Don Applegarth, Audit shareholder at Schneider Downs, is attending this month's AICPA National Conference in Washington, D.C. Below, Don shares his notes from Day 2. If you have any questions on the contents of this article, please contact Don at email@example.com.
Greetings from Day 2 of the AICPA National Conference on Current SEC & PCAOB Developments (Tuesday December 7, 2010)
The day kicked off with Wayne Carnall talking about an IFRS Survey of companies who have adopted IFRS. Companies were sampled from the list of Global Fortune 500 companies, of which about 200 report under IFRS and 20% are registered filers. The survey included companies in over 20 countries and 30 different industries. The Division of Corporation Finance began looking at the disclosures of these companies while developing comment letters using their usual process to begin to get a flavor for variations in IFRS disclosure reporting. The top 10 list of IFRS accounting matters the Division focused on were:
- Consolidated Financial Statements (IAS 27)
- Provisions/Contingencies (IAS 37)
- Employee Benefits (IAS 19)
- PPE (IAS 16)
- Income Taxes (IAS 12)
- Revenue (IAS 18)
- Operating Segments (IFRS 8)
- Financial Statement Presentation (IAS 1 and IAS 7)
- Impairment of Assets (IAS 36)
- Financial Instruments (IAS 39, IAS 32, and IFRS 7)
Angela Crane of the Division of Corporation Finance then spoke about the Division’s response to perceived window dressing and masking of liquidity obligations. The response was the proposal of new disclosure requirements for registrants regarding their short-term borrowings, funding activities, and liquidity obligations. Qualitative disclosures include a description of each borrowing including the business purpose, average short-term borrowings for the period versus year-end borrowings, as well as disclosure of the significant differences between the average and the year-end borrowings. Added quantitative disclosures include weighted average interest rate and maximum amounts outstanding during the period. A companion MD&A release was issued and is currently effective.
Looking back at 2010, over 30 CDIs were issued on non-GAAP financial measures. The Division of Corporation Finance cautioned registrants to keep prominence in mind. Non-GAAP financial measures should not be displayed with more prominence than GAAP measures even though new guidance removed some of the barriers to reporting non-GAAP financial measures. The Division will be focusing on these non-GAAP measures, including but not limited to, the number of shares used in diluted per share performance measures including cash flow per share. Declaring it a performance measure does not alleviate the concerns the Division has over the metric not being properly calculated or displayed. The Staff will cautiously evaluate non-GAAP measures that are similar to GAAP measures and challenge the disclosures as it sees fit.
Some attention in 2010 was given to the calculation of the income test for calculating significance of business acquisitions particularly in the area of using five-year average income. Some changes include:
- Losses can be used in the five-year income averaging whereas in prior rules losses could not be used;
- Limiting any adjustments to income from 5 to 1. Now, only basis issues can be adjusted out of income;
- Discontinued operations are to be excluded from the denominator which is pre-tax income/loss from continuing operations; and
- Using pre-tax income/loss as reported on the investee’s financial statements for determining proportionate significance test.
Other matters rounding out the Division’s presentation on 2010 activities included condensed financial information for guarantor reporting under SX-3-10, IFRS for Small- to Medium-Size Entities (not intended for registrants but is acceptable for non issuers), critical accounting estimates including more robust disclosure requirements when impairment indicators exist as well as critical estimates in stock-based compensation estimates in a first time IPO. Additionally, loss contingency disclosures as well as liability versus equity classifications, and income tax rate reconciliations and disclosures will remain a focus in 2011.
The FASB and IASB Address
Leslie Seidman, Acting FASB Chair, and Sir David Tweedie, the IASB Chair, addressed the audience today.
Ms. Seidman remarked on the priorities of the FASB including increasing the FASB board from 5 to 7 members, serving as a resource through the SEC Advisory Committee on Improvements to Financial Reporting (CIRF) including post implementation review of standards, establishment of a Financial Reporting Forum, and a disclosure framework. A Codification Survey was under taken while the establishment of the Blue Ribbon Panel on Private Company Reporting was discussed and will remain a focus of the FASB.
Sir David Tweedie commented that there are 120+ countries that have adopted IFRS as of 2010 and the expectation is that there will be 150+ by 2013. He discussed several reporting standards that are on the IASB agenda including Agriculture, Share Based Payments, Income Taxes, Pensions, Government Grants, Foreign Exchange Transactions, Performance Reporting, and Disclosure Frameworks.
Post implementation reviews are anticipated on segment reporting, business combinations and de-recognition. Extractive industries accounting and common control are other agenda items.
The FASB will revisit its Consolidation standard in 2011, specifically in the area of determining principal versus agent, and information is being gathered from comments on the FASB’s proposed changes to lease accounting rules.
The FASB did not tag any effective dates to the proposed changes to lease accounting, revenue recognition, or financial instruments which was intentional as the FASB seeks input for a preferred approach to transition and an optimal way of adopting these standards.
Accounting Standard Setting
The FASB is obtaining feedback on its proposed rules for lease accounting. Some preliminary comments revolve around the difficulty in applying the rules for renewal options on leases, probability weighted assessments of contingent rents, and clarification on the difference between a lease and a service contract. Other comments from constituents centered on the nature and types of costs under a lease agreement such as RE taxes a lease may be required to pay, and whether or not these costs should be included as a cumulative cost of the lease and placed on the balance sheet. The FASB acknowledges that there may be practical solutions to these comments and will formulate thoughts in 2011.
The FASB speaker discussed the proposed revenue recognition rules and remarked that there are areas that need improvement including clarification on timing of the transfer of control in service contracts, more focus on timing of cost recognition, warranties, and revenue when collectability is not assured.
Financial Instruments was discussed by the IASB speaker. The IASB chose to issue guidance in three phases: classification & measurement, impairment & offsetting, and hedging. Whereas classification and measurement has been dealt with, more work needs to be done on impairment and offsetting, as well as hedging. The FASB acknowledges that difference of opinions exist between it and the IASB, but both agree to work together to narrow these differences in 2011.
PCAOB Keynote Address
Daniel Goelzer, Acting Chair of the PCAOB, remarked that the PCAOB performed 237 inspections including 53 outside of the U.S. The results of the reviews were reported in September 2010 which included findings in areas such as fair value, impairment, allowance for loan losses, off balance sheet entities, revenue recognition, inventory valuation, and income taxes. The theme, though, was that Firms must do a better job in adapting to the risks associated with the economy.
The focus for 2011 will be on how fee pressure affects audit quality. Clearly, there is concern that reduced fees may impair audit quality. This is mainly due to the fact that PCAOB is interested in monitoring the impact and the reactions of Firms, particularly in a time when there is heightened risk due to economic conditions.
Daniel further discussed standards issued in 2010, including Audit Committee Communications and Confirmations, both of which are proposed standards. A longer term project would be a Codification of the PCAOB’s auditing standards so as to simplify and highlight differences between its standards and those of the Auditing Standards Board.
He spoke about the work of the Enforcement Division of the PCAOB that had 27 formal and informal investigations and settlements in 7 of those cases. Daniel noted one specific matter that may need a legislative fix: the fact that Firms are often litigating the PCAOB’s conclusions, which in turn, creates delays in the process and potentially allows Firms to continue to practice and issue reports. The root cause of the decision to litigate is that the PCAOB’s findings are not public knowledge until actual sanctions are imposed. Thus, Firms are choosing to delay the information becoming public by choosing to litigate the issues.
The PCAOB’s 2011 agenda will focus on three primary areas. First, implementation of an audit plan for firms that audit broker dealers are now required under the Dodd Frank Act. There are 2,500 broker dealers and about 500 Firms that are registered just because they do broker dealer audits. Funding of the PCAOB must be evaluated for the increased workload and it is estimated that it may be as much as 7% of the PCAOB’s 2011 budget. The PCAOB must prioritize its auditing of Firms, particularly in light of the fact that 33 broker dealers have about 80% of net invested capital. The PCAOB may propose an interim inspection program to gather information on the myriad of companies that may fall under the scope of the Dodd Frank Act and thus the purview of the PCAOB inspection of these firms.
The second 2011 agenda item is continuing to negotiate to perform inspections of non U.S. firms. Approaches under consideration include the “enhanced disclosure approach” and a “supervision approach.” The former requires registrants to disclose more information regarding foreign firm involvement and the latter allows the PCAOB indirect access to the work of non U.S. firms through its requirement to inspect U.S. based firms and enforcing the requirement to supervise and review the foreign firms involved in an audit.
The third agenda item involves enhancing the auditor’s report. More insight into the audit process is in demand and the PCAOB will evaluate whether or not changes are necessary to the auditor’s report. Some advocate more limitations in the report on the auditor’s responsibilities to detect fraud while another option being bantered around is a separate audit report akin to management’s MD&A. Challenges exist to adding another auditor’s report including increased liability to a firm and the need for standards to govern what the separate audit report may look like. It may be a free-written report or a structured report, but it is clear more thoughtful discussion is needed and the PCAOB is evaluating alternatives.
PCAOB Standard Setting
In 2010, the PCAOB issued Practice Alert 5 on Significant Unusual Transactions and Practice Alert 6 on Reporting on Issuers with Assets and Operations in Foreign Jurisdictions. In the former, the PCAOB highlighted the importance of a Firm’s requirement to audit and disclose significant transactions that are unusual in nature, while the latter emphasizes the need for U.S. auditors to supervise and review their foreign counterparts involved in an audit.
There is some concern that material weakness comments are lagging in being reported due to the fact that many material weaknesses are reported upon the occurrence of restatements. ICFR audits aren’t always identifying the material weaknesses in advance of the restatement, which is a problem.
The PCAOB’s Standards Advisory Group issued AS 7 on Engagement Quality Reviews and AS 8 through 15 dealing with risk assessments.
The 2011 agenda will be centered on Audits of Broker Dealers, the Auditor’s Reporting Model, Fair Value Measurements and other Accounting Estimates, Going Concern, Subsequent Events, Attestation Reports under Regulation AB and Related Parties.
The PCAOB is closely monitoring convergence projects of the FASB and IASB and has some concern about the pace, volume and nature of the new guidance and the ability of auditors to adapt procedures accordingly so as not to reduce audit quality.
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