May 29, 2013
To our peer review clients:
Annually we make an effort to highlight recent changes in professional standards for our peer review clients. We hope what follows is helpful to you in your accounting and auditing practice.
New Compilation and Review Standards
As noted in our update letter last year, some firms have not yet implemented SSARS No. 19, “Compilation and Review Engagements,” which was effective for periods ended on or after December 15, 2010. According to AICPA guidance to peer reviewers, failure to implement this standard results in a substandard peer review on engagement peer reviews. The percentage of pass with deficiency and fail peer review reports was far higher in 2011 and 2012 than in previous years as a result.
A major new standard on compilation services is in the works. In our letter last year, we described a proposed standard that would have established financial statement preparation as outside the scope of an attest engagement, making it a nonattest service separate and distinct from the compilation engagement. The chief advantage to this approach is it would allow CPAs to prepare and present financial statements without compiling them. This is helpful in a QuickBooks engagement, for example. In response to feedback from the professional community, however, the exposure draft for this proposed statement was withdrawn in January 2013 and will be replaced with a new exposure draft scheduled to be released in June. The new exposure draft will go one step further and redefine the compilation engagement itself as a nonattest service.
The forthcoming exposure draft, which we have seen in preliminary form, places the compilation service in the context of other nonattest engagements. A CPA firm may have a variety of nonattest engagements in connection with one client. The income tax preparation, the bookkeeping engagement (including QuickBooks engagements), and the compilation engagement will be deemed separate nonattest engagements under the new standard. This appears to allow CPAs to prepare and present financial statements in the context of a bookkeeping engagement without compiling them. The client will have to engage the CPA to prepare financial statements before the new compilation standards would apply.
Although reclassifying compilations as nonattest would seem to suggest a more informal approach than under existing standards, nothing could be further from the truth. Engagement letters will be required, and must be signed by both the client and the firm. Accountant’s reports will be required in most circumstances and the reports must be customized to disclose departures from professional standards if any. The reports will have a unique format to distinguish them from audit and review reports. Although the standard will allow CPAs to issue compiled financial statements without an accountant’s report, this will be possible only with a full disclosure presentation. When substantially all disclosures are omitted, a report will be required even when the financial statements are not expected to be used by a third party. The current “SSARS 8” standard for management use only financial statements, where no report is required, used for the most part in connection with financial statements where substantially all disclosures have been omitted, will no longer be available. This new compilation standard, which is subject to revision in the exposure draft stage, will not be effective until periods beginning after December 15, 2014.
Peer Review Process
Peer review will be going paperless starting this year, although this will be a gradual process. Electronic Matters for Further Consideration (MFC) forms will be required on peer reviews commencing after July 1, 2013. The MFC forms will be created and stored on the AICPA web site on the Peer Review Information System Manager (PRISM). Your peer reviewer will ask you to log onto the AICPA site and enter your responses to the MFC forms. If you do not already have one, you may want to obtain a user name and password at the AICPA site now. If your firm is not an AICPA member, you will still be required to participate, although not until later in the 2013 year. AICPA membership will not be required to log onto the AICPA site and respond to the electronic MFC forms.
International Financial Reporting Standards
For many years the eventual adoption of the International Financial Reporting Standards (IFRS) in this country appeared to be inevitable. However, concerns at the SEC regarding the reliance of the International Accounting Standards Board (IASB) on financial support from the Big Four have turned the tide. Nevertheless US standard setters, both the FASB for financial reporting and the AICPA for attest services, continue to revise US standards to be more like the international standards.
Private Company Standards
At its May 23, 2012 meeting FASB’s parent organization, the Financial Accounting Foundation (FAF), announced the creation of a “Private Company Council” (PCC). The PCC is to determine if exceptions to existing GAAP are appropriate for private sector companies. Exceptions will require FASB’s approval before they may be applied. In April 2013 FASB and PCC jointly issued an exposure draft of an updated "decision-making framework" (initially proposed in July 2012), which among other things recommends private companies generally be allowed to adopt new FASB standards one year later than public companies, and in some instances be allowed prospective implementation when public companies are required to use retrospective. The PCC has not yet issued any modifications to existing standards for private companies, but is considering changes in such areas as variable interest entities and interest rate swaps.
To provide an alternative to FASB standards, the AICPA developed the “Financial Reporting Framework for SMEs” (where SMEs stands for small to medium sized businesses), a “Little GAAP” for privately held companies to use instead of FASB standards. The AICPA proposal, scheduled for release in mid 2013, uses historical cost as its measurement basis, reversing the trend for increasing use of fair value accounting in the FASB standards. For example, the proposal allows goodwill to be recorded at acquisition cost less amortization. Among many changes tailored for smaller CPA firms, the proposal eliminates the specialized accounting for uncertain tax positions and variable interest entities, includes an option to record only the current income taxes payable without a provision for deferred income taxes, and allows a straight forward approach to accounting for leases.
New Accounting Standards
Although FASB is not going to be relinquishing its authority to IASB anytime soon, the various projects to converge US standards with international standards continue apace. One of the most controversial of the "convergence projects" is the standard for reporting on leases, which will require that all non-cancelable operating leases be reported on the balance sheet as "right of use" assets along with offsetting capital lease obligations. The initial exposure document on this topic was withdrawn and "re-proposed" and the reproposal passed in April 2013 with a 4-3 vote. There are two approaches to computing the balance sheet accounts depending on whether the lease involves equipment or buildings. The approach that applies to equipment, called the "interest-and-amortization approach," will result in higher lease expense in the earlier years of the lease term, lower expense in later years, which is a timing difference that will affect the deferred income tax provision.
The convergence project on revenue recognition should be completed mid-year and the standard issued. However, there will likely be an unusually long period of time between the issue date and the effective date. The effective date is currently expected to be for periods beginning on or after January 1, 2017.
In our letter last year, we noted FASB had redrawn guidance that would have required the reporting of reclassification adjustments under the comprehensive income standard on the face of the income statement. Now with ASU 2013-02, FASB will allow the reporting of reclassification adjustments in the footnotes, which is current practice, but essentially requires a tabular presentation, much like SFAS 157 on fair value reporting requires a table. It is effective for periods beginning after December 15, 2013.
Firms with Audit Clients
The major change this audit season will clearly be the implementation of the clarity standards. The AICPA undertook the ASB Clarity Project in order to promote the convergence of US GAAS with International Standards on Auditing (ISA). The ASB has reissued all previously issued statements on auditing standards in a new format effective for periods ending on or after December 15, 2012.
Perhaps the most noteworthy change under the Clarity Project is the revision to the auditor's report language, but the wording of other auditor communications will change too, so please be careful, since peer reviewers will focus on compliance in these areas.
There is more to do during the planning phase of the audit under the clarity standards. You need to perform a retrospective review of accounting estimates during planning. For example, ask your clients to provide a report on accounts receivable written off during the year to compare to the prior year allowance. You need to discuss related party transactions during the engagement team’s brainstorming session and therefore you may want to request a report from the client on related party transactions up front. You are now required to review the client’s correspondence with regulators and the best time to obtain this from the client may be during planning.
Additional procedures are required on opening balances in an initial audit engagement, which appears to be intended to compel successor auditors to review the predecessor’s working papers, a practice many firms have abandoned.
Take care to implement the clarity standards. The AICPA is requiring peer reviewers treat lack of compliance with these new standards as a serious matter. In February the AICPA issued a peer review alert on the clarity standards that says: “It is critical that … firms understand the clarified auditing standards.” The 2013 peer review checklists have been updated to include the requirements of the clarified auditing standards. Therefore expect your peer reviewer to emphasize compliance in this area during your peer review.
How serious a matter would it be if your firm does not comply with the clarified auditing standards? Noncompliance could result in a pass with deficiencies or fail peer review. According to Peer Review Alert #13-01, the failure to update the audit report language in accordance with the clarified auditing standards “should be considered a material departure from professional standards, in all material respects.” Therefore expect a pass with deficiencies or fail peer review report if your audit reports have not been updated, although if you correct the matter on your own during the course of your peer review year, a pass report will likely be possible. In general, take care that all client communications have been updated, not only the audit report, but also the engagement letter, the communication of internal control deficiencies, and the management representation letter.
Statement on Auditing Standards No. 126, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern” was issued July 2012 in the clarity format and is effective for periods ending on or after December 15, 2012 and postpones any significant changes until after FASB issues new guidance on this topic. When the auditor believes there is substantial doubt about the going concern, there is a new requirement for a written representation from management.
New Yellow Book
The final version of the 2011 Yellow Book was issued in December 2011 and is effective for periods ending after December 15, 2012. The Yellow Book requirements typically come into play on your audits of nonprofit and governmental entities when the single audit applies. Also your HUD audits come under the Yellow Book.
The most significant changes in the 2011 Yellow Book are in the area of auditor independence, with independence evaluated within a “conceptual framework” and with “threats” to independence resolved through application of “safeguards.” There are documentation requirements in the new Yellow Book that exceed AICPA requirements. You must document significant threats to independence, individually and in the aggregate, and the safeguards applied. Whenever you perform nonaudit services for the client, you must document why management is able to effectively oversee this service. The understanding with the entity regarding the nonaudit service must be documented. The GAQC has a practice aid helpful for creating the independence documentation available on the AICPA web site, and the PPC authors have developed a six part form for documenting the independence evaluation. Preparing the financial statements is a nonaudit service that will require you document your considerations, which can be accomplished most efficiently using either the AICPA or PPC format. Peer reviewers will be looking for this documentation.
On May 14th, the AICPA issued guidance to peer reviewers, in Alert #13-02, that if a firm does not have this independence documentation, the engagements will be deemed substandard, with the likely outcome a pass with deficiency peer review report.
The new audit report on the financial statements under the clarity standards will have a subheading linking to the Yellow Book internal control and compliance report. The format of the internal control and compliance report is significantly revised. For example, you are no longer required to reference a separately issued management letter. Easy to miss is the requirement that the report be titled, just like the audit report on the financial statements, as “Independent Auditor’s Report.” The “restricted use alert” is replaced under AU-C 905 with a “purpose alert.”
Single Audits
Under the clarity project, the format of the auditor report on compliance and controls required under A-133 will be revised. There with be the subheadings the clarity project requires in other auditor communications, including a subheading for your opinion on compliance. The purpose alert in this report applies only to your report on the internal controls over compliance.
The OMB is considering changes in the Single Audit requirements. The latest information is that the Single Audit threshold will increase from $500,000 to $750,000. The threshold for Type A programs will increase from $300,000 to $500,000. Fewer high risk Type B programs will be tested as major. The coverage percentages will decrease from 50% and 25% to 40% and 20%. The questioned cost threshold will increase from $10,000 to $25,000. The most significant change would be reducing the number of compliance requirements from 14 to six.
HUD Audits
Chapter 2 of the HUD Consolidated Audit Guide has been revised effective for periods ending on or after March 31, 2013. The HUD audit report language is much different and is now aligned with Government Auditing Standards and Circular A-133 reporting.
Firms with Not-For-Profit Industry Clients
ASU 2013-06, issued April 2013, describes a change affecting affiliated nonprofit organizations who share employees, such as university employees who perform functions for the university’s affiliated foundation. Under current standards, a nonprofit organization may pay employees who are then assigned to work for other affiliated organizations without allocating the cost of the employees among the various affiliates. This standard requires an allocation of this expense, effective for periods beginning after June 15, 2013.
ASU 2012-05 provides guidance to nonprofits on the reporting in the statement of cash flows of sales proceeds of donated financial instruments, effective for periods beginning after June 15, 2013.
A new edition of the AICPA Audit and Accounting Guide, Not-for-Profit Entities is effective now.
Firms with Governmental Clients
GASB Statement No. 61 on the new approach to component unit presentation is effective now.
GASB Statements No. 63 and No. 65 concern deferred outflows and inflows. Statement No. 63 is effective this year and for small local governments does no more than rename the statement of net assets to the statement of net position with related captioning changes. Statement No. 65 is effective next year and has a significant impact on financial statement presentation, with some liabilities, such as deferred property taxes, moved to a new category on the statement of net position called “deferred inflows” and some assets reclassified to a new category called “deferred outflows.” Under this standard debt issuance costs which were previously reported as a deferred charge will now be expensed.
GASB Statement No 68 requiring recognition of the entire net pension liability will be effective for years beginning after June 15, 2014.
The new AICPA governmental industry guides are available now, as is the updated AICPA guide for preparing OCBOA financial statements for local governments.
Under SAS No 120 governments reporting on the modified cash basis no longer must include MD&A or other supplemental information required under generally accepted accounting principles (RSI). If they do elect to include RSI, auditors will report on it as other information and offer no opinion, the same approach currently followed for statistical information.
On financial statements for smaller governments that are reviewed rather than audited, the accountant’s comments section on compliance is replaced by a management representation. The accountant does not apply review procedures to the representation and reports on as compiled supplementary information.
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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This letter will be posted on our home page, along with additional guidance on peer reviews. Our web site address is: www.peer-review.com
Our email address if your wish to contact us about peer review is: harryb@readandbose.com
Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
READ & BOSE, PC