaling carbon monoxide fumes through a hose in a suicide attempt, a belated audit procedure was finally uncovering the scam that had succeeded for nearly twenty years.

In a suicide note, Wasendorf laid out his plan of deception:

“Through a scheme of using false bank statements I have been able to embezzle millions of dollars from customer accounts at Peregrine Financial Group, Inc.…The bank statements were always delivered directly to me when they arrived in the mail. I made counterfeit statements within a few hours of receiving the actual statement and gave the forgeries to the accounting department…

“I had no access to additional capital and I was forced into a difficult decision: Should I go out of business or cheat? I guess my ego was too big to admit failure. So I cheated, I falsified the very core of the financial documents of PFG, the Bank Statements…I also made forgeries of officials letters and correspondence from the bank, as well as transaction confirmation statements. Using a combination of Photo Shop, Excel, scanners, and both laser and ink jet printers I was able to make very convincing forgeries of nearing every document that came from the Bank.

“With careful concealment and blunt authority I was able to hide my fraud from others at PFG… If anyone questioned my authority I would simply point out that I was the sole shareholder…I was also the only person with online access to PFG’s account.

“When it became a common practice for Certified Auditors…to mail Balance Confirmation Forms to Banks and other entities holding customer funds I opened a post office box. The box was…in the name of… (the)Bank....When online banking became prevalent I learned how to falsify online Bank Statements and the Regulators accepted them without questions.”

The Peregrine fraud was uncovered by the use of an electric confirmation through Capital Confirmation’s system, a newly established requirement by the industry regulator, National Futures Association. has become a major player in this arena, which should reduce this type of fraud where it is employed. Even so, Wasendorf’s scheme could have been uncovered years ago if the auditor had simply verified where the paper confirmation request was being sent. This crime was revealed nine years after billions of dollars of cash were lost in a similar scandal at Parmalat. For this type of fraud to go undetected for so long should be unacceptable in the audit profession.

Integra International members will recall the San Diego conference in 2004 where Barry Minkow, convicted felon of the ZZZZ Best Ponzi scheme fraud, described techniques similar to those of Wasendorf’s. Minkow forged countless documents among other creative deceptions back in the 1980’s. At the time of the 2004 conference, Minkow, apparently reformed, had been out of prison for almost ten years. But in 2011, he was incarcerated once again, for a subsequent securities conspiracy conviction involving the stock of Lennar Corporation.xposure draft to be issued in June 2013 and finalized in June 2014.

 In the case of Peregrine, investors using the company to invest their money should also accept some responsibility. The auditor for Peregine happened to be a one person shop, Jeannie Veraja-Snelling, who operated out of a house in Glendale Heights, Illinois. After the Bernard Madoff scandal in 2008, which was also facilitated by a one person CPA firm, investors should be expected to evaluate more closely the audit firm that reports on the financials of a company with whom they plan to invest. Of course the regulators, as well, should have exercised more scrutiny on these accounting firms, long before these tragedies occurred.

A fraud like the one at Peregrine should worry auditors and investors alike. How many others are out there that have been going on for years undetected? In recent weeks, the SEC even uncovered two more Ponzi schemes costing investors tens of millions of dollars. Modern techniques such as will assist in tackling some of the problems. But careful attention to the basic concepts of internal controls and fraud detection must continue to be a primary focus.

For further information see Anti-Fraud Initiative of the Center for 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. Accounting Differences Crimp Cross-Border Mergers
  2. FASB proposes presenting amounts reclassified out of accumulated OCI
  3. PCAOB Adopts New Standard for Communications with Audit Committees 
  4. FASB Agrees to Tighten Sale Accounting Criteria
  5. AICPA releases draft of proposed not-for-profit guide
  6. US won’t adopt IFRS for at least five years, says AICPA chairman

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]