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 professional standards for compilation and review, the introduction of the preparation standard, and the new ethics codification are the areas to focus on this year. Implementing new standards is always a challenge and the latest versions of the AICPA peer review checklists emphasize these areas.
The New Financial Statement Preparation Service
Because the preparation service has been advertised as a watered down version of the compilation service, there is a tendency on the part of firms to take a casual approach to performing these engagements.
The AICPA announcements regarding the preparation service imply that it is a less time intensive engagement than the compilation. In reality, the time and effort involved under the new service is comparable to that required to perform a compilation engagement. The only meaningful difference between the engagements is the method of communicating the accountant’s involvement to the user. This is done with a legend on each page of the financial statements for the preparation engagement as opposed to making the communication in the accountant’s report for a compilation engagement.
The wording of that legend is critical. Most firms understand the legend must disclose that the accountant is providing no assurance to the financial statement user. However, some firms may not realize engagements will be deemed non-conforming if material departures from professional standards are not disclosed in the legend or, alternatively, in a selected footnotes section.
In addition, guidance from the AICPA indicates that the failure to disclose the omission of substantially all disclosures in the legend will result in a non-conforming engagement. It is likely the majority of the financial statements prepared under the preparation service will be interim tax basis financial statements prepared on accounting software with substantially all disclosures omitted.
The failure to disclose the basis of accounting on the face of the financial statements may also result in a non-conforming engagement, unless it is otherwise apparent what basis of accounting applies.
When non-conforming engagements are identified in a peer review, the reviewer may not be able to issue a pass peer review report on the firm. If the review is an engagement peer review for a firm without an audit practice, a pass with deficiencies or fail outcome is mandatory.
New Compilation and Review Standards
In October 2014 the AICPA issued SSARS No. 21, which is effective for client fiscal years ending after December 15, 2015. SSARS No. 21 requires firms replace existing language in their accountant’s reports, engagement letters, and other client communications with significantly different language.
Most firms understand the accountant’s reports now have different language but there are nuances involved in the preparation of the engagement letters they may not be aware of.
Under the new ethics standards, described later in this letter, the compilation and review services are separate and distinct from the financial statement preparation service. Your engagement letters have to cover both the attest service (compilation or review) and the financial statement preparation service (nonattest). The one exception would be if the client prepares the financial statements and you are performing a “pure” review or compilation service.
Unfortunately, PPC’s guidance in this area is confusing. PPC has sample engagement letters for five different types of service:
* Review only
* Review and financial statement preparation
* Compilation only
* Compilation, bookkeeping and financial statement preparation
* Preparation only
The key to using these sample engagement letters correctly is to understand that under the new ethics codification the compilation and review services do not automatically incorporate the financial statement preparation service as they did in the past. Specifically, ET 1.295.010.06 says financial statement preparation is “outside the scope of the attest engagement” and, therefore, constitutes a nonattest service.
Unfortunately, because PPC places the “review only” and “compilation only” sample engagement letters first and refers to the sample engagement letters that incorporate the financial statement preparation service as “expanded,” there may be a tendency on the part of firms to use the “review only” and “compilation only” sample engagement letters when they are also preparing the financial statements. In addition, firms may mistakenly select the sample letter for “preparation only” service when they are performing a compilation or review service. According to an AICPA technical manager consulted on this topic, any of the errors described within this paragraph will result in a non-conforming engagement.
Ethics Codification
A new codification project, this one on ethics, is effective for fiscal years commencing after December 15, 2014. Your focus should be on ET 1.295, which revises the guidance for maintaining, and for documenting, your independence when you provide nonattest services, such as income tax preparation, to audit and accounting clients. As noted in the discussion on SSARS No. 21 above, preparation of the financial statements is now deemed a separate nonattest service. Your engagement letters for compilation, review, and audit need to be revised to address the financial statement preparation as a nonattest service. In addition, you need to document the other nonattest services, such as income tax preparation, you provide to the client. Further, you must document the objective of the nonattest services, the practitioner’s responsibility, management’s acceptance of its responsibilities, and the limitations of the nonattest services. Much of this documentation was required under the previous ethics standards and historically the PPC sample engagement letters incorporated appropriate language that met the ethics documentation requirement. Unfortunately, the new PPC engagement letters for “review only” and “compilation only” remove all of the language that previously met the ethics documentation requirements. The PPC engagement letters that are “expanded” to cover the financial statement preparation service do have much of the documentation required under the ethics standards, but cover only one nonattest service, the preparation of the financial statements, when it is likely the firm is providing other nonattest services such as income tax preparation. The safest approach is to either complete the non-attest form provided in the PPC service, which is designed to comply with the documentation requirements under the ethics standards, or to write a memo. Contact us and we will provide you with an example of the memo approach.
New Attestation Standard
SSAE No 18 revises the guidance for engagements performed under the attestation standards. It is effective for reports issued after May 1, 2017. The most commonly performed engagement under the attestation standards is the agreed-upon procedures engagement. There are several changes to the agreed-upon procedures service, converting steps that were formerly optional to mandatory. For example, SSAE 18 requires a written assertion from the client. If one is not obtained, this fact must be disclosed in the agreed-upon procedures report. Also, both the responsible party and the engaging party must supply a representation letter. On the positive side, the changes to the report language are relatively minor. For example, the placement of the sentence referencing the professional standards moves from first to second paragraph and there is now a reference to both the review and examination attestation services when cautioning the user of the limitations of an agreed-upon procedures engagement. You will need to update your practice aids for agreed-upon procedures. PPC, for example, includes practice aids on agreed upon procedures in its Guide to Nontraditional Engagements.
New Accounting Standards
FASB has been making an effort to reduce the complexity of the accounting standards.
As part of this effort, FASB has 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.” With Issue No. 15-01, PCC accelerated the effective dates on alternatives for variable interest entities, interest rate swaps, goodwill, and the accounting for intangibles in a business combination, removing their previous effective dates such that they are effective immediately. Implementing the alternative standards is deemed a change in accounting principle.
FASB has undertaken a “Simplification Initiative,” which is intended to reduce the cost of complying with professional standards. Some of the standards issued under this initiative are as follows:
* ASU No. 2015-01 eliminates from GAAP the concept of extraordinary. Previously, extraordinary items were defined as both unusual in nature and infrequent of occurrence. The requirement that unusual or infrequent items be presented as a separate component of income from continuing operations still applies. You may have an item that is both unusual and infrequent but such an item can no longer be described as extraordinary. The standard is effective for fiscal years beginning after December 15, 2015.
* 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 is effective for fiscal years beginning after December 15, 2015.
* 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 is effective for fiscal years beginning after December 15, 2016, although earlier application is permitted as of the beginning of an interim or annual reporting period.
* ASU 2015-17 eliminates the requirement to classify deferred income tax assets and liabilities between current and noncurrent – all will be deemed noncurrent. Early implementation of this standard is allowed.
* ASU 2016-07 eliminates the requirement to retroactively adopt the equity method when, due to an increase in ownership interest, an investment crosses the threshold that requires equity treatment. Now the equity method may be applied prospectively. Early implementation of this standard is allowed.
Other significant new accounting standards include the following:
* ASU 2016-02 makes multiple changes to the accounting for leases. The main change is the treatment of operating leases, which now will be reported on the balance sheet. The standard is effective for fiscal years beginning after December 15, 2019.
* ASU 2014-09 on revenue recognition is the most significant accounting standard of recent years. The effective date is for fiscal years beginning after December 15, 2018.
A recent AICPA interpretation has removed the requirement to disclose years open to examination by major taxing jurisdictions. Unless your client has a material unrealized tax benefit, this disclosure is now optional. This had been a common finding in peer review because this disclosure was featured on the peer review engagement checklists.
Firms with Not-For- Profit Industry Clients
A major revision to the standards for accounting for nonprofit organizations is effective for fiscal years beginning after December 31, 2017. Temporarily and permanently restricted net assets will be combined into an entry captioned “Net Assets with Donor Restrictions.” The accounting for underwater endowments will change. All nonprofit organizations will now have to disclose expenses by both natural classification and function. Nonprofit organizations that elect to use the direct method for the statement of cash flows will no longer have to provide an indirect reconciliation.
Firms with Single Audit Clients
The new audit requirements under the Uniform Guidance (UG) are effective for years ended after December 15, 2015. UG supersedes Circular A-133 on the Single Audit and has six subparts. Subpart F covers the audit requirements.
UG also revised the administrative requirements recipients of federal funds must follow. Your single audit clients had to implement the new administrative requirements for all new federal awards and for additional funding to existing awards received with new terms and conditions by December 26, 2014. As auditors, you will likely have to test some expense under old requirements and some under the new requirements.
Subpart F will increase the threshold for Single Audits from $500,000 to $750,000. The Type A minimum threshold increases from $300,000 to $750,000. Risk assessments on Type B programs can stop once the number of high risk Type B programs identified is equal to 25% of the number of low risk Type A programs. However, auditors will no longer be able to categorize large ongoing Type A programs as high risk simply on account of their complexity, which on some engagements may result in audits of Type B programs not previously audited. Coverage from low risk auditees is reduced from 25% to 20% and for other auditees from 50% to 40%. The de minimis for small programs is increased from $100,000 to $187,500. The threshold for reporting questioned costs increases from $10,000 to $25,000.
Firms with Governmental Clients
When implementing GASB No. 68 on pensions last year, firms discovered that many of their governmental clients had transition liabilities that were not reported previously. When an employer transitions from one multiple-employer pension plan to another one, a long-term payable may be assessed to an individual employer. This payable is recognized separately from, and in addition to, the plan’s net pension liability. Starting in 2001 the State of Oregon allowed local governments to join the State and Local Government Rate Pool (SLGRP), a pool that includes state agencies as well as local governments. When a local government joins the SLGRP, there can be an excess unfunded actuarial liability attributable to the agent multiple employer plan in which it previously participated. This excess represents a long-term payable from the local government to the SLGRP. The liability is amortized over a fixed period. The local government is charged interest based upon the Oregon PERS Board assumed earnings rate (currently 7.75%). The pooled rate for the local government is adjusted by an amount sufficient to meet the amortization schedule requirements. The liability should be reported with other long-term obligations, such as bonds payable. The OSCPA website has templates to use in computing this liability.
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
This letter, along with additional guidance on peer reviews, will be posted to our home page.
Our website 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