Private Companies Accounting Standards

The AICPA, the Financial Accounting Foundation (FAF), FASB’s parent organization, and the National Association of State Boards of Accountancy (NASBA) are sponsoring a blue–ribbon panel that is charged with making recommendations on the future of standard setting for private companies. They will take on the issue of whether separate accounting standards are needed for private companies

This is not a new issue for the accounting profession. In the past other groups have wrestled with questions about accounting standards for U.S. private companies, but they mostly focused on technical issues. This panel is unique in that it has support from standard setters, the CPA profession, and state regulators.

The chairman and members of the panel will be named in January. Members of the panel will include individuals representing a variety of financial reporting constituencies, including lenders, investors and owners as well as preparers, auditors, and regulators.

While no deadline has been set for the panel’s work, recommendations are likely to come in 2010.

Let us know what you think. Should there be a separate set of accounting standards for private companies?

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New SSARS Approved - Non-Independent Review Not In It

The AICPA Accounting and Review Services Committee (ARSC) approved a new compilation and review standard in November 2009. We have previously discussed the exposure draft that resulted in this new standard. The effective date of the new standard is for periods ending on or after December 15, 2010. However paragraph 2.21 may be implemented early. This is the paragraph that that allows CPAs to explain in their compilation reports the reasons why they are not independent.

There are two differences in the exposure draft and the final standard. The ARSC retained the concept of limited assurance rather than moderate assurance and the non-independent review is not part of the final standard. Because of the number of comments on this proposal, for and against, the ARSC decided to defer this issue so the Committee could hold additional meetings with key stakeholders.

The new SSARS contains a number of changes. One change of interest to small firms is that compilation guidance is separated from review guidance. Other significant changes include:

• A discussion of how the accountant obtains limited assurance through the performance of review procedures.
• The introduction of the term review evidence to the review literature.
• A discussion of tailoring the review procedures based on the accountant’s understanding of the client’s industry, knowledge of the client, and awareness of the risk that he or she may unknowingly fail to modify the accountant’s review report on financial statements that are materially misstated.
• A discussion of materiality in the context of a review engagement.
• A requirement that an accountant document the establishment of an understanding with management through an engagement letter regarding the services to be performed.
• Enhanced documentation requirements for compilation and review engagements.

The AICPA has issued a white paper, Significant Change for Compilation Reporting Requirements When Independence is Impaired. It is available from the AICPA at http://www.aicpa.org/.

Let us know what you think about the ability to issue a non-independent review report.

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Thinking Outside the Box--An Auditor's Greatest Gift!

For all audit engagements, documentation must evidence compliance with the requirements of applicable SASs. Because SASs are written to be applicable to audit engagements of all sizes, compliance for a small audit engagement will likely be different than for a large audit. Audit documentation of compliance, therefore, is also likely to be different.

As we begin to think outside the box in planning, performing and documenting small audits, a CPA firm's quality control document must give the engagement executive the authority to make modifications that are tailored to the nature, size and complexity of a small entity. Our next step is to develop alternative documentation for use on our small audits.

In a December, 2009 article in the Journal of Accountancy entitled "Risk-Based Audit Best Practices" by Michael Ramos, CPA (a must read for all auditors!), this statement stands out:

"Once thought to be the purview of only the largest firms, growing numbers of audit firms are developing a more customized, firm-specific set of audit practice aids by creating their own forms or checklists for highly judgmental areas such as the documentation of internal controls."

Particularly on small audits, auditors can no longer afford to simply use all the practice aids of a major publisher! There are many ways to comply with quality control and auditing standards. Common sense and analytical thinking has always been a key to performing high-quality, highly-efficient audits and it still is today! With the increasing standards overload, CPA firms must begin to plan and use key audit documentation relative to the nature, size and complexity of an entity.

On December 23, 2009 I'm presenting a webcast on CPE Link, co-sponsored by AccountingWEB, entitled "Using Only Key Forms and the Most Efficient Documentation." In this webcast, I'll present an illustrative small audits alternative documentation plan which can be integrated with practice aids of major publishers. Participants in this webcast will receive beta copies of forms under development for my Small Audits Handbook along with written suggestions for their use. This webcast could be an auditor's greatest gift this holiday season! You can register on my instructor's page at www.cpelink.com. I hope to see you there!

Tax Practice Standards Effective Jan. 1, 2010

A reminder that, with tax season upon us, the AICPA Statements on Standards for Tax Services (SSTS) Nos. 1-7 are effective January 1, 2010. SSTSs 1-7 supersede SSTSs No. 1-8. The SSTSs are:

• No. 1, Tax Return Positions
• No. 2, Answers to Questions on Returns
• No. 3, Certain Procedural Aspects of Preparing Returns
• No. 4, Use of Estimates
• No. 5, Departure From a Position Previously Concluded in an Administrative Proceeding or Court Decision
• No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings
• No. 7, Form and Content of Advice to Taxpayers
  

SSTSs are enforceable tax practice standards for members of the AICPA and apply to all members providing tax services regardless of the jurisdictions in which they practice. They are intended to complement other standards of tax practice, Treasury Department Circular No. 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, Enrolled Retirement Plan Agents, and Appraisers before the Internal Revenue Service; penalty provisions of the Internal Revenue Code; and state boards of accountancy rules.

You may download SSTSs from the AIPCA at http://www.aicpa.org/.

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Fin 48 Reminder

Fin 48, Uncertainty in Income Taxes, is effective for nonpublic and nonprofit entities for the first time for calendar year 2009. Determination of tax positions which may require a provision for unsustainable portions of more-likely-than-not tax return deductions, as well as penalties and interest for failure to file required tax returns for all open tax years in all applicable jurisdictions, must be made by all entities preparing financial statements on a GAAP basis. According to a recent amendment, Fin 48-3, pass-through entities and non-profit organizations must also be considered.

Both the AICPA and PPC have guides with checklists available to assist in applying Fin 48. Some practitioners are considering the use of an OCBOA to avoid application of this pronouncement. Others are determining the materiality of not applying the pronouncement in GAAP financial statements and either disclosing immaterial effects or discussing a possible departure from GAAP report paragraph with the client and the user of its financial statements.

In any event, consideration of this pronouncement should not be left until the last minute. In some cases, it may require extensive work for the client or the auditor which could delay report issuance. You can download the original pronouncement and its updates from www.fasb.org or find them in FASB's Accounting Standards Codification, Topic 740. Post a comment and tell us about your experiences in applying this pronouncement.

Who Needs Orientation Training?

Arriving for my first day of work on my first job in public accounting a partner took me to a client’s office to begin an audit. After seating me in the conference room, he stacked several large journals and ledgers and many bank statements on the table in front of me. As he left for another appointment he told me to prepare a “proof of cash” while he was gone. Not remembering that term from college Audit 101, I began to search the client records trying to find a proof of cash! When the partner returned several hours later I was still searching!

My first on-the-job experience, like those of many staff assistants, wasted valuable time (not to mention it made me feel like a dummy!). With no training to familiarize new hires with firm philosophies, engagement strategies and various software applications, considerable time is wasted on engagements.

You’ve probably heard the arguments. Our firm is too small for orientation training. We don’t have time to create a formal program. We can’t bill the training time…and so on. It’s true. Time is money for a CPA firm and orientation training isn’t billable. It’s a costly decision to buy into three or four days of unbillable time charges for each new staff person. The important question is, however, “What does it cost not to provide orientation training?

Time spent orienting staff assistants during engagement performance not only increases engagement time for learning firm polices and practice aids, it usually results in more mistakes by new staff persons that, in turn, require more supervision and review time to fix. While some of this learning will be memorable for staff persons, it usually will be engagement specific and probably won’t address the foundational issues that should be included orientation training. In short, the lack of orientation training costs a lot, for a long time!
Many state societies of CPAs and other publishers sell orientation training packages which can be tailored to meet a firm’s specific needs. The cost of these materials and the time to train new hires is small when compared to the costs of not providing this important training. Tell us about your firm’s approach to orientation training.

The Synergism of the Staff Training Mix--Power!

A CPA firm’s staff training goal should be to improve the performance of its personnel to increase engagement and firm profitability. Someone said it this way, “We’ve got to spend money to make money.” I like to say it my way, “We’ve got to spend money THE RIGHT WAY to make money.” Here are four of those right ways:

• Practically designed orientation training.
• Regular in-firm group training.
• Out-of-house CPE.
• On-the-job training.
  
  

To get the most out of our training investments we must remember that staff training and development is a process, not an event. How well we integrate the parts of the process determines the long-range returns on our investments. High-quality training and development inputs result in high-quality performance outputs. “Train to retain” may be a good motto. The ultimate “multiplier” of training occurs when well-trained staff personnel stay with a firm for a long time!

Marketplace power originates from formal, detailed planning of the staff training and development process. The power resides in a staff resource base that is stronger than all a firm’s competition. That power is the ability to survive and succeed in the difficult years ahead. That power is for a CPA firm to be known primarily for its quality services and its quality people.

The capstone for maximizing the benefits of the training process occurs during engagement performance and review. The test question is: Does the on-the-job decision making and documentation of work reflect application of the resources developed through the firm’s staff training and development process. Policies that embody the principles of learning in our holistic approach to staff development must be reflected in the results of engagement procedures. In my next blog, I’ll focus on how good orientation training can result in huge engagement time savings. Please post your comments!

From OCBOA to Special Reports

We are all aware of the AICPA Auditing Standards Board’s (ASB) project on clarifying and converging SASs with with International Statements on Auditing (ISA). One of the auditing standards is AU 623 Special Reports. The ASB has released Proposed SAS, Special Considerations—Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks. This proposed SAS changes much of the terminology that we are used to when preparing OCBOA financial statements. In fact the very term “OCBOA” will be replaced with “special purpose frameworks.”

Special purpose frameworks are defined as financial reporting frameworks other than generally accepted accounting principles (GAAP). These include cash basis, tax basis, regulatory basis, and contractual basis. Cash basis, tax basis, and regulatory basis of accounting are commonly referred to as "other comprehensive bases of accounting" (OCBOA).


How will this proposed SAS affect your practice?
Tell us how you think it will affect your practice by adding a comment.

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Maximizing Returns on Your Investment in CPE

It’s not new news, but the purpose of mandatory continuing professional education (CPE) is to improve the competence of CPAs. By improving the competence of CPAs, standard-setters reasoned, the quality of their services should be higher. Sometimes this has proven to be true; sometimes not! Here are some tips on how to get your money’s worth from CPE.

Maximizing the returns on our investment is CPE is a holistic undertaking. For some firms, this may require taking the axe to the roots of some of the firm’s philosophies and objectives. For others, it may mean trimming some old ways and grafting in some new. For example, if CPA firm management sees CPE as a compliance function and seeks the least expensive training providers and delivery methods, the benefits to firm personnel may be limited. On the other hand, high-quality CPE that is designed to transfer learning to practice can make substantial improvements in engagement quality and efficiency.

Management’s attitudes have a direct effect on CPA firm staff personnel. If management demonstrates and communicates the value of CPE in providing high-quality client services, staff will be inclined to adopt the same values. If management doesn’t apply learning to the job, neither will staff.

For several years, I taught centralized staff training for a larger CPA firm. This week of CPE for progressive staff levels provided foundational accounting and auditing training that contributed to the success of many other CPA firms. To this CPA firm’s partners, however, staff training came to be known as “play week.” Partners returned from their out-of-town seminars sharing stories of humorous, late night events, usually prompted by excessive alcohol intake! When it came time for staff personnel to attend out-of-town training, they too focused on “playing hard.” Playing hard resulted in the firm being barred from returning to three major universities, not to mention having to pay for substantial damages to continuing education facilities.

Maximizing the benefits of CPE begins with the value management ascribes to it. In my next blog, I’ll begin to discuss how management can motivate staff personnel to get the most out of their CPE. Please comment and share how your firm gets the most value out of its training investment.

Training Outstanding Auditors

Having struggled through college with mediocre grades, it took me decades to realize that my grades didn’t matter much! I learned almost everything I know after college, on the job. Before you click your back arrow, let me correct myself a little. Grades do matter. Good grades demonstrate a student’s diligence, commitment and achievement, and they are necessary to get a good job. They are, however, only the beginning.

Unfortunately, much of our college learning was lost after we took our exams. Most of us had little practical experience in accounting or auditing and we didn’t have many instructors that had any either. Our lack of experience made retention more difficult. When I started my first day on the job in public accounting, a partner told me to use the records he dumped on my desk to perform a “proof of cash.” I sat there for hours, afraid to ask what a proof of cash was! He should have explained but I should have known!

Two years ago I accepted an adjunct professor position at a technical college to teach management accounting. Since the prerequisites were two basic-level accounting courses, I assumed the students knew and understood basic principles of accounting. When they couldn’t define terms like depreciation, accrual-basis, conservatism, and others, I quickly realized my assumption was faulty! These were good students at a good school, most of which had earned and A or B in basic accounting classes! Because of huge volumes of required reading, piles of homework and frequent exams, learning was mostly short-term. Their grades mattered, but not really.

While this scenario is not descriptive of all secondary education, it is similar to many colleges and universities. Practitioners are realizing that most accounting and auditing training for staff personnel has to occur on the job. Since staff persons with as little as six months experience are functioning as in-charge accountant on some small audits, they must be adequately trained and supervised. In my next blog, I’ll discuss some CPA firms’ approaches to training staff personnel. What is your firm doing?

IFRS not OCBOA

Back in May of 2008, the Governing Council of the AICPA voted to designate the International Accounting Standards Board (IASB) in London as an accounting body for purposes of establishing international financial accounting and reporting principles. What this means is that AICPA members have the option to use International Financial Reporting Standards (IFRS) as an alternative to U.S. generally accepted accounting principles.

Under Rule 202, a member who performs professional services shall comply with the standards promulgated by the designated bodies. Additionally, a member may not say that financial statements are in accordance with generally accepted accounting principles unless they follow the standards promulgated by a standard setter listed in Appendix A of Rule 203.

The list of designated accounting bodies includes the Financial Accounting Standards Board (FASB), the Governmental Standards Accounting Board (GASB), the Federal Accounting Standards Advisory Board (FASAB), and the IASB.

There have been questions as to whether IFRS and IFRS for Small and Medium Entities (IFRS for SMEs) fall under “other comprehensive basis of accounting” or OCBOA. The answer is that they do not. IFRS and IFRS for SMEs are GAAP.

More information on financial statements prepared on a comprehensive basis of accounting other than GAAP is found in AU Section 623 Special Reports. It includes income tax basis, cash basis, and modified cash basis among others.

CPAs may need to check with their state boards of accountancy to determine the status of reporting on financial statements prepared in accordance with IFRS or IFRS for SMEs within their individual state.

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ASUs on Revenue Recognition

On September 15, 2009 the FASB Accounting Standards Codification™ (Codification) became the source of authoritative U.S.GAAP. Rules and interpretive releases of the SEC are also sources of authoritative GAAP for SEC registrants. The FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead it will issue Accounting Standards Updates (ASU). ASUs are not considered as authoritative in their own right, instead they will serve to update Codification; provide background information about the guidance; and provide the bases for conclusions on the change(s) in the Codification.

As of this writing the FASB as issued 14 ASUs. Many of them are technical corrections to SEC material contained in the Codification. However, you should be aware of two of these Updates, 2009-13 and 2009-14. Both of these Updates have to do with revenue recognition.

ASU 2009–13 Revenue Recognition (Topic 605), Multiple–Deliverables Revenue Arrangement, (a consensus of the FASB Emerging Issues Task Force).

This Update addresses the accounting for multiple–deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. It requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The amendments in this update will affect accounting and reporting for all vendors that enter into multiple– deliverable arrangements with their customers when those arrangements are within the scope of Subtopics 605–25 (Revenue Multiple–Element Arrangements).

ASU 2009–14, Software (Topic 985) Certain Revenue Arrangements that Includes Software Elements (a consensus of the FASB Emerging Issues Task Force).

This update changes the accounting model for revenue arrangements that include both tangible products and software elements. The amendments also provide guidance on how a vendor should allocate arrangement considerations to deliverables in an arrangement that includes both tangible products and software.

ASUs are available for download at http://www.fasb.org/.

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Can Owner/Manager Controls Be Audited?

Many auditors believe that owner or manager controls are unauditable because their performance is usually not documented. Interestingly, new risk assessment standards in 2007 identified inquiries and observations as acceptable procedures for testing controls. For example, obtaining a copy of a bank statement and asking a business owner how she approaches its preliminary review before reconciliation may provide evidence that the assessed level of risk of material misstatements for cash is less than high. This procedure will produce reliable evidence when the integrity of management is high.

An auditor’s evaluation of management’s integrity as high has at least two significant affects on small audits. First, a strong control environment reduces risk at the financial statement level. Lower risk mean less evidence is required to reach a conclusion on the financial statements as whole. Second, high management integrity means higher reliance can be placed on responses to inquiries in tests of key controls, thereby reducing the amount of other substantive evidence necessary at the assertion level.

The answer to the headline question above is yes, owner/manager controls can be audited. Not only are they auditable, selecting and serving clients employing management personnel with good character and high integrity can increase both engagement and firm profits! What has been your experience? Post your comments and questions below.

How Does Management Integrity Affect Audits?

We’ve heard it referred to as the “tone at the top.” The character and behavior of an entity’s management sets the standard for other personnel. Despite elaborate codes of conduct, sanctions and whistle-blowing provisions, employees will follow their leaders. Even when leaders use the “do as I say, not do as I do” philosophy of management, subordinates will do as their leaders do.

From the five elements of internal control developed by the Treadway Commission in the late 1970s, we recognize management’s role as the “control environment.” The control environment of an entity is the backbone of its internal control. The smaller the entity, the more directly management’s practices affect control risk. The existence of key, or entity level, controls performed diligently by an owner or manager can reduce control risk, even when there is limited segregation of duties.

Key controls, like inspecting supporting documents when signing checks, or receiving and reviewing bank statements before a bookkeeper reconciles an account, can provide assurance that misstatements due to error or fraud will not go undetected. In other words, control risk can be less than high!

Based on the assumption management’s integrity is high, the following table demonstrates a good system of internal control for a small entity.

BOOKKEEPER	OFFICE MANAGER	OWNER/MANAGER
RECORDS ACCTS. RECEIVABLE	RECEIVES VENDOR INVOICES	SIGNS CHECKS
RECONCILES PETTY CASH	RECEIVES CASH AND MAIL	PREPARES/REVIEWS DEPOSITS
PRINTS CHECKS	MAILS CHECKS	MAKES BANK TRANSFERS
MAKES GENERAL LEDGER ENTRIES	APPROVES INVOICES	RECEIVES BANK STMT. BEFORE REC.
RECONCILES BANK STATEMENTS	APPROVES PURCHASE ORDERS	APPROVES BANK RECONCILIATIONS
	APPROVES PAYROLL	REVIEWS SALES INVOICES./AGINGS
	DISTRIBUTES PAYROLL	MAKES DEPOSITS
	DISBURSES PETTY CASH

Do you think these controls can be audited? Why or why not? If so, what affect can management's integrity have on a small audit? Post your comments below.

Accepting High Quality Clients...or Not!

The first time I developed a CPA practice years ago, client quality had little affect on my decisions to accept new clients. A local banker sent me new clients regularly and, to keep the stream flowing, I served them all. Because I was young, smart and well-trained (and not the least bit prideful!), I believed I could whip any unethical or dishonest client into shape!

Several of my banker’s referrals proved me wrong. One sued me! I’ll spare you the sad story only to say this client was a liar and built his success at the expense of his employees. At the trial he lied and I paid, well, actually my insurance company paid.
br/>Two other clients referred by my banker friend later went to jail! One for skimming and perpetrating sales tax fraud (I don’t know if the IRS ever found him). The other client I thought I could handle owned a lot of nursing homes; he was eventually convicted of Medicaid fraud (family members on many payrolls). These clients contributed to my revenue growth but I spent more time trying to catch these clients in their illegal acts than I did serving my good clients! And guess the character of other clients these criminals referred to me!

Most CPA firms’ client portfolios represent clients developed over many years. Time, especially hard economic times, affects the behavior of our clients. People change, some for good and some for bad. A participant in one of my CPE seminars said it this way: “Desperate times cause desperate people to do desperate things!” Thorough, annual client acceptance and retention evaluations are crucial to the success of a CPA firm, now more than ever before!

IFRS Are Coming

I recently attended the NASBA CPE Expo 2009. Held in San Antonio, Texas this conference had some outstanding programs given by some of the most knowledgeable speakers in the CPE world. Several of these speakers emphasized that IFRS are coming.

As you are aware, the FASB and the IASB have been working on a joint project designed to converge US GAAP, and international accounting standards. The SEC now permits issurers to file with the SEC using IFRS. The AICPA Council has voted to update Rule 203 of the Code of Professional Conduct to recognize the IASB as an international accounting standards setter, so private companies and not-for-profit organizations have an option to decide if following IFRS makes sense in their situations.

Another indication that IFRS is coming is a call from the AICPA Examination Team for volunteers to develop or review questions on IFRS for the CPA exam.

A perusal of IFRS will show you that in some ways, these standards are not all that different from US GAAP. Of course there are some differences. For instance, there is no such thing as LIFO in IFRS. And while US GAAP has a great many standards (now codified in one section of the FASB Codification™) on revenue recognition, IFRS has only two.

If you are not familiar with the FASB and IASB convergence project or IFRS, there's a couple of websites that will help bring you up to speed on this important subject. The AICPA has www.ifrs.com containing various courses on IFRS as well as news clips on the subject. The International Accounting Standards Board (IASB) website is www.iasb.org. On their website you'll be able to access IFRS.


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Client Acceptance and Retention Evaluations--the Good, Bad and the Ugly

Over the past year or so, the AICPA has alerted CPA firms to the importance of client acceptance and retention evaluation. As a defense for preventing association with less-than reputable clients and potentially erroneous or fraudulent financial statements, these evaluations are an integral part of the financial statement audit process.

One of the first quality standards formulated by the AICPA, these evaluations were treated as a compliance function by many CPA firms. Practice aids were filled out and signed as a matter of routine, only to be initialed and carried forward for many years simply to comply with the quality control standards. Intended to help CPA firms cull their client portfolio to separate out the bad and the ugly, the process resulted in little more than a few extra pieces of paper in working paper files.

One of my business partners decades ago, Don Istvan, was a practice management consultant for hundreds of smaller CPA firms. The starting place for most of his consulting engagements was a required evaluation of a CPA firm’s clients. After completing a questionnaire evaluating client quality, CPA firm partners and managers assigned points to favorable attributes of each of their clients. The point awards were placed on a spreadsheet in descending order to help identify the bad and the ugly. One of Don’s first recommendations was to terminate 10% of the clients ranking the lowest. His second recommendation was usually to complete a similar evaluation for prospective clients and to accept only those with point awards higher than the previous year’s terminations. The results of this process over the years produced client portfolios of the highest quality for Don’s clients.

AICPA quality control standards were intended to accomplish the same end. In our current unstable economic environment, the client acceptance and retention evaluation is still the key to producing a high-quality client portfolio. It may also be the key to our survival!

What do you think about these required evaluations? Are they serving their purpose in your CPA firm or do they simply add more paper to engagements? Please post your comments.

ASB Issues Three Exposure Drafts

The AICPA Auditing Standards Board has issued three new proposed statements on auditing standards:

• Related Parties (Redrafted)
• Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures (Redrafted)
• Audits of Group Financial Statements (Including the Work of Component Auditors)
  Proposed Statement on Auditing Standards, Related Parties (Redrafted)

Proposed Statement on Auditing Standards, Related Parties (Redrafted)

The Proposed Statement on Auditing Standards, Related Parties (Redrafted) is one of the SASs being redrafted under the ASB’s Clarity Project. It is also part of the ASB’s project converging SASs with International Standards on Auditing (ISAs). It has been drafted using ISA 550, Related Parties, as a base. It would supersede the “Related Parties” section of SAS No. 45, Omnibus Statement on Auditing Standards—1983 (AICPA, Professional Standards, vol. 1, AU sec. 334). It also represents the redrafting of the “Related Parties” section of SAS No. 45.

Issued September 11, 2009, the comment period ends December 15, 2009. It would be effective for would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Changes From Existing Standards

Since this proposed SAS is a redrafting of an existing SAS you should be aware that there are changes to existing standards. The current AU section 334 is based on the related party requirements in FAS No. 57, Related Party Disclosures, so it’s focus is on auditing the amounts and disclosures pursuant to accounting principles generally accepted in the United States.

The proposed SAS is framework neutral, so the proposed SAS would include financial reporting frameworks, such as U.S. GAAP and International Financial Reporting Standards as promulgated by the International Accounting Standards Board, as well as special purpose frameworks described in the proposed SAS Special Considerations—Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks. The applicability of the objectives, requirements, and definitions in the proposed SAS are irrespective of whether the framework establishes such requirements.

Proposed Statement on Auditing Standards, Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures (Redrafted)

Supersedes SAS No. 57, Auditing Accounting Estimates and Auditing Fair Value Measurements and Disclosures and SAS No. 101, Auditing Fair Value Measurements and Disclosures (AICPA, Professional Standards, vol. 1, AU sec. 342 and 328). It represents the redrafting of SAS Nos. 57 and 101 to apply the Auditing Standards Board’s (ASB’s) clarity drafting conventions and to converge with International Standards on Auditing (ISAs).

Issued September 4, 2009 with a comment period ending November 30, 2009, the proposed SAS would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Changes From Existing Standards

The proposed SAS does not change or expand SAS No. 57 or SAS No. 101 in any significant respect.

Proposed Statement on Auditing Standards, Audits of Group Financial Statements (Including the Work of Component Auditors)

This proposed SAS has been drafted using ISA 600 as a base. ISA 600 addresses group audits. A group audit is defined as an audit of group financial statements. Group financial statements are financial statements with more than one component, which is defined as an entity or business activity for which management prepares financial information that should be included in the group financial statements.

There is a difference in the proposed SAS and ISA 600. ISA 600 does not permit the auditor’s report on the group financial statements to make reference to another independent auditor (referred to as a component auditor), unless required by law or regulation to include such reference. The proposed SAS, consistent with the current AU section 543, permits the auditor’s report to make reference to a component auditor.

Issued September 4, 2009 with a comment period ending December 15, 2009 the proposed SAS would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Comparison of AU Section 543 and the Proposed SAS

The proposed SAS is broader than AU section 543. The proposed SAS lists the procedures necessary for the group engagement team to perform in order to be involved with component auditors to the extent necessary for an effective audit and, compared with extant AU section 543, better explains the degree of involvement required when reference is made to component auditors in the auditor’s report.

The requirements of the proposed SAS concern:

• Acceptance and continuance considerations
• The group engagement team’s process to assess risk
• The determination of materiality to be used to audit the group financial statements
• The determination of materiality to be used to audit components
• The selection of components and account balances for audit testing
• Communications between the group engagement team and component auditors
• Assessing the adequacy and appropriateness of audit evidence by the group engagement team in forming an opinion on the financial statements.

In situations when the group engagement partner does not make reference to a component auditor in the audit report on the group financial statements, all of the requirements of the proposed SAS apply, when relevant in the context of the specific group audit engagement.

The exposure drafts may be downloaded at http://www.aicpa.org/.

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FIN 48 Changed

Disclosure Requirements for Private Companies Under FIN 48 Dropped by FASB

On September 2, 2009, the FASB issued an Accounting Standards Update (ASU) 2009-06. As you recall, since July 1, 2009, the FASB Accounting Standards Codification™ (ASC) has been the source of authoritative U.S. GAAP. This latest ASU provides implementation guidance on accounting for uncertainty in income taxes. It also eliminates the disclosure required in ASC, Paragraphs 740-10-50-15(a) through (b) for nonpublic entities, including pass-through and not-for-profit entities.

The guidance in this ASU involves requirements in what was previously known as FASB Interpretation no. 48 (FIN 48). FIN 48 was first effective for fiscal years beginning after Dec. 15, 2006.

The Private Company Financial Reporting Committee (PCFRC) and others had recommended that FASB defer FIN 48’s effective date for nonpublic entities until annual financial statements for periods beginning after Dec. 15, 2008. Another PCFRC recommendation was that FASB exempt private companies from FIN 48.

What the FASB did was to decline to exempt private companies and not-for-profit entities from FIN 48 in its entirety, but they did decide to modify the disclosure requirements for nonpublic entities and provide further guidance for pass-through and not-for-profit entities.

The implementation guidance applies to financial statements of nongovernmental entities presented in conformity with U.S. GAAP. The disclosure amendments apply only to nonpublic entities as defined in Section 740-10-20.

The Amendments are effective for financial statements issued for interim and annual periods ending after September 15, 2009 for entities that are currently applying the standards for accounting for uncertainties in income tax. For those who deferred the application of standards for accounting for uncertainties in income tax, the guidance and disclosure amendments are effective upon adoption of those standards.

The Update contains a number of examples that you may find useful in applying the standards, including:

• definition of a tax position,
• attribution of income taxes to the entity or its owners,
• financial statements of a group of related entities, and
• transition related to ASU 2009-06.

ASU 2009-06 may be assessed on the FASB Website, http://www.fasb.org/.
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Safeguards to Prevent Ethics Rules Violations

The Conceptual Framework for AICPA Independence Standards and Guide for Complying with Rules 102-505 identify seven threats to ethics rules violations. These pronouncements also discuss professional, client and CPA firm safeguards to eliminate or mitigate the threats. The quality control safeguard may be the most important for smaller CPA firms.

For smaller CPA firms, especially sole practitioners, meeting quality control standards for attest engagements is increasingly difficult. Staying abreast of new professional standards and providing for thorough internal reviews of engagement performance, for example, are essential ingredients for audit quality and among the most costly for smaller firms.

Increasing the focus on quality control, the AICPA issued SQCS No. 7 which became effective January 1, 2009. This quality control standard incorporated the requirements of previous standards and, among other things, requires documentation of compliance in firm administrative or engagement files. Fortunately, the AICPA has created a practice aid, Establishing and Maintaining a System of Quality Control for a CPA Firm's Accounting and Auditing Practice, which provides a framework for quality control documents for smaller firms. Creating a quality control document, and complying with its provisions, could be a primary safeguard against threats to ethics rules violations.

Please post your comments about what your CPA firm has done to comply with the new quality control standards. Do your think these standards are essential for audit quality? Do you think the standards eliminate or mitigate the threats to ethics rules violations?

FASB'S ACCOUNTING STANDARDS UPDATES

As you know, the FASB Accounting Standards Codification™ has been the source of authoritative U.S. GAAP since July 1, 2009. As a result of this change we now have a new acronym, ASU. An ASU is an Accounting Standards Update. This is how changes to the FASB Codification are now made. Note that ASUs are not authoritative. Instead they are transient documents that summarize the key provisions of the project that led to the ASU, details the specific amendments to the FASB Codification, and explain the basis for the Board’s Decision.

ASUs are numbered using the year (2009) and the order in which they are issued (01, 02, etc.). So far this year the FASB has issued six ASUs.

No. 2009–01—Topic 105—Generally Accepted Accounting Principles—amendments based on—Statement of Financial Accounting Standards No. 168—The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles.

No. 2009–02—Omnibus Update—Amendments to Various Topics for Technical Corrections.

No. 2009–03—SEC Update—Amendments to Various Topics Containing SEC Staff Accounting Bulletins. (SEC material is included in the Codification for the convenience of those who are involved with public companies.).

No. 2009–04—Accounting for Redeemable Equity Instruments—Amendment to Section 480-10-S99 (Another amendment to SEC material)

No. 2009–05—Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value.

No. 2009–06—Income Taxes (Topic 740)—Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities.

ASUs are available on the FASB website, http://www.fasb.org/.

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More on the Familiarity Threat and Ethics Rules Violations

In the last blog in our series on small audits, I discussed the AICPA’s Conceptual Framework for Independence Standards and Guide for Complying with Rules 102-505. Among seven identified threats to independence and other ethics rules, the familiarity threat may be one of the most important. Here is an example from my personal experience.

Working for an international CPA firm, I supervised a director’s examination of a small bank for the last two of the five years the engagement was performed by the firm. I liked the bank’s three employees and quickly developed a personal relationship with them. Our engagement team found very few deficiencies or circumstances to include in our agreed-upon procedures report. In fact, we were amazed at the quality of employees work. For example, we had no exceptions to notes and deposit confirmations and their loan files were perfect!

Shortly after our last visit, however, a bank director discovered two complete sets of bank records indicating most of the bank’s assets were missing, and had been missing for nearly ten years! A subsequent review of our last examination by firm partners and legal counsel revealed a few findings that may have been clues to the potential fraud. Our team failed to recognize the clues mainly because of our familiarity with the bank’s personnel.

Because of our personal relationships with bank employees, our level of professional skepticism inadvertently decreased. We applauded the bank employees work in maintaining perfect loan files instead of asking ourselves, “How could loan files be perfect?” Excessive familiarity through long client associations can influence our evaluations of observations of engagement circumstances and audit findings. Extra “due professional care” must be employed on audits performed by the same CPA firm personnel over a number of years!

Reminder about FAS no. 165, Subsequent Events

Just a reminder that FAS no. 165, Subsequent Events, is effective for interim or annual financial periods ending after June 15, 2009. The FASB issued this Standard to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It sets forth:

• The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements
• The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements
• The disclosures that an entity should make about events or transactions that occurred after the balance sheet date.
  

FAS no. 165 does not result in significant changes in the subsequent events that an entity reports through recognition or disclosure in its financial statements. It does however,

• Introduce the concept of financial statements being available to be issued.
• Require the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date whether that date represents the date the financial statements were issued or were available to be issued.

This disclosure then alerts all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented.
Key Terms
This Standard contains a number of key terms, including a description of what is meant by "financial statements are available to be issued." Let’s look at three of these key terms.
1. Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. The two types of subsequent events are (1) events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (recognized subsequent events) and (2) events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date (nonrecognized subsequent events).
2. Financial statements are issued. Financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for general use and reliance in a form and format that complies with GAAP.
3. Financial statements are available to be issued. Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained, for example, from management, the board of directors, and/or significant shareholders. The process involved in creating and distributing the financial statements will vary depending on an entity’s management and corporate governance structure as well as statutory and regulatory requirements. An entity that has a current expectation of widely distributing its financial statements to its shareholders and other financial statement users, including a public entity shall evaluate subsequent events through the date that the financial statements are issued. All other entities shall evaluate subsequent events through the date that the financial statements are available to be issued.

Disclosure
This Standard requires that the entity disclose the date through which subsequent events have been evaluated, as well as whether that date is the date the financial statements were issued or the date the financial statements were available to be issued.

In addition some nonrecognized subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading. In that case the entity shall disclose:
a. The nature of the event
b. An estimate of its financial effect or a statement that such an estimate cannot be made.

The entity also shall consider supplementing the historical financial statements with pro forma financial data, if a nonrecognized subsequent event is so significant that disclosure can best be made by means of pro forma financial data.

How will FAS no. 165 affect your practice?
Tell us how you think it will affect your practice by adding a comment.

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How Do Ethics Rules Affect Our Audits?

I’m sure most of us would answer that we must comply with the AICPA Code of Professional Conduct and the rules of applicable state boards of accountancy in all functional areas of practice. A quick read of the disciplinary actions reported at www.aicpa.org, however, indicates not everyone understands the rules!

Some practitioners forgot requirements like we have to know what we’re doing when we engage to audit, we have to understand accounting principles and we can’t audit our own non-attest services. In the current economic environment, threats to our noncompliance with ethical requirements increase exponentially.

In 2008, the AICPA issued a Conceptual Framework for AICPA Independence Standards and a Guide for Complying with Rules 102-505. These pronouncements establish a framework for evaluating noncompliance with ethical rules. Among seven threats to impairment of independence, and to noncompliance with other ethical rules, is the familiarity threat. Members having a close or longstanding relationship with a client, the pronouncements indicate, may have an increased threat to violation of ethical rules.

While there are professional, client and CPA firm safeguards that may be implemented to eliminate or mitigate the threats, CPAs auditing smaller entities may be more at risk. The Framework and Guide will not only be used to evaluate our compliance with ethical rules, they will be the tools plaintiff’s attorneys use against us in adversarial actions! Discussions of the risk of potential violations of ethical standards due to client familiarity should be part of ongoing engagement planning on every audit.

FAF and FASB Response to CIFiR Report

The FASB and the FAF recently issued a response to the Recommendations of the Advisory Committee on Improvements to Financial Reporting to the United States Securities and Exchange Commission (CIFiR or the Committee). The Committee was chartered by the SEC in July 2007 and issued their final report August 1, 2008. The FASB and FAF response was issued August 7, 2009.

The CIFiR's final report contains a number of recommendations that are intended to increase the usefulness of financial information to investors. At the same time the recommendations were designed to reduce the complexity of the financial reporting system to investors, preparers, and auditors.

The FAF and the FASB strongly supported the formation of the Committee and its work. Robert Herz, FASB Chairman, was an Official Observer to the Committee while other FASB members participated as observers to each of the Committee’s four subcommittees. In addition the FASB provided several staff resources to the Committee.

The FAF and the FASB response explains the actions they are taking or will be taking with respect to each of the Committee’s recommendations. The response contains two parts (1) an Executive Summary that includes their response to key Committee recommendations related to accounting standards; and (2) an Appendix detailing their response to each of the Committee’s recommended improvements to accounting standard setting.

The response is available for download at http://www.fasb.org/.

Why this FAF and FASB response is important to you.

The recommendations of the Committee emphasize:

• The investors as the primary users of financial statements
• The need for a disclosure framework
• That accounting standards should be based on business activities broadly and not on specific industries.
• Improvement needed for gathering input about potential benefits and costs of proposed standards.

Additional details on the FAF and FASB response are available at www.cpafirmsupport.com.

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The Foundation for Audit Documentation

Underpinning the small audit documentation outlined in my last blog, a CPA firm’s operating philosophies can contribute significantly to engagement efficiency. First on the list is the involvement of leadership on engagements.

Involvement on audit engagements for many CPA firm partners or sole proprietors is often limited to a brief meeting with staff personnel before the engagement begins and a review of the working papers and report after the engagement is finished. While this may limit the executive’s time charges on an audit, it also limits the opportunities to train personnel, to set the tone at the top, to ensure audit quality and to deal with engagement problems throughout the job. Limited executive participation usually results in increased time charges during the wrap-up phase to clean up review points and resolve problems after the fieldwork is finished.

Auditing standards now require participation of the top line authority in planning meetings on all audit engagements. Many executives also require in-charge accountants to communicate the status and problems of engagements throughout the performance phase. Some executives perform their engagement reviews in stages to avoid last minute problems. The result of all these practices is that engagement problems are dealt with early and engagement procedures are done correctly the first time! On large or small audits, much wasted time is eliminated and higher profitability is achieved when executives are involved in all phases of engagements.

Small Audit Documentation that Satisfies SASs

For all audit engagements, documentation must evidence compliance with the requirements of applicable SASs. Because SASs are written to be applicable audit engagements of all sizes, compliance for a small audit will likely be different than for a large audit. Audit documentation of compliance, therefore, is also likely to be different.

Here is a list of annual “key” documentation that will support most small audit strategies:

• Client acceptance and retention evaluations
• General ledger analysis worksheet
• Small audit internal control questionnaire, flowcharts or memos by financial statement classification
• Systems walk-through memo or other documentation
• Analytical procedures worksheets for engagement planning and review
• Risk of material misstatements evaluation by financial statements classification
• Linking working paper to guide the selection of tests of controls and tests of balances procedures based on risk
• Tolerable misstatements calculation by financial statements classification
• Sampling and non-sampling decisions worksheet
• Audit planning document summarizing audit strategies
• Small audit programs tailored for audit risk

Future blogs will discuss the impact of a CPA firm’s quality control, preparation of this documentation, formulation of audit strategies and related opportunities for efficiencies. Visit us often!

The Root of Audit Requirements and Documentation

There is good news and bad news. First, the good news: for over two decades, publishers of auditing practice aids have supplied us with forms, checklists and programs to comply with existing professional standards. The bad news: the volumes of accounting and auditing pronouncements have increased exponentially causing huge stacks of paper or long lists of electronic forms for even the smallest audits.

When the new audit risk assessment standards were effective in 2007, the length and number of audit practice aids from most publishers increased substantially. Because it became very difficult to determine which documentation was required to comply with the new standards, conservatism ruled and many auditors used all the practice aids available. Audit quality was good but budget overrun was high!

Here is a foundational principle of audit efficiency. The root of audit requirements is not the practice aids purchased from a provider. Audit requirements for non-public and non-profit entities are rooted in the Statements on Auditing Standards (SASs) published by the Auditing Standards Board of the AICPA. Audit efficiency begins with choosing documentation that, first, satisfies the applicable requirements in SASs and, second, is the most efficient considering engagement circumstances. Watch for examples in future blogs on this site.

AICPA to Release Proposed Revisions to Ethics Rules

You should be aware that the AICPA Professional Ethics Executive Committee (PEEC) is about to release exposure drafts of revisions to guidance regarding the AICPA Code of Professional Conduct (the Code). The exposure drafts will be released in August for a 60-day comment period. The expoure drafts are designed to make clarifying revisions to:

• An ethics ruling under Rule 301, "Confidential Client Information,"
• Two interpretations and one ethics ruling under Rule 101—Independence.
• Revisions to related guidance including Ethics Ruling no. 107, "Participation in Health and Welfare Plan Sponsored by Client" (under Rule 101) and the “Retirement, Savings, Compensation, or Similar Plans” section of Interpretation 101-15 "Financial Relationships."

Rule 301

The proposed revisions to the ethics ruling under Rule 301:

If client information that is not in the public domain or available to the public, such as statistical information and other data, is shared with a third-party on a “no-name” basis for research or benchmarking purposes, it would be considered a breach of confidentiality unless the member received the client’s consent.

The Committee is proposing a new definition to ET Section 92, "Definitions" that would provide further clarification into what information would be considered confidential client information.

Interpretation 101-1

Proposed revisions to the “Application of the Independence Rules to Covered Members Formerly Employed by a Client or Otherwise Associated with a Client” section of Interpretation 101-1:

• Are intended to make clear that both individuals on the attest engagement and individuals in a position to influence the attest engagement that were formerly employed by or associated with a client also need to disassociate from the client.
• Would ease restrictions on participation of immediate family members in client sponsored employee benefit plans.

Current guidance permits, with safeguards, immediate family members of only certain covered members to participate in a retirement, savings, compensation, or similar plan that is a client, is sponsored by a client or that invests in a client, whereas all immediate family members in permitted employment positions are allowed, with safeguards, to participate in client sponsored health and welfare plans.

The revision would allow all immediate family members to participate in all employee benefit plans with the exception of certain share-based compensation arrangements or nonqualified deferred compensations plans, provided certain safeguards are in place.

Other Revisions

The ED also calls for revisions to related guidance including Ethics Ruling no. 107, "Participation in Health and Welfare Plan Sponsored by Client" (under Rule 101) and the “Retirement, Savings, Compensation, or Similar Plans” section of Interpretation 101-15, "Financial Relationships."

We will bring you more details when the Committee releases the exposure drafts.

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Achieving Small Audit Efficiency

Welcome to the first of many practical blogs dedicated to maximizing profitability on small audits. Normally you’ll find one or two blogs here each week which will be progressive in their order. In other words, foundational subjects will be presented first with applications discussed later in the series. If you miss a few days, be sure to catch up before reading the most current blogs. Plan to visit often.

It may seem that putting the word “efficiency” in the same sentence as the word “audit” seems like an oxymoron. Given the costly explosion of professional standards’ in recent years, it’s not surprising that many smaller CPA firms have given up their audit practices. The truth is, however, we can still make money on small audits!

Here’s the key: To maximize efficiency on small audits, every planning and performance decision must emphasize efficiency. I call this the “Ten-Minute Rule.” Taking advantage of every opportunity to save 5 or 10 minutes can result in huge overall engagement time savings! Read this blog often to accumulate your list of time savers!

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