SEC Comment Letter Trends
By Anonymous | |
Proquest LLC |
By
It is that time of year when many public companies are in the midst of the financial reporting season and nearing the deadline to file audited financial statements with the
Income Taxes
Realizability of deferred tax assets. The guidance under Accounting Standards Codification (ASC) Topic 740, "Income Taxes," requires a valuation allowance on deferred tax assets if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. A company must consider both positive and negative evidence when determining whether a valuation allowance is needed. When weighting available evidence, companies should consider how objectively verifiable it is.
The
* file magnitude and duration of past losses and the expected magnitude and duration of profitability;
* the factors leading to losses in prior periods and current profitability; and
* the accuracy of income (loss) forecasts in prior periods, as compared to actual results.
The
Projecting future taxable income requires estimates and judgments about future events. Companies should consider how much actual results have deviated from forecasted results in the past. When significant deviations have historically existed, projections of future income might be less objectively verifiable and might deserve a lower weighting in the consideration of all available evidence. Companies should also ensure that projections used as positive evidence are consistent with projections used to support other account balances in the financial statements, such as in impairment assessments.
Foreign earnings. Companies can overcome the presumption in ASC Topic 740 that all undistributed foreign earnings will be transferred to the parent company. No income taxes should be accrued by the parent if sufficient evidence shows that the foreign subsidiary or foreign corporate joint venture has invested or will invest the undistributed earnings indefinitely.
The
Reportable Segments
Consistent with the guidance under ASC Topic 280, "Segment Reporting," segment disclosures should be based on the "management approach" (i.e., aligned with a company's internal management reporting structure). As a result, the
The
When a company concludes that operating segments can be aggregated into a reportable segment, the
A company should consider how changes in its business might affect its segment reporting. For example, the
Goodwill Impairment
The
* The carrying value of the reporting unit
* The percentage by which fair value of the reporting unit exceeded the carrying value for the most recent impairment test
* A description of the methods and key assumptions used to determine fair value and how the key assumptions were derived
* A discussion of the degree of uncertainties associated with key assumptions
* A discussion of any potential events, trends, or changes in circumstances that could reasonably be expected to negatively affect the key assumptions.
The
The ASC Topic 350 goodwill guidance allows companies to perform qualitative, rather than quantitative, impairment assessments under certain circumstances. The
Fair Value Measurements
The guidance under ASC Topic 820, "Fair Value Measurement," requires companies to disclose which level within the fair value hierarchy certain fair value measurements are categorized. This hierarchy is based upon the inputs used in valuation techniques, as follows:
* Level 1. Quoted prices (unadjusted) in active markets for identical assets and liabilities that the reporting entity can assess at the measurement date
* Level 2. Inputs other than quoted prices in active markets for identical assets and liabilities that are observable, either directly or indirectly
* Level 3. Unobservable inputs.
The
The
The fair value guidance requires companies to disclose the valuation processes related to their Level 3 measurements, quantitative information about the significant unobservable inputs they use in determining these fair value measurements, and a description of the sensitivity of the fanvalue measurements to changes in these significant unobservable inputs. The
* When companies disclose a wide range of significant unobservable inputs for a given class of assets or liabilities, disclosure of weighted-average information or expanded discussion of the reasons for this wide range, in order to provide additional context and understanding for investors
* When certain classes of assets or liabilities are valued using different methods, separate disclosure of the population valued under each method
* Enhanced disclosures about valuation processes, including how a company determines its policies and procedures and how it analyzes changes in fair value measurements from period to period
* Expanded descriptions of a fair value measurement's sensitivity to changes in unobservable inputs in order to address all of the unobservable inputs for which quantitative information is provided and to explain how the inputs significantly affect the fair value measurement.
Loss Contingencies
Despite the fact that the guidance for loss contingencies has existed for many years, the
Recently, the
Revenue Recognition
Gross versus net presentation. For some companies, determining whether revenue should be reported gross or net of certain amounts paid to others can be challenging. This reporting depends upon whether the company functions as a principal or agent in the revenue transaction. The guidance on principal and agent considerations under ASC 605-45 does not provide any bright lines on whether gross or net presentation is appropriate; rather, it provides indicators suggesting gross or net reporting that often require companies to apply considerable judgment to their specific facts and circumstances. Companies in service and technology industries that do not carry inventory are especially likely to be questioned by the
The
Multiple-element arrangements. The guidance under ASC 605-25 addresses the accounting for revenue arrangements with multiple deliverables-for example, a company may provide multiple products, services, or combinations thereof to its customers as part of a single arrangement. In such cases, the
* Provide a complete description of rights and obligations, separate from the discussion of the accounting for those rights and obligations.
* Disclose the judgments made in concluding whether a deliverable is or is not a separate unit of accounting, and, if a deliverable is deemed to be perfunctory, disclose the reasons supporting this conclusion.
* Provide an analysis of how the total arrangement consideration was allocated to each unit of accounting, explaining how the estimated selling price for each was determined and any significant assumptions used in this determination.
* Provide a discussion of the timing and pattern of recognition for each unit of accounting.
Long-term contracts. The
MD&A
This continues to be the most frequent area of
In addition, the
Companies should consider disclosing the amounts outstanding and available at the balance sheet date under each source of liquidity. These disclosures also should highlight the company's cash needs over the next 12 months, including any significant planned capital expenditures and whether these expenditures are necessary or discretionary.
In addition, the
Non-GAAP Measures
The
Additional Disclosure Tips
In addition to the disclosure improvement ideas gleaned from
* Challenge existing disclosures to make them clearer and more transparent.
* Ensure consistency between matters disclosed within the financial statements and discussed elsewhere in the Form 10-K and within other information that is publicly available.
* Explain the timing of significant income and expense items.
* Use precise and defined language. Using terms that are not defined or understood in U.S. GAAP can confuse readers.
* Remove disclosures that relate to matters that are no longer material, including immaterial disclosures provided in response to prior
* Eliminate excess information and redundancy by looking for ways to streamline disclosures.
* Provide a clear description of significant accounting policies when several alternatives are available under U.S. GAAP.
The
Recently, the
Should the Accounting Profession Embrace Mandatory Audit Firm Rotation?
By
The subject of mandatory audit firm rotation has been periodically discussed in
Members of the accounting profession have almost unanimously rejected the concept of mandatory auditor rotation, but I believe that we would be better served by accepting it. I find the arguments against mandatory rotation unconvincing. Given the never-ending skepticism the profession faces from the public, it should lobby for audit firm rotation. Our focus should be on the rules of rotation-that is, which are required to make rotation work and which are not needed? This discussion will focus on the general concept of rotation, rather than addressing specific details, such as for how many years an auditor may serve or when an auditor can return to an audit.
Addressing the Profession's Challenges
The auditing profession is facing many challenges that could be ameliorated by the required rotation of auditing firms, such as independence, lack of competition, and regulatory overload. Because our clients pay us, the public has always questioned our independence. This issue is a significant source of the "expectations gap." Engagements that last for many years add fuel to this public doubt. The lack of acceptance of auditor independence is supported by a belief that we are "in bed" with our clients, who have retained us for many years and have supported our incomes over that time. In an effort to eliminate this negative perception, we have imposed on ourselves, and have had imposed on us by laws and regulators, massive independence rules; however, these rules fail to address the psychological effect on audit partners who know that the loss of an important, substantial client would significantly affect their compensation and standing in the firm.
The profession is also impeded because the vast majority of public company audits is concentrated in the four largest firms. The "second tier" picks up a moderate number of public company audits, leaving many smaller audit firms with a very small number of public company clients. In addition, the profession is saddled with intra-profession peer review, PCAOB inspections, and regulators that write more and more detailed rules. We should restructure the profession to create a high level of public trust, which the current levels of independence rules and outside inspections have failed to achieve. To do this, I suggest we turn to mandatory firm rotation.
Concerns Expressed by Commenters
Why would firm rotation work? It would make many of the issues of independence irrelevant because it would force auditors to be highly skeptical and mentally independent. Members of the profession, as well as legislators and regulators, could then take the appropriate position that the auditor is psychologically independent, due to the awareness that in a number of years, a new replacement auditor will be in a position to expose any major mistakes or even minor cover-ups. Thus, there would be no reason for an auditor to "go along" with a client just to protect a long-term revenue stream.
* Mandatory rotation would raise audit costs, as each new firm would face a learning curve for which they would have to charge clients.
* Mandatory rotation would result in clients having higher internal costs, as they would have to "train" a new set of auditors after each rotation.
* There is little or no objective evidence that the adage "a new broom sweeps clean" would occur in practice.
* Many audit failures occur in the early years after the appointment of a new auditor.
* The small number of firms able to handle large international audits makes it difficult for such companies to find a new auditor.
* Public companies might be forced to retain a less experienced auditor in light of the small number of large international audit firms.
* The number of accounting firms willing to perform audits of public companies would drop as a result of the inability to retain a client indefinitely.
Numerous articles have been published on auditor rotation. The Deloitte response to the request for comment evaluated empirical studies and listed 37 articles that opposed mandatory rotation, 8 articles that supported mandatory rotation, and 4 articles that were neutral on the topic. Nonempirical "opinion" studies have also been performed. None appeared to be sufficiently cogent to be quoted in the responses I studied.
The Case for Rotation
It is almost impossible to address these objections empirically, because there is no data on mandatory rotation. The auditors of large and small public companies change frequently; I do not believe that the start-up costs would be as significant as some of the respondents have claimed. Institutions such as
Furthermore, there is no empirical data on the learning-curve costs for a company being audited by a new firm. Such costs might be insignificant, or they might not exist at all. Some studies have indicated that audit failures are more likely to occur on a new engagement, rather than a long-standing relationship, but these studies do not appear to have been decisive. If mandatory rotation were in place, there would be greater demand for international auditing firms. The supply response to this development would increase competition and spread auditing knowledge.
Because all of these studies appear not to have produced empirical data that would support an objective opinion, one is left with the following subjective questions:
* Is audit error more likely to be created by a long-time audit firm wanting to keep its client happy, or by a new audit firm lacking experience with the client and an understanding of the issues or where the issues might be hidden?
* Will there be increased audit costs for a new firm, and can they be mitigated by greater competition?
* Will mandatory rotation create the need for more firms, resulting in greater competition, or will the inability to maintain long-term clients drive firms out of business? Will the need for clients to reach out beyond the Big Four result in greater exposure for second-tier and smaller firms, thereby creating more competition?
* Would mandatory rotation decrease individual auditor expertise, as change would drive young auditors out of firms, or would the need for more firms create added opportunities?
* Would an auditor try to do a better job by thinking that a good audit would retain the client or by worrying that a successor would find fault?
Under mandatory rotation, the entire area of independence would have to be reevaluated. For mandatory rotation to be viable, the current independence rules would have to be relaxed. SEC Regulation S-X Article 2, covering the qualifications of accountants, contains detailed rules covering auditors and their families with respect to various types of financial arrangements that would render the firm not independent. Furthermore, there are many services that, if provided, would render a firm not independent. In
In its periodic reports and speeches, the PCAOB has emphasized that it has found examples of a lack of skepticism, inadequate audit support, and excessive reliance on management representations in its inspections. It seems unlikely that either mandatory rotation-or the lack thereof-would affect these issues.
Finding a Solution
Many of the comments on the concept release sent to the PCAOB describe suggested improvements in auditor independence, effectively saying that mandatory audit firm rotation would not be necessary if the independence rules were revised accordingly. Suggestions include improving communications with audit committees, having more accountants on audit committees, requiring better public company disclosures, and discussing PCAOB inspection findings with the audit committee. One suggestion is that audit committees become more involved in auditor independence. But is it really useful to have directors parsing the profession's lengthy, esoteric rules on independence? I believe that these responses demonstrate the inability of the comment-letter writers to directly address the question. The profession has collectively taken a position against mandatory rotation without any real basis. Given the points above, I believe we should rethink this issue. ?
Members of the accounting profession have almost unanimously rejected the concept of mandatory auditor rotation, but I believe that we would be better served by accepting it.
If mandatory rotation were in place, there would be greater demand for international auditing firms. The supply response to this development would increase competition and spread auditing knowledge.
A Reference for Audits of Single Financial Statements and Specific Elements, Accounts, or Items of a Financial Statement
By
The recent
Overview
In some cases, a business might not need an audit of all its financial statements, but rally of one financial statement. In other cases, a business might only request an audit of an element, account, or item in the financial statements (i.e., an "account"). For example, an auditor might audit all the financial statements and the business might also request an opinion on an account, or tie auditor might only audit one account. In some situations, the auditor might not give an opinion on a specific account without auditing the financial statements. AU-C section 805 does not apply to an audit of group financial statements by a component auditor at the request of a group engagement team.
When auditing a single financial statement or a specific account, it is necessary to audit any interrelated accounts, including any related notes to the financial statements. When performing an audit of a financial statement or an account, an auditor must understand the reason the audit was requested, the appropriate financial reporting framework, and who the users of the report are. When auditing a single statement, the auditor should determine materiality based upon that financial statement. If the audit is of a specific account, the auditor should determine materiality based upon that specific account, rather than the entire set of financial statements. If auditing several accounts, the auditor should determine materiality for each individual account, not the total of the accounts.
Account based on stockholders' equity or net income. When auditing a specific account, the auditor should determine if that account is based on stockholders' equity. If it is, the auditor must obtain enough evidence to express an opinion on financial position. As a practical matter, this requirement would mandate auditing the balance sheet. The auditor should also determine if the account is based on net income. If it is, the auditor should obtain enough evidence to express an opinion on financial position and results of operations. As a practical matter, this requirement would mandate auditing these financial statements, but not the cash flow statement.
Modified Opinion on the Complete Rnancial Statements
When auditing all of the financial statements and giving a modified audit opinion, an auditor should determine how this modification would affect the opinion on the specific account, if any. This effect depends upon whether the modification is due to an accounting deficiency or an audit deficiency.
For example, consider a business that refused to capitalize a material lease. A qualified audit opinion would be issued, due to the material accounting deficiency on the overall financial statements. If the business requests an audit of property, plant, and equipment, the opinion on these accounts would be affected. Because the modification of the complete financial statements affects a specific account, the auditor is required to give an adverse opinion on that specific account.
On the other hand, if the auditor gave a qualified opinion on the complete financial statements, due to an inability to obtain sufficient appropriate evidence, the auditor would disclaim an opinion on the specific account. If the auditor were unable to confirm receivables that are material, nor apply alternative procedures, the auditor would qualify the opinion on the complete financial statements. In this case, if the business requested an opinion on its accounts receivable, the auditor would disclaim an opinion on the schedule of receivables.
If the audit opinion on the complete financial statements is adverse or a disclaimer of opinion, a piecemeal opinion on a specific account that would contradict the overall opinion cannot be given. In some cases, an opinion on a specific account would not contradict the overall opinion. In these cases, an auditor can express an unmodified opinion on the specific account if the following two conditions are met: 1) the item is not a major portion of the financial statements, and 2) the opinion on the specific account is not published together with the opinion on the complete financial statements.
The balance sheet or income statement is a major part of the complete financial statements; therefore, an auditor cannot give an opinion on either one if the auditor gave an adverse or disclaimer of opinion on the complete financial statements.
Emphasis-of-Matter or Other-Matter Paragraphs
When an auditor has audited the entire financial statements and included an emphasis-of-matter or other-matter paragraph in the audit opinion, the auditor should determine how this would affect the opinion on the specific account, if at all. If the paragraph is relevant to the specific account, the auditor should include a similar paragraph in the opinion on the specific account.
Incomplete Presentation That Is Otherwise GAAP
The guidance for reporting on an incomplete presentation that is otherwise GAAP is now included under AU-C section 805. When reporting on an incomplete presentation that is otherwise in accordance with GAAP, such as a partial balance sheet or a partial income statement, the auditor should include an emphasis paragraph in the report. This paragraph should state the purpose of file presentation and should refer to the foot- note that describes the basis of the presentation. In addition, the emphasis paragraph should indicate that the presentation is not intended to be a complete presentation of the entity's assets, liabilities, revenues, or expenses. Examples include an audit of certain assets and liabilities to be sold but not the entire balance sheet, or an audit of direct operating expenses but not the entire income statement.
Specific Elements, Accounts, or Items of a Financial Statement
The following are examples of specific elements, accounts, or items of a financial statement, as provided in the appendix to AU-C section 805:
* Accounts receivable
* Allowance for doubtful accounts
* Inventory
* liability for accrued benefits of private benefit plans
* Intangible assets
* Reported claims in an insurance portfolio and notes
* Schedule of externally managed assets and income of private benefits plans and notes
* Schedule of disbursement in relation to leased property and notes
* Schedule of profit participation and notes
* Schedule of employee bonuses and notes.
A Quick Reference
The Exhibit presents a flowchart of the audit of a specific item, element, or account of a financial statement. It is divided into two sections: when the auditor has audited the complete financial statements and when the auditor has not audited the complete financial statements. AU-C section 805 describes the requirements of auditing a single financial statement, and it changes the previous guidance on auditing a specific element, account, or item of the financial statement. This short guide provides a quick reference for an auditor dealing with these audits. ?
When auditing a single financial statement or a specific account, it is necessary to audit any interrelated accounts, including any related notes to the financial statements.
Copyright: | (c) 2014 New York State Society of Certified Public Accountants |
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