June 25, 2019
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 in your accounting and auditing practice.
Data Hosting Update
The AICPA issued an independence interpretation in August 2017 (ET 1.295.143) on “data hosting.” According to this interpretation, as we noted in our letter last year, if you have sole custody of the client’s depreciation schedule your independence is impaired. To retain your independence, you must provide a copy of the depreciation schedule and underlying information (e.g., depreciation method, useful life, etc.) to your client so that the client’s records are complete. The interpretation was to be effective September 1, 2018, but the AICPA has extended the effective date to July 1, 2019.
New Peer Review Initiative Affecting Firms with an Audit Practice
Beginning in October 2018, the National Peer Review Board has directed peer reviewers to emphasize risk assessment, both the documentation and performance, on system peer reviews. This includes reviewing the documentation of control walk-throughs. If firms are not in compliance with the professional standards for risk assessment, their audit engagements will be deemed non-conforming. This will not automatically result in a pass with deficiency peer review but will result in mandatory CPE and the firm may have to submit an audit engagement performed subsequent to the peer review for review by an outside party. A full explanation is on the AICPA site at:
If you are subject to a system peer review, we strongly recommend you take the following CPE self-study course from the AICPA as soon as possible: Risk Assessment Deep Dive: How to Avoid Common Missteps (Course Acronym RAEAQ). Here is the link:
https://www.aicpastore.com/AuditAttest/EnhancingAuditQuality/PRDOVR~PC-157000/PC-157000.jsp
For peer reviews commencing after September 30, 2021, noncompliance in this area will result in a pass with deficiency or fail peer review report.
Firms with Nonprofit Industry Clients
The major new standard on the nonprofit industry, FASB ASU 2016-14, is effective with the 2018 calendar year. The AICPA has several resources available, including a revised Audit and Accounting Industry Guide and a help center on its website. The AICPA help center is extensive and includes Excel and Word documents with the new formats and disclosures at:
Perhaps the most important change is the requirement to disclose expenses by both their natural and functional classifications, which was previously only required for health and welfare organizations. This can be done with a statement of functional expenses included in the basic financial statements or, alternatively, in footnote disclosure. In addition, peer reviewers will be checking for the new footnote on liquidity required by the standard.
Other changes in standards for nonprofit industry include:
- ASU 2018-08 clarifies the reporting of contributions received and made in the context of the new revenue recognition standard. It is effective for contributions received in 2019.
- ASU 2019-03 expands the exception to capitalizing collections. Currently, the collection-holding entity (usually a nonprofit organization) need not recognize contributions of works of art, historical treasures, and similar donations in the financial statements as long as the entity has a policy requiring that the proceeds from sales of collectibles be used to acquire other collectibles. The new standard allows the proceeds from the sales of collectibles to be used for the direct care of existing collections. This standard applies to business entities too if they maintain collections. The standard is effective for fiscal years beginning after December 15, 2019, and early application is allowed.
- ASU 2019-06 extends the private-company alternative for goodwill accounting to nonprofits. Nonprofits will now be able to amortize goodwill on a straight-line basis over ten years. The standard was effective upon issuance.
New FASB Concepts Statement on Disclosures
In August 2018 FASB finalized a concepts statement on the topic of footnote disclosure. The standard footnote disclosures for small and medium sized private sector companies have not changed significantly in recent years. Accountants perhaps take for granted that the footnote language and format for their small business clients can be rolled forward from the prior year without change. That may be changing. FASB ASU 2018-13 is the first standard resulting from this concepts statement and removes and modifies some of the disclosure currently required for fair values. It is effective for fiscal years beginning after December 15, 2019.
Accounting for Variable Interest Entities
In response to Enron, FASB implemented the Variable Interest Entities (VIE) standards in 2001, compelling many companies under common control to consolidate when consolidation had not previously been required. In 2014, FASB provided an exemption for nonpublic companies when “common-control leasing arrangements” are involved. This addressed the most common scenario private entities face when determining whether a VIE should be consolidated, which is when the stockholders in the operating company also have ownership in the entity that owns and leases back the building housing the operations to the operating company. In October 2018, FASB issued ASU No. 2018-17, expanding the private company alternative. Now a private company may elect out of consolidating entities under common control in all circumstances. However, detailed footnote disclosure about entities under common control is required. ASU No. 2018-17 is effective for fiscal years beginning after December 15, 2019, but early adoption is allowed.
Revenue Recognition Standard
ASU 2014-09 on revenue recognition is a comprehensive new standard effective for fiscal years beginning after December 15, 2018. The revenue recognition standard impacts legally enforceable contracts, oral or written, between your client and its customers, and requires your client to identify the separate performance obligations within the contract and to allocate the transaction price among these obligations.
Under the new standard, the contracts may splinter into separate performance obligations.
The AICPA has an Audit and Accounting Guide on the new revenue recognition standard, which we recommend you purchase. Several industries, including construction, have separate chapters. According to Chapter 11 on the construction industry, when the contract is for the construction of a single, combined output, such as a single structure, resulting from the “contractor’s significant service of integrating the component goods and services in the contract” such a contract may be deemed a single performance obligation.
Private companies have fewer disclosure requirements than public companies but will need to disclose the following:
- How much of reported revenue is recognized over a contract term and how much is recognized at a point in time (e.g., on delivery);
- The opening and closing balances of receivables, contract assets and contract liabilities;
- Information about the nature of the performance obligations, such as when the company satisfies its performance obligation;
- Significant payment terms, obligations for returns and refunds, and warranties; and
- Methods used to recognize revenue for performance obligations satisfied over time (e.g., describe the output or input methods).
For smaller entities, implementing the new revenue recognition standard may not be feasible because their accounting systems do not capture all of the necessary information. In these circumstances, you may give serious consideration to advising your clients to change the method of accounting they use for financial reporting from GAAP to the AICPA Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). Under FRF for SMEs, your clients can continue to use their current approach to revenue recognition. Coordinate with the users of the financial statements, such as banks and bonding companies, to ensure this approach is acceptable to them. The AICPA standards for this method of accounting are at:
https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr.html
Standards for Leases
ASU No. 2016-02 on accounting for leases is a comprehensive new standard effective for fiscal years beginning after December 15, 2019. Operating leases will now be reported on the balance sheet as assets and liabilities. FASB continues to fine tune this standard with new guidance for transitioning in various standards updates, such as ASU No. 2018-01, ASU No. 2018-11, ASU No. 2018-20, and ASU No. 2019-01. For example, ASU No. 2018-11 removes the requirement to implement the new standard at the beginning of the earliest period presented in the financial statements, which would have meant restating the 2019 year on a comparative presentation when the standard is implemented for 2020. A restatement that will no longer be necessary.
Other New Accounting Standards
In May 2012, FASB established the Private Company Council (PCC) to better tailor accounting standards for small and midsize companies. The PCC standards are referred to as “PCC Accounting Alternatives.” In addition, starting in 2014 FASB has undertaken a “Simplification Initiative,” which is intended to reduce the cost of complying with professional standards. As a result of these two FASB actions, there have been numerous new ASUs over the past few years. Here are a few of the more recent ones:
- ASU No. 2014-15, which provides formal guidance on going concern considerations, was effective for fiscal years ended after December 15, 2016. The standard requires management to evaluate whether there is substantial doubt about the company’s ability to continue as a going concern within one year after the date the financial statements are issued, as opposed to one year after the fiscal year end.
- ASU No. 2015-03 requires debt issuance costs to be recorded as a direct deduction from the carrying amount of the debt liability, and to no longer be presented as a deferred charge on the balance sheet. The standard was effective for fiscal years beginning after December 15, 2015. If you are recording loan fees with the assets on the balance sheet, you are out of compliance with this standard.
- ASU No. 2015-11 simplifies the measurement of inventory, by allowing only one method, the net realizable value method, in determining the fair value of inventory. The standard was effective for fiscal years beginning after December 15, 2016. In your footnote disclosure for inventory, rather than say inventory is recorded at the lower of cost or market, you might say it is recorded as the lower of cost or net realizable value, since that is the only allowed method for determining market.
- ASU 2015-17 eliminates the requirement to classify deferred income tax assets and liabilities between current and noncurrent – all balances will be deemed noncurrent. The standard is effective for periods beginning after December 15, 2017.
- ASU 2017-04, FASB simplifies the goodwill impairment test for entities that did not adopt the amortization alternative. Under the new standard, if the fair value of the company exceeds its carrying amount overall, goodwill is unimpaired. There will no longer be a need to allocate fair value among all of assets and liabilities of the company and value goodwill as the residual. The standard is effective in 2022, with early implementation permitted.
Other recent changes in accounting standards include:
- ASU 2016-01 removes the distinction between trading and available-for-sale securities and requires the change in the fair value of all marketable equity securities go to net income rather than appearing in Other Comprehensive Income. The standard is effective in 2019.
- ASU 2016-13 on credit losses provides guidance on measuring the allowance for credit losses, with the emphasis on loans receivable but also covering trade receivables – it does not apply to promises to give (pledges receivable) in the not-for-profit industry or to related party loans. The standard is effective in 2021.
- ASU 2016-15 provides guidance on the treatment in the statement of cash flows of certain cash receipts and cash payments. For example, receipt of a settlement of corporate-owned life insurance policies should be classified as cash inflows from investing activities, even though the premium outflow may have been classified as either operating or investing. The standard is effective for 2019.
- ASU 2016-18 revises the presentation of changes in restricted cash on the statement of cash flows. The standard is effective for 2019.
Reporting
Regarding reviews and compilations:
In June 2019 the Accounting and Review Services Committee issued an exposure draft that would require the accountant to calculate materiality in a review engagement and to design and perform analytical procedures and make inquiries covering all material items in the financial statements, including disclosures. In addition, the new standard would increase the number of required inquiries, expanding on the list currently found at AR-C 90.2 in the codification. Further, the standard would allow for an adverse conclusion in a review report when there are pervasive material misstatements in the financial statements. Comments for the exposure draft are due by September 20, 2019 and the standard would be effective for periods ending on or after June 15, 2021.
Effective for periods ending on or after June 15, 2019, SSARS No. 24 provides guidance for reporting on compiled or reviewed financial statements when there is a going concern. Due to SSARS No. 24, and the new ethics guidance on data hosting discussed earlier, there are two new representations to add to the management representation letters on review engagements. Take care when drafting representation letters this year to include them.
Regarding audit reports:
In May 2019 the AICPA issued SAS No. 134 on the auditor’s report, converging AICPA auditor reporting standards with those of the International Standards on Auditing. In addition, the AICPA issued SAS No. 135, an omnibus statement on auditing standards. You will recall the audit clarity standards increased the length of the audit report. SAS No. 134 will change the sequence of the paragraphs and add as much as another page to the report. The opinion paragraph will be presented first in the report, followed by the basis for the opinion. There will be a new lengthy section under a sub-heading “Auditor’s Responsibilities for the Audit of the Financial Statements.” New language will be required in communications with those charged with governance, and the engagement letter wording changes. The standard is effective for periods ending on or after December 15, 2020, with early implementation not permitted.
Firms with Clients Audited under Government Auditing Standards
The new Yellow Book was published July 17, 2018 and is effective for periods ending on or after June 30, 2020.
The CPE requirements are mostly unchanged, although new staff will now have to obtain the CPE before beginning work on the audit, and there is a new exemption for nonsupervisory staff that charge less than 40 hours to GAGAS engagements.
The 2018 Yellow Book clarifies that when the auditor prepares the financial statements, this is always a significant threat requiring a safeguard. Perhaps the best safeguard to apply is a second partner review or equivalent. Note that this second review can be limited to the financial statements and related disclosures. Review of the working papers is not necessary.
Note that preparation of financial statements is a non-attest service performed in the year subsequent to the client’s fiscal year end. For example, if you are preparing the client’s financial statements for the year ended June 30, 2019 you are performing that service during the client’s subsequent fiscal year ended June 30, 2020. Therefore, this service should be performed under the new guidance for non-audit services in the 2018 Yellow Book.
In the past year, a common finding in peer review has been that the firm is not documenting significant threats and safeguards when the firm both audits and prepares the financial statements. This is a complex area and should not be confused with the auditing standards for significant control deficiencies. Under the 2011 Yellow Book, there are circumstances when the preparation of the financial statements may not constitute a significant threat, but firms are not always documenting this exception correctly when it applies. Firms that acknowledge the financial statement preparation is a significant threat do not always document appropriate safeguards. Reference Paragraphs 3.16 – 3.19 in the 2011 Yellow Book for examples of safeguards. There should be safeguards at both the firm and client levels.
Firms with Single Audit Clients
Under the Enhanced Audit Quality program, the AICPA continues to hire Subject Matter Experts (SME) to oversight peer reviewers on high risk engagements such as Single Audits. The SME will frequently challenge the peer reviewer’s judgment as to whether the Single Audit conforms to professional standards. Two areas the SME tends to deem nonconforming are:
- The documentation of controls over compliance and the documentation of tests of controls over compliance.
- The documentation of the reasons an applicable compliance requirement is not considered direct and material.
Be wary of dual-purpose tests. When testing transactions, we recommend you document your tests of controls on a separate spreadsheet or have a separate set of tick marks for the control tests, which helps to concentrate your attention. Your working papers should describe how the client documents performance of the controls over compliance. For example, if the supervisor initials an intake form, your audit working paper should demonstrate, on a transaction by transaction basis, that you reviewed the intake form for the initials and the initials were present.
The practice aid most firms use, Practitioners Publishing Company, has a form (CX-7.3) for documenting which compliance requirements are direct and material, but that format does not clearly allow for the auditor to document the reasons a compliance requirement is not direct and material. For example, if your client does not have subrecipients, you should explicitly document this. Entering “N/A” opposite Subrecipients on CX-7.3 is not adequate. If the compliance requirement for procurement applies to the program but your client had no material procurement transactions, that needs to be documented.
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. Using the PRIMA system, you can enter my last name “Bose” and all of the relevant information will load automatically. In case that doesn’t work, my AICPA member number is 1153765, and my firm number is 10083621.
This letter, along with additional guidance on peer reviews, will be posted to our website. Our website address is: www.peer-review.com. Our email address, if you wish to contact us about peer review, is: hbose@rbhcpas.com.
Very truly yours,
The RBH Group, LLC