May 21, 2008
To our peer review clients:
Annually we make an effort to highlight recent changes in professional standards for our peer review clients. We hope what follows is helpful to you in your accounting and auditing practice.
Sweeping Changes
Although the following two revisions to professional standards are still in the works, we wanted to get some guidance to you as soon as possible:
New Formats for Financial Statements: As part of its continuing effort to conform GAAP to international accounting standards, the FASB board is changing the formats of the basic financial statements. Financial statements will be organized into five sections as follows: business, discontinued operations, financing, income taxes and equity. The business category will have two subsections: operating and investing. Management can decide whether an item is classified in operating, investing or financing. As a result, companies may have dissimilar financial statements depending on management perspective. How financial information is displayed in the financial statements will undergo significant revision. For example, on the balance sheet, assets and liabilities will be commingled and netted in each section and subsection. The FASB board issued a “Tentative Preliminary Views” document on this topic in November 2007 and should issue the “Preliminary Views” document by late summer of 2008. An Exposure Draft will follow and the Statement issue date is targeted for June 2011.
Complete Redrafting of Auditing Standards: The Auditing Standards Board plans to redraft all of the auditing standards over the next two to three years as part of its continuing effort to converge its standards with those of the International Auditing and Assurance Standards Board. This is called the “clarity project.” Along the same lines, FASB exposed the FASB Accounting Standards Codification in January 2008, which is currently in the “one-year verification phase.” You can use the online Codification Research System on the FASB website free of charge to research accounting issues (although it is not yet approved as authoritative).
Risk Assessment SAS for Firms with Audit Clients
As you know, the Risk Assessment SAS (SAS No. 104 through 111) are effective with audits of 2007 calendar year financial statements. We have covered the Risk Assessment SAS in our previous two update letters, although the subject is too involved to cover comprehensively in a letter like this.
This year we are going to go over our experience with the PPC SMART e-practice aid, since this is the tool that the majority of firms will be using to implement the Risk Assessment SAS. Here are a few observations based on our experience with the PPC product:
There are a number of new PPC forms that you haven't seen in prior years, some of which are optional. A step on the general procedures audit program for planning lists the forms you need to complete to comply with the new standard's documentation requirements. These are the planning forms that you have to complete at a minimum. In addition, we recommend you use the forms that PPC has designed to document evaluation of internal controls including walk-throughs. SAS No. 109 requires auditors to evaluate the design of controls and determine whether these controls have been implemented.
The PPC approach to the new standards relies more on memoranda than on the checklists you are familiar with from prior years. You are writing a mini essay in each area addressed. Two of the required forms in particular that require you to write narratives (to “tell the story”) are:
“Understanding the Design and Implementation of Internal Control,” which requires an essay in each of the following five areas: control environment, risk assessment, monitoring, internal control communication, and control activities. Previous standards required you to thoroughly document the control activities area, typically with memoranda, flowcharts or comprehensive checklists, and this requirement is unchanged. However, the other four areas tended to have minimal documentation, usually a rather brief checklist incorporated in the planning form. The new standards require more documentation in the other four areas.
The “Risk Identification Form” requires approximately 20 responses, or 20 mini essays, demonstrating your knowledge of the risks, including fraud risks, affecting your client.
The new standards require you to tailor your audit program in response to the risk assessment. This can be done manually, but requires considerable effort. The PPC SMART e-Practice Aid automatically generates an audit program given your entries for inherent and control risks.
The PPC approach to documenting fraud risk is to blend the documentation for fraud risk considerations, and the responses to identified fraud risk factors, with other audit risk areas. Unless you are careful, it is not difficult to omit some of the fraud documentation required under the fraud standard (SAS 99).
Take care during the risk assessment process to assess risk appropriately. For example, if you are not relying on internal controls, control risk for all assertions should be set to high. The PPC SMART e-Practice Aid will default to this.
If you determine inherent risk is high for a particular account or assertion this will frequently (not always) result in a “significant audit risk” and you should identify these risks as significant on the PPC “Risk Assessment Summary Form.” Audit risk at the financial statement level may also be deemed significant. Analytical review procedures alone are not a sufficient audit response to significant audit risks.
You will find the risk assessments that PPC has established for the specified risk audit programs helpful; this is the material that precedes each specified risk audit program (actually the terminology is audit “plan” rather than “program” in the new standards), but you cannot default to these risk assessments. You need to complete the “Risk Assessment Summary Form” for each of your audit clients. However, many (not all) of the risk assessments that underlie the specified risk audit programs will apply to your smaller audit engagements. By the way, it is very unlikely that inherent risk for all cash assertions would be set at low. It is likely peer reviewers will home in on your cash risk assessment.
Statement on Quality Control Standards No. 7
All CPA firms are subject to the quality control standards. If you are receiving a system peer review, your peer review includes steps to determine if you are complying with the quality control standards. SQCS No. 7 represents a major revision to the quality control standards, and will require significant effort on your part to implement. Although, in the past, firms were not required to have a written quality control document, this new standard requires one. Even if you already have a written quality control document, the new standard will require you to rewrite the document to incorporate the new language and concepts contained in the standard. In addition, SQCS No. 7 requires written confirmation of compliance with independence requirements from all firm personnel at least annually. The new standard expands the monitoring requirement, such as annual inspections, and introduces the concept of “engagement quality control review,” a form of independent pre-issuance review, and requires firms to establish which, if any, engagements are subject to the engagement quality control review.
Effective January 1, 2009, SQCS No. 7 is a major new standard that will have ripple effects. For example, SQCS No. 7 requires you to identify the engagement partner to management by name, and this will likely be accomplished through a revision to the standard engagement letter language.
New Accounting Standards
SFAS 157 and 159: Although some portions of this standard have been deferred, for the most part SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, including interim periods within those fiscal years. The standard will have to be implemented for financial assets and liabilities. Some of your clients have marketable securities, which you already record at fair value, and disclose, but SFAS No. 157 requires additional disclosure, including quantitative disclosures that should be presented in a tabular format. A related standard, SFAS No. 159, permits companies to elect the fair value option selectively for some financial instruments but not for others at the discretion of management.
EITF Issue 06-3: This EITF is effective for periods beginning after December 15, 2006, and requires disclosure of whether the company reports sales and similar taxes on a gross or net basis. If the company reports on a gross basis (i.e., the sales tax is reported in both revenue and expense) the company should disclose the amount of the sales tax if significant.
EITF Issue 06-4: This EITF is effective for periods beginning after December 15, 2007, and requires companies to report a liability for endorsement split-dollar life insurance arrangements. Under such arrangements, a company pays the premiums and splits the death benefits with the employee's beneficiaries. Typically the company retains the portion of the death benefit that equals total premiums paid. A FASB technical bulletin issued in 1985 required companies to record an asset for the cash surrender value of the policy, but there has been diversity in practice on how to record, or whether it is necessary to record, the liability side. This EITF requires the company to record a liability when the obligation extends into the postretirement period. If the company has an obligation regardless of whether the insurance company defaults, the liability is recorded following the guidance in either APB No. 12 or FASB No. 106. If there is no obligation to fund the death benefit upon default of the insurance company, the liability is equal to the present value of the expected premium payments.
FIN No. 48: FASB has decided to delay the effective date of Financial Accounting Standards Board Interpretation No. 48, the controversial new standard on income tax accounting, to periods beginning on or after December 15, 2007.
SFAS 141R/160: With SFAS No. 141R and SFAS No. 160, FASB has issued significant new guidelines for reporting business combinations and consolidations. Minority interests will now be included in the equity section.
New Peer Review Standards
The AICPA has issued the revised peer review standards effective January 1, 2009. The new standards eliminate the letter of comments, although the matters that previously went to a letter of comments now go to permanent file working papers that will include recommendations and require a response from firms. Under the new standards, a firm will either “pass” or “fail” its peer review. Although that would seem to result in the elimination of the modified peer review report, the new standards introduce the concept of a “pass with deficiencies” peer review report that will resemble the old modified peer review report format.
New Accounting and Review Standards
SSARS No. 15, 16 and 17 are housecleaning in nature, eliminating references to auditing standards and replacing them with suitable guidance in the SSARS themselves, defining professional requirements as either unconditional (“must” do) or presumptive (“should” do), and establishing the “objectives” for compilation and review engagements. However, there are ripple effects. For example, the illustrative engagement letters for compilations and reviews are revised to incorporate the stated objective, and the word “primarily” has been deleted from the paragraph referencing the supplemental information in the standard review report. In addition, an appendix to SSARS No. 17 includes new suggested language for the management representation letter. Changes such as these, which aren't effective until periods ending after December 15, 2008, make it abundantly clear that we can no longer simply update last year's Word document when generating reports or representation and engagement letters. Incidentally, SSARS No. 17 includes an exhibit with several good examples of how to document expectations for analytical review in a review engagement.
For Firms with Nonprofit Industry Clients
The Uniform Prudent Management of Institutional Funds Act of 2006 has been adopted by most states including Oregon . In the past endowments were maintained at historical cost and the historical cost was recorded in permanently restricted net assets. The new act permits nonprofits to utilize the principal portion of the endowment to some extent and to close out smaller endowments. In response, the FASB has proposed a Staff Position: FSP FAS 117-a. This standard will require additional disclosure, including the composition of endowments by net asset class, and will be effective for June 30, 2008 year ends.
For Firms with Governmental Clients
There are a number of new standards and exposure drafts. Here is one of the exposure drafts that will affect all of your governmental clients: GASB has proposed a new statement on fund balance reporting that would do away with the “reserved” component of fund reporting and replace it with an array of new categories: unspendable, spendable, restricted, limited, assigned and unassigned. There will also be additional guidance on accounting for “rainy day” or “stabilization” amounts.
Our Peer Review Clients
When scheduling your peer review with the state society, the scheduling form requests information about the firm you have hired to perform the peer review. This is the information you will need if you select our firm to perform your peer review:
Name of Reviewing Firm: Read & Bose, PC
AICPA Firm Number: 10083621
Team Captain's Name: Harry Bose
AICPA Member Number: 01153765
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Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
Read & Bose, PC