June 27, 2018
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.
Data Hosting
Do you maintain your client’s depreciation schedules and store them on your firm’s server? The AICPA issued an independence interpretation in August 2017 (ET 1.295.143) on “data hosting.” According to this interpretation, 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 is effective September 1, 2018. Keep in mind, there may be both a book depreciation schedule and a tax depreciation schedule.
Tax Cuts and Jobs Act
Under ASC 740-10-45-15, companies with deferred assets or liabilities on their balance sheets must recognize the impact of changes in income tax rates due to new tax laws in the period that the new law is enacted. For example, if the timing difference is $100,000, and the company computed a deferred federal tax liability of $35,000 using the highest corporate rate of 35%, under the Tax Cuts and Jobs Act the company would record a deferred tax liability of $21,000 using the new highest corporate rate of 21% and the $14,000 difference goes to the income statement in the fourth quarter of 2017.
Reporting
While performing peer reviews in the past two years, we see firms continue to struggle implementing SSARS No. 21, which was effective for periods ended on or after December 15, 2015. The AICPA is directing peer reviewers, on engagement peer reviews, to write pass with deficiency or fail peer review reports when the accountant’s reports have not been updated for new standards. Many firms have implemented the standard, but a significant number have not, or have not implemented it consistently for all engagements performed in the firm.
SSARS No. 21 requires firms replace existing language in their accountant’s reports, engagement letters and other client communications with significantly different language. For example, the format for the new review report has a layout much like an audit report, including bolded subheadings above each paragraph. To help you understand how little tolerance the AICPA has for departures from standard report wording, you should know the AICPA requires the engagement peer reviewer to write a pass with deficiencies or fail report even when the only departure is the omission of these bolded subheadings.
In addition, SSARS No. 21 introduced the new non-attest service for financial statement preparation, known as the preparation service, which was codified at AR-C 70. Although firms usually have, as required by the standard, a legend on each page advising the user the firm offers no assurances, firms frequently fail to communicate departures from the applicable financial reporting framework and the decision by management to omit substantially all disclosures or to disclose the use of a basis of accounting other than generally accepted accounting principles. These matters can be communicated on the face of the financial statements in an expanded legend and by tailored financial statement titles. If you miss any one of these, your engagement peer review will be pass with deficiency or fail.
SSARS No. 23, which was effective for reports issued after October 2016, is another standard firms had difficulty implementing. This standard changed the wording in the accountant’s compilation or review report in the paragraph that covers the supplementary information, if any. If your reports include the word “representation” you are using the old language. The new reports use the word “responsibility” instead of “representation.” Firms that have not adopted the SSARS No. 23 language will receiving a finding in their peer reviews although this finding does not result in a pass with deficiency or fail peer review report.
SSARS No. 24 was issued in May 2018. One provision of SSARS No. 24 is effective on issuance but it has no impact on your accountant’s review and compilation reports. That provision changes some of the language in the standards so that it is consistent with the language in the sample reports included in the application section of SSARS No. 21. The reports themselves don’t change. The balance of SSARS No. 24 concerns reporting on financial statements prepared under standards generally accepted in another country, and reporting on financial statements when there is a going concern and is not effective until periods ending on or after June 15, 2019.
In addition to the new standards impacting compilation and review reports as outlined above, the auditing standards for the auditor’s report are changing again. Following fast on the new standard eliminating the limited scope audit opinion on ERISA audits, the AICPA has issued an exposure draft that will converge AICPA auditor reporting standards with those of the International Standards on Auditing. Responses to the exposure draft were due in May 15, 2018, and the standard would be effective for periods ending on or after June 15, 2019.
You will recall the audit clarity standards increased the length of the audit report. The new SAS will change the sequence of the paragraphs and add as much as another page to the report established under the clarity standards. 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.” If the audit opinion has an emphasis-of-matter paragraph, the subheading will now have to include the phrase “Emphasis of Matter.” If there is a going concern, that will be disclosed in a separate paragraph under the subheading “Substantial Doubt About the Entity’s Ability to Continue as a Going Concern” rather than in an emphasis-of-matter paragraph. New language will be required in communications with those charged with governance, and the engagement letter wording changes.
Accounting for Variable Interest Entities
In response to the collapse of Enron in 2001, FASB implemented the standards for Variable Interest Entities (VIE), without a carve-out for private sector companies. The standards on VIE compelled companies to consolidate many previously unconsolidated related entities. Finally, in March 2014 FASB issued ASU No. 2014-07 providing an exemption to the consolidation requirement for private companies when “common-control leasing arrangements” are involved. This addressed the most common scenario private entities face, which is when the stockholders in the operating company also have ownership in the entity that owns and leases back the building to the operating company. Now the news gets better. In June 2017, FASB issued an exposure draft that expands the private company alternative for common control leasing arrangements, as established in ASU No. 2014-07, to all private sector entities under common control.
Accounting Standards for Revenue Recognition and Leases
The two most significant upcoming changes to the accounting standards are: 1) ASU 2016-02 on accounting for leases, effective for fiscal years beginning after December 15, 2019; and 2) ASU 2014-09 on revenue recognition, effective for fiscal years beginning after December 15, 2018.
Discussion of these extensive new standards is outside the scope of this update letter, but we will go over some aspects of the revenue recognition standard briefly. The revenue recognition standard impacts legally enforceable contracts, oral or written, between your client and its customers, and requires the client identify the separate performance obligations within the contract, and to recognize the transaction price on a component basis. Incentive and penalty provisions may or may not be considered part of the transaction price. In summary, under the new standard, the contracts may splinter into separate performance obligations, and the transaction price may be an estimate based on expected outcomes.
The revenue recognition standard is complex. To give you an idea, after issuing ASU 2014-09 on revenue recognition, FASB issued the following standard updates to provide further clarification and guidance: ASU 2015-14, 2016-08, 2016-10, 2016-11, 2016-12, and 2016-20. FASB has an implementation guide, and the AICPA has an Audit and Accounting Guide on the new revenue recognition standard, which we recommend you purchase.
Chapter 11 of the AICPA revenue recognition guide covers the construction industry, and several other industries have separate chapters devoted to them. According to Chapter 11, 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. If the contract includes engineering services, this is usually considered part of the single performance obligation, but may represent a separate performance obligation if, for example, the customer has the option of awarding construction to a different contractor upon completion of the engineering. According to Chapter 11, contractors may use either output or input methods in determining percentage of completion. Input methods include labor hours expended, costs incurred, time lapsed, or machine hours used relative to the total expected inputs needed to satisfy the performance obligation.
The standard permits private companies to elect out of providing many of the disclosures required for public companies. For example, although the standard requires public companies to include disaggregated revenue in their footnote disclosures, categorized by market, product type, or otherwise, private companies may limit their disclosure to revenue information disaggregated according to the timing of transfer of goods or services (i.e., revenue from goods or services transferred to customers at a point in time, verses revenue recognized over a contract term).
Although private companies disclose the opening and closing balances of receivables, contract assets and contract liabilities, unlike public companies, they do not need to disclose other contract balance information, such as the amount of revenue recognized in the current period that was previously recognized as a contract liability, or the amount of revenue recognized that is related to performance obligations satisfied in previous periods because of changes in the transaction price. Although private companies disclose information about the nature of their performance obligations, such as when the company satisfies its performance obligation (e.g., upon shipment), and private companies disclose significant payments terms, obligations for returns and refunds, and warranties, private companies do not have to disclose backlog information. Although private companies disclose methods used to recognize revenue for performance obligations satisfied over time (e.g., describe the output or input methods), unlike public companies, they do not have to include extensive disclosures regarding significant judgments used in determining revenue recognition.
Other New Accounting Standards
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.” Alternatives for variable interest entities, interest rate swaps, and goodwill were issued in past years and have been in effect since periods beginning after December 15, 2014. The private company alternative for goodwill allowed companies to amortize goodwill over ten years and test for impairment only when there is a triggering event rather than test annually. With 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.
FASB has undertaken a “Simplification Initiative,” which is intended to reduce the cost of complying with professional standards. Firms are not always aware of the standards issued under this initiative that have recently taken effect. Two standards to watch for are:
- 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. Although this appears to complicate rather than simplify the presentation, contrary to the spirit of the Simplification Initiative, 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 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. The standard includes specific guidance on footnote disclosure requirements. With SAS No. 132 issued in 2017 and now SSARS No. 24 issued this year, auditing standards and the standards for compilation and review engagements, respectively, have been revised in response. If you have a going concern, exercise care to follow the new presentation, disclosure, and reporting requirements.
Here is a recap of other changes that became effective in recent years or will go into effect soon:
- ASU No. 2014-10 eliminates the special presentation requirements for development stage companies. The standard was effective in 2015.
- ASU No. 2015-12 allows employee benefit plans to report guaranteed investment contracts at contract value rather than fair value, and streamlines investment disclosures – for example, the standard removes the requirement that plan assets representing five percent or more of net assets be listed individually. This standard was effective in 2016.
- ASU No. 2015-01 eliminates the concept of extraordinary item from GAAP. The standard was effective in 2016.
- ASU 2015-17 requires all deferred income tax assets and liabilities be presented as noncurrent. The standard is effective in 2018.
- ASU 2016-18 revises the presentation of changes in restricted cash on the statement of cash flows. The standard is effective for 2018.
- ASU 2016-01 requires the change in the fair value of marketable equity securities be included in net income rather than in Other Comprehensive Income. The standard is effective in 2019.
- ASU 2018-08 clarifies the reporting of contributions received and made in the not-for -profit industry. The standard is effective for contributions received 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.
Firms with Nonprofit Industry Clients
Discussion of FASB ASU 2016-14 on presentation of financial statements of not-for-profit entities is beyond the scope of this update letter. The new standard is effective with the 2018 calendar year. FASB has an implementation guide and 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:
Also, we recommend you join the AICPA Not-for-Profit Section, which has nominal dues, and which makes available a marked-up sample conversion to the new standard for a typical nonprofit entity named “Save Our Charities.”
Firms with Clients Audited under Government Auditing Standards
The new Yellow Book is scheduled to be released June 30, 2018, effective for periods ending on June 30, 2019. The current CPE requirements are retained. The new standard will clarify that when the auditor prepares the financial statements, this is a significant threat requiring a safeguard. This may close the last “loop hole” for sole proprietors, requiring they contract with an outside CPA to perform pre-issuance reviews on the financial statements the sole proprietor prepares on behalf of his or her clients.
Firms with Single Audit Clients
As part of its Enhanced Audit Quality program, the AICPA has made many changes to the peer review program. One change is to hire Subject Matter Experts (SME) to oversight peer reviewers on high risk industries, which includes Single Audits. The SME, whose review includes the working papers on the Single Audit, will frequently challenge the peer reviewer’s judgment as to whether the Single Audit conforms to professional standards. Regulators have concluded Single Audits performed by smaller firms or by firms with few such engagements are nonconforming 50 percent of the time, and the SME are finding the same noncompliance rate. The review by the SME takes place after the exit conference but before the peer review committee accepts your peer review. The two areas the SME tends to deem nonconforming are:
- The SME deems the documentation of controls over compliance and the documentation of tests of controls over compliance inadequate. 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 SME deems the documentation of the reasons an applicable compliance requirement is not considered direct and material insufficient. 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, you need to clearly document that.
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