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Issue 6 | July 2015
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At-A-Glance
Integra International‘s place in the
forefront of worldwide accounting
standards was evident again this past
month. While in Brussels for the June
Conference, Integra leaders met with
European Commission officials. As
recounted in our first article, the EC
officials presented a briefing on the
process for accepting International
Financial Reporting Standards into the
European Union. Following the briefing,
Integra became among the first to
receive a copy of a new report
evaluating the effectiveness of IFRS
since placed into law ten years ago.
Speaking of accounting standards, who
would not be in favor of reducing the
complexities of financial reporting
standards? Apparently the trend toward
simplification, covered in last month’s
Audit & Accounting Alert, has not been
universally embraced. Our second article
describes negative consequences that
diverse groups have pointed out.
Finally, the latest round of audit
quality inspections has been completed.
Though there is always room for
improvement, the news is better for the
United Kingdom than it is for the United
States, as our third article reports.
Editor Gerald E. Herter, CPA |
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In This Issue
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Integra Meets With European Commission in
Brussels!
EC Officials brief Integra leaders on newly
released IFRS evaluation report
In conjunction with the Integra International
June 2015 Conference in Brussels Belgium, Integra
CEO Maria Nazario and Integra Global Board
member Steve Austin met with Zbigniew Zach, IFRS
Policy Officer, and Christelle Fontbonne
Proniewski, Policy Officer, for the Accounting
and Financial Reporting Office of the
Directorate-General for Financial Stability,
Financial Services and Capital Markets Union (DG
FISMA) of the European Commission (EC).
The EC officials apprised the Integra leaders
of the European Parliament’s acceptance process
for International Financial Reporting Standards
(IFRS), just before release that same day of the
new EC report that evaluated the process. The
evaluation comes ten years after enactment of
the law that put IFRS in place for European
Union (EU) members.
The press release accompanying the report’s
release stated: “The adoption of IFRS in the
European Union was designed to improve the
efficiency of EU capital markets by increasing
the transparency and comparability of financial
statements…The Commission's evaluation of the
IAS Regulation assesses whether:
- The Regulation achieved its objective in
an efficient and effective manner;
- The criteria that all new IFRS should
meet to become EU law are appropriate and
whether the process for adoption of
standards works properly;
- The governance structure of the
bodies developing the standards and advising
the Commission is appropriate.”
The report was quite favorable as to the
efficiency and effectiveness of the adoption
process, noting the enhanced transparency of
financial statements by virtue of “improved
accounting quality and disclosure and greater
value-relevance of reporting” and “greater
comparability between financial statements
within and across industries and countries.”
There is still room for improvement, but the
progress is encouraging.
As the EC officials explained to the Integra
leaders, processing time for recent
International Accounting Standards Board (IASB)
pronouncements has averaged only about eight
months from the IASB date of issuance to final
acceptance by the EU. Considering that the
proposed standards have to pass through the
European Financial Reporting Advisory Group
(EFRAG), the EC, and the European Parliament
with its 28 members, that timeframe is
commendable. Also noteworthy is that only one of
those pronouncements required any modification
from the IASB version.
Nevertheless, the report calls for further
improvement of the endorsement process. EFRAG
provides technical advice to the EC and weighs
in on endorsement. A more interactive working
relationship between these groups, along with an
EFRAG that is more balanced in membership
between public and private interests, is
expected to facilitate efforts toward the common
goal.
There also was concern expressed about the
complexity of IFRS standards, even though the
cost and effort of adoption was generally felt
by companies to be worthwhile. Even so, while
the desire for simplification may seem
universal, the reality is that simplification is
not always considered feasible or desirable. For
contrary views on simplification, see the next
article in this Alert.
While enforcement of IFRS was found adequate,
differences in implementation by various EU
members need further refinement. Further
interpretive material would enhance consistency.
While the EU’s adoption of IFRS goes a long
way toward establishing IFRS as the global
standard, the failure of the United States to
embrace IFRS is stated as a definite impediment
in that regard. The report encourages the US SEC
to adopt IFRS, and calls for a requirement that
members of the IFRS Foundation and IASB use IFRS
and provide financial support.
The Integra leadership has extended an
invitation for the EC officials to share further
about the Commission’s endeavors at a future
Integra conference. Details will be announced
when a date and location are formalized.
For further information, see
The European Commission adopts report on use of
International Financial Reporting Standards in
the EU.
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Pushback on Simplification?
Challengers lay out concerns
Last month, the Audit & Accounting Alert
applauded the ongoing progress shown by the
United States and Europe toward the goal of
accounting and reporting standards
simplification. The Financial Accounting
Standards Board (FASB) and related Private
Company Council (PCC) have made substantive
inroads, for example, with measures easing the
treatment of deferred taxes, variable interest
entities, and eliminating the extraordinary item
concept altogether. The Financial Reporting
Council of the United Kingdom (FRC) implemented
European Union directives, greatly reducing the
volume of standards governing SMEs.
While many private companies and their
stakeholders welcomed the practical measures,
not everyone was pleased. The concerns differ
between the United States (US) and Europe. In
most of Europe there are two distinct standards:
International Financial Reporting Standards
(IFRS) generally for large and/or public
companies and IFRS for SMEs for smaller private
companies. In the US, there is just one
authoritative standard: US Generally Accepted
Accounting Principles (US GAAP), as promulgated
by the FASB, for all companies. However, now
that some private company alternative accounting
standards are being approved as a part of US
GAAP, users may not be aware of the double
standard that exists, potentially leading to
confusion.
The CFA Institute, an organization of
investment professionals, found that its members
questioned the need for double standards. Also,
others like Edward Trott, former FASB member,
believe that allowing accounting alternatives
“dilutes the GAAP brand and creates unnecessary
complexity for the statement preparer, auditor
and financial statement user.” Both the CFA and
Trott contend that the existing option, for
private companies to take an exception in the
audit report as a means of avoiding unwieldy
standards, is the proper means of dealing with
the situation. In this way, users are at least
put on notice of the differing accounting
treatment. Unfortunately, some users
automatically attach a stigma to qualified
opinions.
Trott’s opinions were contained in his
comment letter responding to the Financial
Accounting Foundation (FAF). In February 2015,
the FAF issued a Request for Comment (RFC)
document to assist in assessing the
effectiveness of the Private Company Council
(PCC) over the three years of its existence.
With ten questions, the RFC asked generally if
the PCC had accomplished its goal of private
company alternatives, if that job was
essentially done, if the PCC should now function
solely as an advisory body on future issues, and
whether other suggested structural changes were
warranted.
The FAF received more than 50 comment
letters. The comment period ended May 11, 2015,
so the FASB is now in the evaluation process.
From a brief scan of the comment letters, most
feel that the work of the PCC with the FASB has
been a clear success. A general sense is that
while the largest, national, firms tend to feel
that the “look-back” work is essentially done
and that the PCC can assume an advisory role,
the smaller firms more strongly feel that there
is more work to be done. In that regard, the
American Institute of Certified Public
Accountants (AICPA) emphatically stated that
there is certainly more work to be done. Also,
the tenor of the AICPA and most other
respondents calls for a continued prominent
voice for the PCC in the FASB’s work, with
substantive interactions, scheduled meetings and
transparency of actions.
In Europe, with two clearly different, but
related standards (IFRS and IFRS for SMEs), the
user knows which is in effect for a company, and
can act accordingly. The concerns lately are
more with the size of companies required to use
IFRS as opposed to IFRS for SMEs. In an effort
to extend the benefits of simplification to more
companies, the revenue and asset thresholds for
requiring IFRS use have been increased by 60%.
In the United Kingdom (UK), companies falling
below the new thresholds will only be required
to provide a balance sheet and income statement,
as well as a more limited number of footnotes.
Smaller accounting firms in Europe are
concerned, since most of their clientele are
private companies that no longer have the rigors
of full IFRS to contend with. Also, they may be
freed of the audit requirement if that measure
is finalized in the UK. Consequently, a
significant amount of client work may be lost.
In order to replace that work, the accounting
firms will need to adjust their offerings, for
example, to encompass more advisory assistance
or other services.
For further information, see
Addressing Financial Reporting Complexity: Investor Perspectivess and
Accounting threshold shifts risk lasting damage to audit profession.
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Mixed Results for Latest Audit Inspections
British fare better than Americans
This past month, the Financial Reporting
Council of the United Kingdom (FRC) issued its
annual report on inspections of audit quality.
At the same time, the United States Department
of Labor (DOL) released the fourth study of
employee benefit plan audit quality since the
creation of its Office of the Chief Accountant
in 1988. While the FRC reported improvement in
the overall quality of auditing in the UK, the
DOL study disclosed a disturbingly negative
trend in quality since its last study in 2004.
The FRC inspected 126 audit engagements. The
engagements selected were primarily from listed
companies, and the majority of those were
audited by Big 4 firms. 67% of the engagements
were assessed as good or only requiring limited
improvements. This result compares to 60% in the
prior year and even lower percentages in the two
years before that. Nevertheless, the FRC still
expressed concern over the 33% percent that
require improvements.
The three overriding themes noted for the
shortcomings were:
- Insufficient skepticism in
challenging the appropriateness of
assumptions in key areas of audit judgment
such as impairment testing and property
valuations;
- Insufficient or inappropriate
procedures being performed. This is common
to many audit areas including revenue
recognition;
- The failure to adequately identify
the threats and related safeguards to
auditor independence and to appropriately
communicate these to audit committees.
Of the 255 specific matters of concern
identified that the FRC expects auditors and
audit committees to address in future audits,
over 50% related to four areas:
- Fair value measurements
(especially impairment testing and
investment property valuations);
- Audit of allowance for loan losses
and loan impairments (for banks);
- Reporting to audit committees
(inadequacies regarding planned audit
approach and issues raised);
- Revenue recognition.
In an effort to increase favorable audit
results, the FRC is requiring firms “to develop
action plans to address the weaknesses
identified in individual audit engagements and
firm-wide procedures.” Also required are root
cause analyses to identify the sources of the
shortcomings and remedial actions to correct
major issues.
As expected, audits of the largest companies
resulted in the lowest number requiring
significant improvements, while audits of
smaller companies contained more deficiencies.
This condition was cause for even more concern
since, as the FRC pointed out, investors “rely
particularly heavily on the quality of reporting
in smaller listed companies given the absence of
other analysis.”
Turning to the United States, the Department
of Labor reviewed 400 employee benefit audits
performed by 232 different CPA firms. 61% of the
engagements complied with professional auditing
standards or only had minor deficiencies. That
means 39% had major deficiencies that were
unacceptable. Since the 1988, 1997 and 2004
reviews produced 23%, 19% and 33% major
deficiencies, respectively, the trend and
current 39% result are understandably troubling
to the DOL.
The overall findings of the DOL study
were that:
- There is a clear link between the
number of employee benefit plan audits
performed by a CPA and the quality of the
audit work performed;
- The accounting profession’s peer
review and practice monitoring efforts have
not resulted in improved audit quality or
improved identification of deficient audit
engagements;
- CPA firms that were members of the
American Institute of Certified Public
Accountants’ (AICPA) Employee Benefit Plan
Audit Quality Center (EBPAQC) tended to
produce audits that have fewer audit
deficiencies;
- Training specifically targeted at
audits of employee benefit plans (EBPs) may
contribute to better audit work;
- Of the 400 plan audit reports
reviewed, 67 (17%) of the audit reports
failed to comply with one or more of ERISA’s
reporting and disclosure requirements.
In drawing conclusions from the study, the
DOL acknowledged that employee benefit plans
have their own special characteristics not found
in other entities. Consequently, if an auditor
has not been specifically trained and is not
familiar with the distinctive issues involved in
this niche, flawed audits are more likely to
occur. Similarly, if a firm conducts only one or
just a few plan audits, the likelihood of
deficiencies is much greater. Specialized
training and repetitive experience are a
necessary combination for optimal results.
The unfortunate quandary in the US is that
efforts have been implemented in recent years
explicitly to reverse the trend of substandard
audits. Peer reviews are required to include
reviews of plan audits. Also, the AICPA
established the EBPAQC for the express purpose
of enhancing audit quality by providing targeted
resources and requiring fundamental
accountability. Though audits of EBPAQC members
did contain fewer shortcomings, the overall
results were still disappointing.
The DOL’s recommendations included:
- Enforcement – focusing on firms
with a smaller number of plan audits, and
working with authorities to strengthen
disciplinary measures;
- Regulatory/Legislative –
tightening qualification restrictions for
plan auditors, eliminating the limited-scope
audit exception, and providing standard
making authority to the DOL;
- Outreach – working with states to
stiffen licensing requirements, and
expanding distribution of relevant
information to plan administrators, state
boards of accountancy and state CPA
societies, to better inform them about
problems and to encourage training programs.
The AICPA has not hesitated to address the
DOL concerns. The Enhancing Audit
Quality (EAQ) Initiative launched in
May 2014 (see September 2014 Audit & Accounting
Alert for details) called for renewed efforts on
competence, quality control, resources, peer
review, and ethics. Then in May 2015, the
Six Point Plan to Improve Audits
was released, incorporating broad-based feedback
to the EAQ from stakeholders and profession
leaders. The points of the plan are:
- Pre-licensure – Accounting
education and the CPA Exam are addressed to
relate closer to real world working
conditions;
- Standards and Ethics – Monitoring
and evaluation of the implementation of
auditing and quality control standard
updates and audit report revisions, along
with the newly revamped ethics code;
- CPA Learning and Support –
Competency assessment models developed with
the Chartered Institute of Management
Accountants (CIMA), modernized experience
and training tools, and new initiatives from
the Audit Quality Centers and the Center for
Plain English Accounting;
- Peer Review – enhancing the
quality of peer reviewers, targeting firm
quality and accountability, and improving
engagement and firm tracking;
- Practice Monitoring of the Future
- Developing new technology to promote an
“ongoing, near real-time practice monitoring
program;”
- Enforcement – A more robust and
inter-agency-coordinated investigation and
disciplinary process to deal with deficient
audits and auditors.
For further information, see
U.K. Financial Reporting Council - Audit Quality
Inspections: Annual Report 2014/15 and
AICPA releases 6-point
plan to enhance audit quality.
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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.
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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]
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