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Issue 9 | November 2016
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At-A-Glance
The new lease accounting standard is
slowly working its way toward
implementation over the next two to
three years. Along with the imminent new
revenue accounting standard, these two
epic pronouncements will form a virtual
one-two punch of major reform in
financial reporting. Our first article
emphasizes the importance of planning
ahead, in order to avoid any unexpected
last minute effects with leases that can
produce unfavorable results.
Time and time again over the last
several years, we have reported on
concerns and shortcomings in audit
quality, along with calls for
transformational change. In 2014, the
American Institute of Public Accountants
(AICPA) took up the challenge,
announcing a robust, comprehensive plan
to turn things around. Now that two
years have passed, as our second article
reports, the AICPA details tangible
progress that is being made.
Though the bitcoin cryptocurrency has
experienced a volatile reputation in
recent years, the underlying blockchain
technology has received increasingly
more attention and investment. The Big
Four accounting firms are collaborating
on joint approaches, while the Untied
States Congress has even formed a
Blockchain Caucus. Our third article
describes current developments and
potential applications.
Editor Gerald E. Herter, CPA
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In This Issue
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Leases to Take Center Stage on Balance Sheets
World-Wide
Financial implications can be substantial
“I don’t think anyone is ready for this,”
commented Simon Terry-Lloyd, principal with real
estate firm, Cresa San Diego, while addressing
the upcoming new standard on leases, at Integra
member Swenson Advisors’ Hot Topics Seminar in
September. Terry-Lloyd was referring to the far
reaching impact of the 2-3 trillion dollars of
lease related assets and liabilities anticipated
to collectively appear on balance sheets across
the world within the next three years or so.
Cresa is one of the newest members of Integra
International, as recently announced at the
association’s annual world conference, held at
Cape Town, South Africa, in October, 2016. Cresa
is the world’s largest tenant-only commercial
real estate firm.
Along with the monumental changes coming from
the new Revenue Accounting standard, recapped in
last month’s Audit & Accounting Alert, the near
future is shaping up to be “the most exciting
time for accountants in years,” as Swenson
managing partner Steve Austin characterized it.
The speakers emphasized that though the lease
standard does not officially go into effect
until 2019, the potential effect is so
significant that companies need to plan far
ahead to avoid unexpected consequences.
The International Accounting Standards Board
(IASB) and the Financial Accounting Standards
Board (FASB), with the issuance of their
corresponding standards in early 2016, have both
agreed to the overall concept of reporting
leases on the balance sheet as assets with
corresponding liabilities. However, the boards
differ as to the model for accomplishing that
goal.
The FASB retains a two model approach for
lessees. Under this approach, finance leases,
which current accounting considers capital or
purchase leases, will have the right-of-use
balance sheet asset amortized as an expense
using a straight line basis. The balance sheet
lease liability will produce a separately
reported interest expense. Operating leases will
have the periodic lease cost amortized as a
single expense using a straight-line method.
Leases meeting any one of five criteria will be
considered finance leases. All other leases will
be considered operating leases. The criteria
generally provide that the lessee receives the
bulk of the value of the asset over the lease
term, considering the nature and expected life
of the asset, purchase options, and present
value of payments. However, the old rules-based
measures are replaced with principles-based
determinations, so that leases cannot be
cleverly structured to avoid the standard.
The IASB approach will consider all leases
the same, using a one model approach. The lease
costs will all be reported in a similar fashion
as finance leases, with both amortization and
interest expenses reported on the income
statement.
Lessor lease accounting under both boards
will be similar to the current standards, which
already use an approach that corresponds to the
finance and operating models above. Also, leases
with terms of a year or less will be exempt from
the standard, and groups of leases with
comparable characteristics can be reported
collectively as a portfolio.
According to the standards, “a lease is
defined as a contract, or part of a contract,
that conveys to the customer the right to use an
asset for a period of time in exchange for
consideration…A lease exists when the customer
controls the use of the identified asset
throughout the period of use. This is when the
customer has the right to: 1) obtain
substantially all of the economic benefits from
use of the identified asset throughout the
period of use, and 2) direct the use of the
identified asset throughout that period.”
The new standard will change the way leases
are looked at. As Don Mitchell, managing
principal of Cresa San Diego put it, “it’s not
about cash flow any longer, it’s about the
impact on the balance sheet and profit & loss.”
Consequently, companies should be planning now
and not wait. Systems will need to be updated,
along with proper controls, to accommodate the
new standard. Some retrospective reporting will
be required. With the new revenue accounting
standard coming into place as well,
consideration needs to be given to whether the
two standards should be implemented together or
in separate years. Also, the year of adoption
will determine the interest rate used in asset
and liability calculations, so the impact could
be different depending on the year chosen. In
addition, upcoming lease expiration dates and
the potential for restructuring should be
assessed while there is ample time for
negotiating desirable terms.
Recognizing the need for a solution that
combines accounting and real estate expertise to
successfully maneuver through these potentially
significant and complex issues, Swenson Advisors
has teamed up with Cresa to develop
AccountLease, an integrated service to assist
clients with their lease planning process.
Further details can be found at the Swenson
Advisors
website
and
the AccountLease
Press Release.
For further information, see
FASB In Focus on Leases
and
IASB shines light on leases by bringing them
onto the balance sheet
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Making Headway Toward Heightened Audit Quality
Progress report two years into AICPA’s
enhancement initiative
In May, 2014, the AICPA announced a bold new
plan to address the multiple challenges faced by
auditors: the Enhancing Audit Quality Initiative
(EAQ). The EAQ came three months after the
release of the International Auditing and
Assurance Standards Board’s (IAASB) Framework
for Audit Quality (February, 2014). The impact
of the IAASB framework was the subject of
articles in the last two issues of the Audit &
Accounting Alert, covering the perspectives of
two European based studies.
Looking back over the first two years of the
EAQ, the AICPA has reason to be encouraged with
the results thus far, as described in their new
report: Highlights and Progress 2016. The first
step, issued in May, 2015, was A Six Point Plan
to Improve Audits, the U.S. CPA profession’s
answer to quality financial statement audits of
private companies, employee benefit plans and
governmental entities. The Plan introduced a
roadmap for moving forward, focused on the six
critical areas:
- Pre-licensure
- Standards and Ethics
- CPA Learning and Support
- Peer Review
-
Practice Monitoring of the Future
- Enforcement
The progress report highlights
accomplishments according to the six areas.
Pre-licensure - A pipeline covers various
levels to stimulate entry to the profession for
a wide diversity of qualified students. A
successful four-state, pilot high school program
partnering with the NAF Academy of Finance was
recently launched nationwide, offering multiple
learning platforms and a rigorous achievement
program, coupled with accounting profession
familiarization and career guidance. At the
college level, a pilot program with seven state
CPA societies is working to identify and support
accounting students, while expansion of
accounting doctoral programs and community
college initiatives have reached more students
with increased funding and scholarships. Also,
the CPA exam is being revamped for use early in
2017 to enhance “testing of higher-order
cognitive skills, incorporating critical
thinking, problem-solving, analytical ability
and professional skepticism.”
Standards and Ethics - The AICPA is committed
to supporting practitioners with clear,
practical standards on an ongoing basis, through
the Auditing Standards Board. Also, the
Assurance Research Advisory Group (ARAG) was
established to tackle pressing issues. Working
through a group of practitioners, academics and
the American Accounting Association, ARAG
focuses on challenging aspects of auditing, to
offer helpful insights to auditors and the
standard setting process.
CPA Learning and Support – Employing the new
venture with the Chartered Institute of
Management Accountants (CIMA), the AICPA
established The AICPA | CIMA Competency and
Learning Website, drawing together a wide range
of audit and assurance educational
opportunities, emphasizing the new approach
toward programs that develop and improve
competency, rather than just require compliance
with completion of a certain number of hours.
Peer Review – Efforts during the first two
years determined that effective methods for
detection of deficiencies, and assurance of
their remediation, topped the list of needed
reforms. Resulting changes include new peer
reviewer training requirements, new procedures
for removal of poor performing firms, and closer
focus on high-risk areas and industries, such as
employee benefit plans and governmental single
audits.
Practice Monitoring of the Future – In
December, 2014, the AICPA issued a concept
paper,
Evolving the CPA Profession’s Peer Review
Program for the Future
. The paper envisioned an
ongoing process of internal and external
monitoring of audit firms, encompassing the
following functions:
-
Continuous analytical evaluation of
engagement performance
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Human review when
system-identified concerns are raised
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Involvement of external monitors when necessary
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Periodic inspection of system integrity
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Oversight of the system’s operating
effectiveness
The paper has stirred substantial discussion
of what direction practice monitoring should
take. The discussion continues, as well as pilot
testing of a self-monitoring tool to assess how
the new concept approach could be implemented.
Enforcement – Enhancement of this area
includes the AICPA working with the National
Association of State Boards of Accountancy and
the U.S. Department of Labor to develop ways of
sharing files to facilitate investigations.
Considering the comprehensive nature pf the
above proposals, the AICPA has demonstrated a
clear acknowledgement of the critical importance
of attaining and maintaining the highest
possible audit quality now and going forward.
For further information, see
Enhancing Audit Quality
- Initiative Highlights
and Progress
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Blockchain Technology Advances
Underlying technology for bitcoin has potential
for wide range of activities
When bitcoin was last covered in the Audit &
Accounting Alert about a year and a half ago,
the market capitalization of the cryptocurrency
had bottomed out at about $3 billion, the price
was about $225 per bitcoin, and the daily
trading volume was around $20 million. Despite
lingering security concerns, the market cap,
price, and volume in early October, 2016, were
in the ranges of $10 billion, $600 and $60
million, respectively. That was despite news of
the early August hack of the Bitfinex exchange
where 120,000 bitcoins were stolen for a loss of
$65 million. Of course, that loss paled in
comparison to the Mt. Gox exchange collapse in
2014 that cost investors $500 million.
Undoubtedly, improvements implemented since that
episode will be supplemented with further
tightening of controls in the wake of the more
recent theft.
Apparently, one of the major concerns with
bitcoin security lies with the safeguarding of
the private keys used to access the bitcoins,
rather than the underlying blockchain technology
on which it is built. Two keys are required to
access bitcoins, something like a virtual safe
deposit box. When these keys are maintained
online, the possibility of hacking is always a
threat. In fact, exchanges, like Bitfinex, have
even employed low-tech techniques, such as
storing keys offline on hard drives placed in
actual safe deposit boxes, to strengthen
security.
Though bitcoin is the most popularly known
use of blockchain technology, a number of other
applications have been developed, or are the
focus of substantial investment dollars. For
example, the tiny country of Estonia utilizes
blockchain with its X-Road and e-Residency
programs. The distributed public ledger system
allows citizens through X-Road to obtain their
personal information from all governmental
sources through a single entry point, while
e-Residency provides a transnational digital
identity for establishing and administering
location-independent businesses online. Also,
Estonia is working with NASDAQ on an e-voting
process that will authenticate and record
shareholder votes. The security features and
speed of blockchain are desirable aspects. The
small size of Estonia makes the country a
manageable testing ground for these
forward-looking technologies, prior to their
expected launch on a larger scale.
Some other applications where blockchain
technology is emerging involve electronic
medical records and healthcare payment
administration, organization of electricity
microgeneration from home sources into energy
markets, and legal “smart contracts” that are
continually and validly updated. Countries in
Africa that have faced challenges catching up
with the rest of the world in various ways, may
reap benefits. Just as the wireless cell phone
has enabled countries to rapidly upgrade
communication systems by bypassing the need for
extensive cable infrastructure, blockchain
technology can facilitate cross border payment
transaction structures between disparate banking
systems that are common in Africa.
As a refresher, here is a description of
blockchain from the earlier Audit & Accounting
Alert article:
“Virtual currencies, such as bitcoin, offer a
triple entry approach, signified by an
underlying technology known as the “blockchain.”
The blockchain is described by Ryan Lazanis of
Xen Accounting in a recent Techvibes article:
The blockchain is a public,
decentralized, distributed ledger that is
capable of storing and confirming the
transactions that pass through it. This means
that the ledger is not owned nor controlled by
any one party. Instead the control of the
network, or protocol, is distributed among the
network’s users. As transactions hit the
blockchain, they are confirmed as true and
accurate by the network’s users, called miners.
If you see a transaction on the blockchain, the
transaction has been confirmed and it cannot be
reversed.
When two parties enter into a virtual
currency transaction, the blockchain becomes the
third party, independently holding a copy of the
entry, thus completing the triple entry.”
Lazanis predicted that blockchain would
replace the current “third party,” the auditor
accountant. The reality may be more of a shift
in emphasis to real-time auditing and a
different level of oversight. Nevertheless, as
blockchain matures over coming years,
accountants need to prove agile enough to adapt.
Indeed, a consortium from the Big 4 accounting
firms is collaborating over a process for
developing blockchain standards, as well as ways
to assist clients moving into this arena.
Meanwhile, the U.S. Congress has established a
Congressional Blockchain Caucus that will “work
to raise awareness, promote policies and
safeguard consumers.”
For further information, see
How
blockchain will impact
accountants and auditors
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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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