May 29, 2012
To our peer review clients:
Annually we make an effort to highlight recent changes in professional standards for our peer review clients. We hope what follows is helpful to you in your accounting and auditing practice.
New Accounting Standards
We will start with a reminder. Although footnote disclosure requirements for small business clients had not changed significantly in several years, there were several major changes, as reported in our update letter the past two years, which affect private sector companies and nonprofit organizations, as follows: a) accounting standards codification, b) uncertain tax positions, c) subsequent events, and d) fair values. We included sample footnote disclosures for these items in our 2010 letter, which has been posted to our website at www.peer-review.com .
Performing peer reviews the past two years, we have noticed that most firms have implemented the new standards on subsequent events and codification, but many struggle with the fair value note, and the disclosure for years subject to examination by major taxing jurisdictions required by the standard on uncertain tax positions is frequently omitted. Many firms omit this disclosure on flow-through entities that do not typically pay income taxes, which is understandable given the requirement originated in a standard on uncertain tax positions, but we recommend including the disclosure of years open to examination on flow-through entities and nonprofits too. The peer review checklists include a step requiring the peer reviewer to look for this footnote. The disclosure on years subject to examination should be part of the boilerplate in your accounting policies footnote, like the disclosure on use of management estimates.
FASB and the IASB have been working on major convergence projects for several years, initially with anticipated release dates in 2011. It now appears the only major standard resulting from these efforts with a release date in the near term is the standard on revenue recognition. FASB and the IASB recently issued a revised exposure draft of the revenue standard. The original exposure draft would have required significant changes in revenue recognition for the construction industry. The revised exposure draft appears to allow for continued use of percentage of completion in the construction industry. There is a possibility that the standard on leases, converting operating leases to capital leases, will be issued in 2013, although there is a lot of push back on this one. Recently 62 members of Congress signed a letter to FASB expressing their concerns about the standard on leases.
A quick overview of recent Accounting Standard Updates (ASU) follows:
Goodwill Impairment: ASU 2011-08 simplifies the goodwill impairment test, which is a concession by FASB to the needs of local firms. The standard had required a company calculate its fair value annually as the first step in determining if goodwill is impaired. The new standard allows management to forego the fair value computation as long as “events and circumstances” suggest it is “more likely than not” that fair value exceeds the “carrying amount” (i.e., fair value exceeds net book value). The standard is effective for fiscal years beginning after December 15, 2011, and early implementation is permitted.
Disclosures for Multi-Employer Plans: In the past disclose was limited, for the most part, to the dollar amount of plan contributions. ASU 2011-09 requires much more disclosure, including information on the financial health of the plan. Clients operating in the construction industry are the most likely to be affected by this standard, which is effective for years ending after December 15, 2012.
Other Comprehensive Income: As discussed in last year's update letter, ASU 2011-5 significantly revised presentation standards for other comprehensive income. Now ASU 2011-12 defers the effective date for presentation of reclassification adjustments, allowing disclosure in the footnotes instead of on the face of the income statement, which is consistent with current standards. The other changes contained in ASU 2011-5, such as the prohibition against reporting comprehensive income on the statement of stockholders' equity, still apply. ASU 2011-5, as amended, is effective for years ending after December 15, 2012.
Fair Value: Although ASU 2011-04 has new fair value disclosure requirements, beginning in 2012, some of them, such as disclosures regarding transfers between Level 1 and Level 2 measurements, do not apply to nonpublic companies.
Investment Property Entities: Another change in the fair value area is pending. A proposal from FASB would require companies whose business activities are related to investing in real estate to report real estate properties at fair value.
New Compilation and Review Standards
SSARS No. 19, “Compilation and Review Engagements,” was effective for periods ended on or after December 15, 2010. We discussed this standard in our letter the past two years. This represented a major change, requiring new report language, among other things. If you are unfamiliar with this standard, you will want to read it right away. According to AICPA guidance to peer reviewers, failure to implement this standard results in a substandard peer review on engagement peer reviews. The percentage of pass with deficiency and fail peer review reports was far higher in 2011 than in any previous year as a result.
ARSC has issued new guidance on the compilation and review report language to use when reporting on required supplementary information, which is already present in the sample reports in the PPC service.
Looking forward, there are major changes on the horizon for compilation and review services, although they are not yet in exposure draft stage. Just as the ASB had its Clarity Project, the ARSC has embarked on its own Clarity Project, which will likely be effective for periods ending on or after December 15, 2014. The SSARS Clarity Project is tied to a proposed revision to Ethics Interpretation 101-3. The most significant change is to separate financial statement preparation services (non-attest) from the compilation service (attest). The new standards will define financial statement preparation as a non-attest service, just as currently tax preparation services are non-attest. Financial statements issued without a report will be “plain paper” engagements. Accountants will no longer report on financial statements unless the client engages the accountant to read and report on them, in which case a compilation report may be issued. Each page of the financial statements will caution the user that the financial statements are neither audited nor reviewed, nor are they compiled. Management use only (also known as “SSARS 8”) engagements, which are a form of “plain paper” engagement under current standards, no longer make sense in this environment and in fact go away under the Clarity Project.
Private Company Standards and the Fate of the Blue Ribbon Panel
It may be instructive to view the standard setting process through a political lens. Historically FASB received funding through voluntary contributions from the large auditing firms and publicly traded companies. These voluntary contributions might be perceived in the same light as political contributions to candidates for public office: as a method of buying influence. But after Enron, starting in 2002, the federal government required mandatory contributions to FASB from market participants. The large auditing firms could no longer threaten to withhold funding if they were unhappy with a proposed standard. This gave FASB more independence and it was at this juncture that the large auditing firms increased funding to the IASB and the movement to adopt international standards gained momentum. Unlike FASB the IASB relies on voluntary contributions. The Big Four contribute millions annually to the IASB. The replacement of US GAAP with international standards may be perceived as a mostly successful effort by the large auditing firms to regain control, after Enron, of the standard setting process. The SEC is concerned that FASB may cede control over GAAP in the United States to the IASB and is working to prevent that.
Unfortunately for smaller firms, this kind of maneuvering at the international level has an impact locally. Publically traded companies gain more flexibility in reporting results of operations, while local firms struggle to learn a new set of rules. Under these circumstances, it's not surprising there is so much interest in establishing a new board to set standards exclusively for private companies. A blue ribbon panel formed by the AICPA and FASB's parent organization, the Financial Accounting Foundation (FAF), recommended in January 2011 that such a board be formed.
FAF did not accept the recommendation and proposed, as an alternative, the creation of a Private Company Standards Improvement Council (PCSIC) that would advise FASB on whether private companies are exempt from standards not suitable for the environment in which they operate. The AICPA was unhappy with the proposal because FASB would have the right to veto PCSIC recommendations.
FAF received over 10,000 comment letters on this topic overwhelmingly favoring an independent standards setting board but was not swayed. At its May 23, 2012 meeting the FAF announced the creation of a “Private Company Council” (the acronym will be PCC rather than PCSIC). The PCC will determine if exceptions to existing GAAP are appropriate for private sector companies, but exceptions will require FASB's approval before they may be applied. As expected the AICPA's reaction was negative. Within an hour of the announcement from the FAF, the AICPA said it will develop a new “enhanced and simplified financial reporting framework” or “Little GAAP” for privately held companies to use instead of FASB standards.
Firms with Audit Clients
The ASB Clarity Project involves the converging of US GAAS with International Standards on Auditing (ISA). The ASB has reissued all previously issued statements on auditing standards in a new format. SAS No. 122, Statements on Auditing Standards: Clarification and Reconciliation, was issued in October 2011 and is effective for periods ending on or after December 15, 2012. SAS No. 123 is an omnibus statement that amends previous statements, such as SAS No. 117, that were issued in the Clarity format in recent years.
SAS No. 122 and 123 cannot be early implemented. Continue following existing auditing standards for fiscal years ending June 30 and September 30, 2012.
Some accountants may have a sense of complacency regarding the Clarity Project, viewing the project as simply the reformatting of existing standards, but there are significant revisions included.
Perhaps the most noteworthy change under the Clarity Project is the revision to the auditor's report language, but the wording of other auditor communications will change too, so please be careful, since peer reviewers will focus on compliance in these areas.
Here are some of the more significant changes in practice required under the Clarity Project:
• New auditor's report language (with “section headings”)
• New audit engagement letter language
• New language for communicating internal control deficiencies (i.e., the old “SAS No. 115 letter”)
• New management representation letter language (with “section headings”)
• New requirement to document audit “strategy” (though this may be steps on the audit program, since an audit strategy memorandum is not required)
• New documentation required for “performance” materiality (similar to the tolerable misstatement concept in current standards)
• New requirements for group audits, which may apply even when the audit is conducted by one firm
• Additional procedures required on opening balances in an initial audit engagement
• Requires an understanding of accounting estimates, including a retrospective review, during the risk assessment stage, with new documentation requirements
• New requirement to discuss related parties during engagement team discussion and potentially treatment of related party transactions as significant audit risks
• Required review of the client's correspondence with regulators
• Removes the term “OCBOA” from the standards and replaces with more specific references to cash, tax, contractual or regulatory “special purpose frameworks”
The PPC audit practice aids have guidance under both the new and the pre-clarification audit standards.
SAS Nos. 118, 119 and 120 on supplementary information affect the wording of your audit opinions, increase the level of audit procedures applied to supplementary information, and are effective for periods beginning after December 15, 2010. Many firms used the new report language last year, since the sample reports in the PPC practice aids incorporated the changes before the implementation date.
SAS No 125 will replace the “restricted use” paragraph that appears in audit reports in certain circumstances with an “intended use” alert paragraph. On audits preformed under Government Auditing Standards, there will be a “purpose” rather than “intended use” alert paragraph. Language limiting use of the report is seen most often as the final paragraph on the internal control and compliance reports issued in audits performed under Government Auditing Standards. See discussion of effective dates for this standard in the “Firms with Governmental Audits” section that follows.
Firms with Governmental Audits
The final version of the 2011 Yellow Book was issued in December 2011 but it is not effective until periods ending after December 15, 2012, which is the same time period the ASB Clarity Project becomes effective. Neither standard may be early implemented. The most significant changes in the 2011 Yellow Book are in the area of auditor independence, including a documentation requirement that exceeds AICPA requirements: the auditor must document why management is able to oversee a nonaudit service performed by the auditor. The prohibition on auditing a bookkeeping client remains in force for all intents and purposes. As before, the auditor may prepare financial statements for an audit client even when the client's controls over financial reporting are deemed a material weakness. The GAQC has a nonaudit services practice aid that is helpful in creating the independence documentation.
On February 28, 2012, the OMB released an “advance notice” to revise Circular A-133. This is not a proposed regulatory change, so nothing may come of it, but the OMB is considering an increase in the Single Audit threshold from $500,000 to $1 million. For entities with between $1 million and $3 million of federal expenditures, the Single Audit would be more streamlined with a focus on only two compliance requirements. Tests for compliance for allowable and unallowable under the new standard would always be required, while the second compliance area will vary.
Other areas to consider on your governmental engagements include:
- As noted in our letter last year, funding under the American Recovery and Reinvestment Act (ARRA) continues to increase the number of major programs subject to audit under A-133. Programs listed in the Compliance Supplement with a Recovery Act CFDA number will not qualify as low-risk Type A programs, unless the ARRA funds do not exceed 20% of expenditures in the current year, and unless the Type A program was audited as a major program in one of the two prior years. The two year window is an improvement over last year, when a one year look back period applied.
- SAS No. 120 on required supplementary information (RSI) changes the definition of RSI such that this terminology can no longer be used when reporting on OCBOA presentations. Many smaller governmental units report on a modified cash basis and on such engagements auditors will have to report on the MD&A and any other information formerly designated “RSI” as Other Information (OI) following the SAS No. 118 guidance. Guidance from the Oregon Audits Division suggests that the MD&A section will be optional on such engagements.
- The AICPA plans to issue an updated guide for preparing OCBOA financial statements for local governments.
- You will recall the recommended format for the auditor's comments required under the Oregon Minimum Standards changed a couple of years ago, and now the approach to follow on review engagements for smaller municipalities is changing. The comments section will be deemed a management report, and the accountant will report on it as supplementary information, effective with the June 30, 2012 fiscal year. A reporting template will be posted to the OSCPA site.
- SAS No. 125 (discussed above under the “Firms with Audit Clients” heading) is effective for Single Audit reports issued after December 15, 2012, so may apply to a June 30, 2012, fiscal year end, for example, when the Single Audit section is issued after December 15, 2012. On the other hand, the effective date for the SAS No. 125 language with respect to the Yellow Book internal control and compliance report is based on the fiscal year of the related financial statements. For example, you would use the old language if the report is issued in connection with a June 30, 2012, financial statement even if the report is issued after December 15, 2012.
- Note that there are a number of GASB Statements effective next audit season for years ended June 30, 2013, on highly technical topics such as derivatives and service concession arrangements that have ramifications for all engagements. For example, the introduction of the concepts of deferred inflows and deferred outflows leads to the renaming of the statement of net assets “the statement of financial position” and the caption for the equity section changing from “net assets” to “net position.” There is a new standard redefining component units, which is intended to result in a reduction in the number of entities included as component units in the financial statements.
- GASB is expected to issue new standards in June 2012 on pensions that will require recording a liability on the statement of nets assets (financial position), and you may want to give your clients a heads up on this now.
Our Peer Review Clients
When scheduling your peer review with the state society, the scheduling form requests information about the firm you have hired to perform the peer review. This is the information you will need if you select our firm to perform your peer review:
Name of Reviewing Firm: Read & Bose, PC
AICPA Firm Number: 10083621
Team Captain's Name: Harry Bose
AICPA Member Number: 01153765
___________________________
This letter will be posted on our home page, along with additional guidance on peer reviews. Our web site address is: www.peer-review.com .
Our email address if your wish to contact us about peer review is: harryb@readandbose.com .
Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
READ & BOSE, PC