Impact on Financial Issuers and Users

In previous blogs, I mentioned that Release No. 2013-005 was issued to improve the audit report for financial report users. As a result, Release No. 2013-005 will have a significant impact on auditors and the audit report. Since the Release No. 2013-005’s objective was to enhance the audit report, the financial users and issuers will be effected by these changes as well.

There are several different impacts that Release NO. 2013-005 could have on financial users. The first possible impact is that financial users may become confused with the discussion of audit procedures since these readers lack a proper understanding of the audit process and audit procedures (Yungmann & Drula, 2013). In addition, financial statement users may lack the context for the discussion of discrete audit procedures for a particular financial statement line item (Yungmann & Drula, 2013). The changes in the audit report could cause financial users to read duplicated information which would make the report not nearly as effective (Yungmann & Drula, 2013). In addition to making financial users read duplicated information, the Release No. 2013-005, may force financial users to read extensive discussion topics that are unimportant for them (Dalkin, 2013).  As a result of adding addition disclosures about auditor independence, financial users may have a difficult time fully understanding the concepts regarding to auditor independence without an extensive discussion afterwards (Dalkin, 2013). This will cause the report to be cumbersome, which will hinder the benefit associated with this change. The changes created by Release No. 2013-005 have a potential to mislead financial users to believe that the auditors have an authoritative basis to conclude on the sufficiency, accuracy, or completeness of the other unaudited information (Yungmann & Drula, 2013). This would create an expectation gap between the financial users and the auditors which in the past has caused several law suits to arise.  The changes associated with Release No. 2013-005 regarding to audit tenure can lead financial users to an incorrect interpretations about the company, its current fiscal situation, and the auditors (Dalkin, 2013).

As for financial issuers, they will also be significantly impacted by the changes stated in Release No. 2013-005. The first major impact would be that financial issuers will have to spend more on audit fees since auditors will have to spend more time on conducting the additional audit procedures. The higher fees have the potential to outweigh the benefits to the investors. In addition to spending more on audit fees, the changes stated in Release No. 2013-005 open up situations where the financial issuer will disclose sensitive information that normally would have not been required to be disclosed (Yungmann & Drula, 2013). An example of a possible situation is when a company discloses information regarding to control deficiencies that are less severe than a material weakness noted in the Company’s internal controls (Yungmann & Drula, 2013). The information regarding to this disclosure will be presented with a limited context and give the issuer a minimal opportunity to clarify the discussion during the audit committee meeting regarding this matter (Yungmann & Drula, 2013). Besides spending more money, financial statement issuers will have to spend more time in the later stages of the audit where the issuers’ time is already limited (Yungmann & Drula, 2013).

References

Dalkin, J. R. (2013, December 11). PCAOB Rulemaking Docket Matter No. 034. Retrieved from U.S. Government Accountability Office: http://gao.gov/assets/660/659649.pdf

Yungmann, G. L., & Drula, C. T. (2013, December 11). PCAOB Rulemaking Docket Matter No. 034. Retrieved from National Association of Real Estate Investment Trusts: https://www.reit.com/sites/default/files/media/2013/NAREIT%20Comment%20Letter%20on%20PCAOB%20Auditor%20Report%20and%20Other%20Information%20Proposal.pdf

Release 2013-005 Impact on Auditors

As mentioned previously, the Public Company Accounting Oversight Board, PCAOB, issued Release 2013-005. This release proposed two new auditing standards in order to improve the auditor’s reporting model and increase auditor’s responsibilities which is discussed more into detail in the Changes to the Auditor’s Reporting Model. These changes would impact several different parties such as auditors, auditor’s clients, and the client’s audit committee. This post will mainly focus on Release 2013-005 impact on auditors and the audit report. In future posts, there will more of a focus on Release 2013-005 impact on clients and their audit committee.

The first possible impact on auditors is that they could become responsible for being their client’s spoke person to shareholders (Zwick & Gibbons, 2013). Since Release 2013-005 requires auditors to put their analyses and judgement of the company in the annual report, shareholders could accidently expect that auditors will now be responsible for speaking for the company regarding certain company matters (Zwick & Gibbons, 2013). As a result, the extinction between auditors and the client could be further blurred together which could hinder auditor’s independence. When Release 2013-005 is mandated, auditors’ litigation risk has the potential to increase since auditors are required to disclose their subjective analysis on the company (Zwick & Gibbons, 2013). By disclosing auditor’s subjective analysis on the company on the annual report, auditors will become subject to liability in areas where they previously had a limited exposure to (Zwick & Gibbons, 2013).

Another impact of this release is that the proposed changes regarding the communication of CAMs could create a conflict with the governance and oversight role of the audit committees (Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report, 2014). This could impair the open communication and transparency among auditors, management, and the audit committee (Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report, 2014). As a result, management could avoid asking for auditor’s help when addressing complex financial issues since communication during the audit is required to be disclosed (Zwick & Gibbons, 2013). This could result in a negative impact on the audit quality (Zwick & Gibbons, 2013).

Auditors will be required to perform additional audit procedures that could be unnecessary  (Wagner, 2013). In addition, this release will make the auditor’s job of developing and performing audit procedures on forward-looking information more difficult (Wagner, 2013). As a result, auditors will have to spend more time on each engagement which may create additional time pressure to complete engagements and meet the SEC filing deadlines (Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report, 2014). In addition, the proposed changes will increase audit firm’s expenses which may hinder the firm’s ability to grow.  By requiring auditors to evaluate other information for any material inconsistency may create an expectation gap regarding the auditor’s performance requirements (Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report, 2014).

As for the audit report, the discussion of CAMs may reduce the clarity of the audit and internal control opinions because discussing CAMs provides a less clear picture to investors about the financial statements taken as a whole and the overall effectiveness of the internal controls (Wagner, 2013). Another impact on the audit report, is that the report can cause investors to become overloaded with information because auditors could report too many CAMs or have lengthy descriptions of the audit procedures performed (Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report, 2014).

References

Heads Up- PCAOB gathers more input on proposed changes to the auditor’s report. (2014, April 30). Retrieved from IAS Plus: http://www.iasplus.com/en/publications/us/heads-up/2014/pcaob-auditors-report

Wagner, D. (2013, December 11). Comments on PCAOB Release 2013-005. Retrieved from The Clearing House: file:///C:/Users/Ashley/Downloads/2013%2012%2011%20TCH%20Comments%20on%20PCAOB%20Revisions%20to%20Auditor%20Reports.pdf

Zwick, P. C., & Gibbons, A. J. (2013, September). PCAOB Proposes Important Changes to Audit Report. Retrieved from Jones Day: http://www.jonesday.com/files/Publication/63c3939b-f9e0-4093-a4a1-afa9c3a1ebd4/Presentation/PublicationAttachment/99e7b963-1d4c-4be3-b525-085c7e6fa539/PCAOB%20Proposes.pdf

Changes to the Auditor’s Reporting Model

In the past couple of years, the Public Company Accounting Oversight Board, PCAOB, has proposed several changes to auditing practices. On August 13, 2013, PCAOB issued Release 2013-005 which proposed two new auditing standards regarding to auditor’s reporting model and responsibilities  (Zietsman, Burns, Pruitt, & Simer, 2013).  Under Release 2013-005, the proposed auditing standard will keep the pass/fail model, but implements three significant changes to the auditor’s report  (PCAOB’s Proposed Changes to the Auditor’s Reporting Model and Responsibilities for Other Information, 2013).

PCAOB Release No. 2013-005. (2013, August 13). Retrieved from PCAOB

The first significant change would be adding a new section to the report where critical audit matters, as determined by the auditor, would be communicated (Zietsman, Burns, Pruitt, & Simer, 2013).  Auditors would be required to address topics that were discussed during the audit that either required complex auditor judgments, posed a difficulty in obtaining sufficient audit evidence, or posed difficulty in forming an opinion on the financial statements (Proposals to Enhance the Auditor’s Report, 2013). These critical audit matters relate to the current period, however, there is an exception. Auditors must consider communicating critical audit matters relating to the prior periods when the prior period’s financial statements are made public for the first time or previously issued auditor’s report could no longer could be relied upon (Proposals to Enhance the Auditor’s Report, 2013).

The next significant change would be enhancing the language within the audit report to include statements about the auditor’s responsibility for fraud and notes to the financial statements (PCAOB’s Proposed Changes to the Auditor’s Reporting Model and Responsibilities for Other Information, 2013).  With this change, the auditors will have to include the phrase “whether due to error or fraud” when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements (PCAOB Proposes Two Auditing Standards to Enhance Auditor’s Report, 2013). Also, the phrase “and the related notes” would be added into the introductory paragraph in order to clarify that the financial statements include the related notes  (PCAOB Proposes Two Auditing Standards to Enhance Auditor’s Report, 2013).

The last significant change is that a new element would be added to communicate more information about the auditor independence, auditor tenure, and the auditor’s responsibility for the evaluation of other information outside the financial statements (Zietsman, Burns, Pruitt, & Simer, 2013). Under this change, auditors will have to describe the scope of “other information” and procedures that are required to be performed  (PCAOB’s Proposed Changes to the Auditor’s Reporting Model and Responsibilities for Other Information, 2013). This change also requires auditors to evaluate the “other information” for inconsistency regarding to the amount, information, or the manner of their presentation in the financial statements (Proposals to Enhance the Auditor’s Report, 2013). If so, the auditor is required to respond appropriately (Proposals to Enhance the Auditor’s Report, 2013). As a result, this will add additional audit steps for auditors to perform when evaluating other information based on relevant audit evidence obtained and conclusions reached during the audit  (Proposals to Enhance the Auditor’s Report, 2013).  Also, the last change to the auditor’s report will require auditors to include an information regarding when the firm began serving consecutively as the auditor  (Proposals to Enhance the Auditor’s Report, 2013).

References

PCAOB Proposes Two Auditing Standards to Enhance Auditor’s Report. (2013, August). Retrieved from KPMG: http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Newsletters/Defining-Issues/Documents/Defining-Issues-O-1308-40.pdf

PCAOB’s Proposed Changes to the Auditor’s Reporting Model and Responsibilities for Other Information. (2013, September 13). Retrieved from Wall Street Journal : http://deloitte.wsj.com/riskandcompliance/2013/09/13/pcaobs-proposed-changes-to-the-auditors-reporting-model-and-responsibilities-for-other-information/

Proposals to Enhance the Auditor’s Report. (2013, October). Retrieved from AICPA: http://www.aicpa.org/interestareas/frc/auditattest/downloadabledocuments/enhanced_reporting/frc_asb_proposals_enhance_auditor_report.pdf

Zietsman, M., Burns, J., Pruitt, A., & Simer, B. (2013, August 13). PCAOB Proposes a New Auditing Standard to Enhance the Auditor’s Reporting Model. Retrieved from Public Company Accounting Oversight Board: http://pcaobus.org/News/Releases/Pages/08132013_OpenMeeting.aspx

 

 

 

Filtering Your Data Can Help Find Fraud!

With the advancement of technology, auditors have an endless amount of tools applications that they can use to detect fraud like the Benford’s Law. Most of the tools and applications have improved the efficiency and effectiveness of an audit. One of these tools used in auditing software is the device to subset or filter the data. From my experience with working with two of the most widely used auditing software, ACl and CaseWare IDEA, the use of the filter tool is very common and easy to implement.

(What are Subsets?, 2013)

Filtering the data is the process of naturally grouping data in a data base (Nigrini, 1999). The grouping generally depend on a certain characteristics like the picture on the left (Nigrini, 1999).  For an example, if you were trying to subset accounts payable information the characteristics could be a specific invoice amount or vendor number (Nigrini, 1999). Other characteristics include but not limit to employee number, transaction dates, travel agents, inventory location, or accounts numbers (Nigrini, 1999). Filtering the data by a specific characteristic makes the process of analyzing the information more manageable in addition to being more efficient. There are several ways that the analysis of subset data can be used to detect fraud.

The first use of data subsets analysis is to help auditors identify a small list of serious anomalies in the large data base (Nigrini, 1999). This will allow auditors to focus more closely on possible errors, fraud, or processing inefficiencies that were identified by the anomalies (Nigrini, 1999). The analysis of filtered data can also summarize whether the data satisfies a given constraint with a certain confidence level (Golab, Karloff, Korn, & Srivastava). The results from filtering the data by a given constraint and confidence level can help auditors pick transactions that may need further investigation. By defining the odd pattern or transactions, auditors then can use these results to see if they were caused by fraudulent activity, an error, or a malfunction in the system. Besides determining how the anomalies occurred, the results from subset of data can help narrow possible employees who were committing the fraud.

(Data Analysis Stock Photos and Images, 2014)

Auditors could use data subsets analysis to narrow down the results from other auditing tools such as the Benford’s Law in order to get a closer look if any oddities occurred (Smith). In addition to narrowing down the results from the Benford’s law, auditors can use data subset analysis to sort and analysis the results of different tests such as number duplication, excessive round numbers, last-two digits test, and relative-size test (Wallace, 2002). Another possible use is to provide specific answers to client who are concerned with the activities regarding a certain department or location of the business.  This will allow the auditor to be specific on which location or department is doing and whether any possible anomalies occurred.

References

Data Analysis Stock Photos and Images. (2014). Retrieved from 123RF: http://www.123rf.com/stock-photo/data_analysis.html

Golab, L., Karloff, H., Korn, F., & Srivastava, D. (n.d.). Data Auditor: Exploring Data Quality and Semantics using Pattern Tableaux. Florham Park: AT&T Labs.

Nigrini, M. j. (1999). I’s Got Your Number. Journal of Accountancy.

Smith, C. A. (n.d.). Detecting Anomalies in Your Data Using Benford’s Law. Statistics and Data Analysis, 27.

Wallace, E. P. (2002). The Influence of Technology on Auditing. Retrieved from Pennsylvania Institute of Certified Public Accountants: http://www.picpa.org/Content/cpajournal/2002/winter/26.aspx

What are Subsets? (2013). Retrieved from TIBCO Spotfire: https://docs.tibco.com/pub/spotfire/5.5.0-march-2013/UsersGuide/subsets/subsets_what_are_subsets.htm

Benford’s Law

Benford’s Law

There are several different techniques and methods that auditors and forensic accountants use in order to detect fraud. One of the methods for detecting fraud is the Benford’s Law. The Benford’s Law is a mathematical theory that was created in 1938 by Frank Benford (Singleton, 2011).  The Benford’s law states that “in numbered lists providing real-life data, the leading digit is one almost 33 percent of the time” while “larger numbers occur as the leading digit with less frequency as they grow in magnitude to the point that nine is the first digit less than 5 percent of the time” (Lynch & Zhu, 2008). The Benford’s law can be applied to the first digit, second digit, first two digits, last digit and other combinations of digits of a data set (Singleton, 2011).  The graph at the bottom further demonstrates the Benford’s Law digit distribution . The Benford’s Law can only be used with natural occurring numbers or numbers that arise naturally from real-life sources such as death rates, baseball statistics, or financial transitions (Lynch & Zhu, 2008). The Benford’s law is used by comparing the client’s digit frequency distribution with the Benford’s expected distribution. This will enable the auditors or forensic accountants to spot possible errors or fraudulent transactions that would need further investigation since there would be an unusual amount of transactions for a specific leading number.

There are several different ways that Auditors can use the Benford’s law during their audit plan. Firstly, auditors are able to use Benford’s law in order to detect expense and accounting fraud since expenses and accounting transactions are generally natural occurring numbers. Forensic accountants and auditors can also detect fraud in a client’s disbursement cycle by being able to measure the actual occurrence of leading digits in disbursements compared to the digit’s probability (Singleton, 2011). The Benford’s law can be used to investigate credit card transactions, purchase orders, journal entries, customer balances, and customer refunds in order to determine if fraud has been occurring. Other items that Benford’s law could be to test for accuracy and potential fraud are inventory prices, loan data, stock prices, and accounts payable transactions. Auditors might use the Benford’s law when they are testing a large data set, 1,000 records or greater, since the results will be more reliable. Benford’s law can be used to test for duplicate payments, missing checks, or missing invoices (Durtschi, Hillison, & Pacini, 2004). The Benford’s Law is useful when testing accounts receivable and accounts payable since the numbers come from a mathematical combination of numbers in addition to coming from two distributions (Durtschi, Hillison, & Pacini, 2004). Benford’s Law is applicable to use when testing full year’s transactions since the data set is general lager which creates more observations (Durtschi, Hillison, & Pacini, 2004).

There are several data sets that the Benford’s Law would not be suitable for. Auditors should not use the Benford’s law if they are trying to test data information with 500 or less transactions since the data will not provide accurate distributions. Auditors also shouldn’t use the Benford’s law, if the information was created by formulas such an YYMMDD because the formula causes the numbers to be restricted (Singleton, 2011). Forensic accountants should avoid using the Benford’s law when testing data that has a maximum or minimum number since it limits the data to a specific range.  While testing, auditors should avoid using Benford’s law when the data being tested is assigned by either the client or the vendor such as check numbers or invoice numbers since this theory assumes that the data is naturally occurring (Singleton, 2011). Forensic accountants should also avoid using Benford’s law when testing ATM withdrawals since these numbers are influenced by human interactions (Durtschi, Hillison, & Pacini, 2004). Benford’s law will not help auditors find any thefts, kickbacks, contract riggings, or any other illegal activity since this theory only helps auditors determine any indications of fraud.

Financial Ratio Analysis is Useful

Fraud investigators use several tools in order to discover and examine accounting anomalies that may lead to discovering fraud at companies. However, many professionals have debated on whether using financial ratio analysis is actually useful to auditors and other fraud investigators. In my opinion, I believe that the use of financial ratio analysis does provide a benefit to auditors in several ways. Also, auditors and fraud investigators should continue to use financial ratio analysis on their audit engagements. Financial statement analysis has several uses throughout the audit engagement.

The first way that financial ratio analysis is helpful during the beginning stages of the audit engagement. Financial ratio analysis is useful at the beginning of the audit engagement because it helps them to discover and examine unusual relationships demonstrated by the stated financial information (Investigation Techniques for Fraudulent Financial Statement Allegations).  The unusual relationships are a starting point for auditors or fraud investigators in order to effectively conduct further investigation, which increases efficiency and leave more time in the audit plan to perform audit test (The Use of Analytical Procedures in Auditing, 2014). The next way that financial analysis improves efficiency is that it helps auditors identify specific audit risks more effectively in order to further investigate certain based on the unexpected relationships (The Use of Analytical Procedures in Auditing, 2014). Financial ratio analysis also helps auditors determine the investigation threshold for the audit plan (The Use of Analytical Procedures in Auditing, 2014). Another benefit of using financial ratio analysis is that it helps auditors determine the nature, timing, and extent of their procedures in addition to increasing the auditor’s understanding the client’s business and general operations (The Use of Analytical Procedures in Auditing, 2014).

The second major helpful use of financial ratio analysis is during the final steps in an audit engagement.  Financial ration analysis is extremely helpful in developing the final assessment of the audit in order to reach an appropriate conclusion with certain accounts and evaluating the general financial statement presentation (The Use of Analytical Procedures in Auditing, 2014). By using financial ratio analysis as one of the last steps in an audit, auditors better acquit to determine the company’s ability to continue business and the prediction of the company’s possibility of going into bankruptcy (The Use of Analytical Procedures in Auditing, 2014).

Besides the uses of financial ratio analysis being beneficial to auditors, there has been several studies done in order to test the accuracy and usefulness of financial ratio analysis during fraud investigation. Based off Guan, Kaminski, and Wetzel research determining if Ratio Analysis is a predictor of fraud, they concluded that there is a “widely held contention that financial ratio analysis can be a useful tool for identifying irregularities and/or fraud” (Gaun, Kaminski, & Wetzel, n.d.) According to Cynthia Harrington’s research, financial ratios analysis can help “carry out the SAS 99 requirement to perform audits to be reasonably assured that financial statements are free from material misstatement” in addition to helping “flag problems areas for auditors and CFEs” (Harrington, March/April 2005).

References

Gaun, L., Kaminski, K. A., & Wetzel, T. (n.d.). Ratio Analysis – Predictor of Fraud? Retrieved from American Accounting Association: https://aaahq.org/audit/midyear/01midyear/papers/kaminski.pdf

Harrington, C. (March/April 2005, April). Analysis ratios for detecting finacial statement fraud. Fraud Magazine. Retrieved from Association of Certified Fraud Examiners: file:///C:/Users/Ashley/Downloads/ACFE%20Article%20Formulas%20for%20detection%20Analysis%20(2).pdf

Investigation Techniques for Fraudulent Financial Statement Allegations. (n.d.). In Finanical Statement Fraud.

The Use of Analytical Procedures in Auditing. (2014). Retrieved from N R Doshi & Partners: http://www.nrdoshi.ae/index.php/publications/articles/the-use-of-analytical-procedures-in-auditing

Data Analytics

Data analytics has become more popular for the past several years due to the advancement of technology and the amount of data that individuals have access to. There are several definitions of data analytic, but the basic definition of data analytics is “the science of examining raw data with the purpose of drawing conclusions about that information” (Rouse, 2014).  Data analytics is also defined as the qualitative and quantitative techniques and processes used to increase productivity (Janssen, 2014). According to KPMG, data analytic is defined as “an analytical process by which insights are extracted from operational, financial, and other forms of electronic data internal or external to the organization” (Littley, 2012).  The basic definition of data analytics is generally compared with data mining but there is a significant difference between these two terms based on the scope, purpose and focus of the analysis (Rouse, 2014). Data analytics focuses on inference, the process, of deriving a conclusion based solely what is previously known while data mining is the process of sorting through vast amounts of data in order to discover patterns and hidden relationships (Rouse, 2014).

Data analytics is a useful tool for auditors and forensic accountants because it can determine whether a client’s accounting system effectively protects the client’s information and operates efficiently (Rouse, 2014). Auditors and forensic accountants use data analytics in order to extract and categorized client’s information in order to identify and analyze the behavioral patterns and possible identify any potential fraud leads more efficiently (Janssen, 2014). Another way that data analytics is a helpful tool for auditors and forensic accountants is that it allows them to analyze large amounts of data in a smaller amount of time. Data analytics is very helpful for auditors when analyzing data associated with accounts payable and accounts receivable in addition to being able to detect duplicate payments and invoices more efficiently (Top 10 Area Where Data Analysis is Adding the Most Value, 2011).  Auditors also use data analytics for sampling, data imports and extractions, continuous auditing/monitoring, and fraud detection (Top 10 Area Where Data Analysis is Adding the Most Value, 2011).

Auditors and forensic accountants use several tools in order to conduct data analytics. The first tool is any spreadsheet software such as Microsoft Excel (DeKroon & Karp, 2013). They also used several databases and generalized auditing software (DeKroon & Karp, 2013). The most common database software that fraud investigators use is desktop software such as Microsoft Access of sever-based software such as SQL or Oracle (DeKroon & Karp, 2013). As for generalized auditing software, the top two programs used by auditors and forensic accountants are ACL Analytics and CaseWare IDEA. These two software are very powerful database tools that have several features that are designed especially for auditors just as being read only, audit log, scripting, and powerful data connectivity (DeKroon & Karp, 2013). These traits allow auditors to trace certain commands, prevent modification of client’s data, conducts automated audits, and be able to access several types of data (DeKroon & Karp, 2013). Auditors also used Raytheon’s VisualLinks, IBM’si2 Analyst’s Notebook, Centrifuge Visual Network Analytics, SAS Analytics, and Actionable Intelligence Technologies’ Financial Investigative Software in order to conduct data analysis during their audit engagements (Spann, 2014) .

References

DeKroon, N., & Karp, B. (2013, May 11). An Auditor’s Guide to Data Analytics. Retrieved from https://chapters.theiia.org/raleigh-durham/Events/Training%20Presentations/2013_May_Raleigh%20IIA%20Presentation_Data%20Analysis.pdf

Janssen, C. (2014). Data Analytics. Retrieved from Techopedia: http://www.techopedia.com/definition/26418/data-analytics

Littley, J. (2012). Leveraging data analytics and continuous auditing processes for improved audit planning, effecriveness, and efficiency. Retrieved from KPMG: http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/data-analytics-continuous-auditing.pdf

Rouse, M. (2014). Data Analytics . Retrieved from Search Data Management : http://searchdatamanagement.techtarget.com/definition/data-analytics

Top 10 Area Where Data Analysis is Adding the Most Value. (2011). Retrieved from Audimation Services Inc. : http://www.audimation.com/articles/top-10-areas-where-data-analysis-is-adding-the-most-value.html?url=articles%2Ftop-10-areas-where-data-analysis-is-adding-the-most-value.html

Recent Steps Towards Little GAAP

As of recently, Little GAAP has not been established, but there has been several major steps in this direction.  The first major step to Little GAAP has been FRF for SMEs. FRF for SMEs, or otherwise known as “No GAAP”, is a third option for private companies (Merklin, 2014). One negative attribute about this framework is that falls under the other comprehensive bases of accounting instead of being a part of GAAP (Merklin, 2014). FRF for SMEs is a simplified reporting that focuses on clearly what a business assets, liabilities, and cash flow (Merklin, 2014).  FRF for SMEs is primarily principles-based with a focus on historical cost as its measurement basis (Merklin, 2014). This framework incorporates alternative accounting methods so business owners have the flexibility to choose which accounting methods are most suitable to their company’s facts and circumstances (Merklin, 2014). FRF for SMEs was intended to be a stable policy so there will be no need for continuously updating or amending this framework  (Merklin, 2014).

The second major step occurred while AICPA was releasing the FRF for SMEs, Private Company Council, PCC, issued three exposure drafts which would reduce the burden of financial reporting for private companies in regards to certain accounting transactions (Roth, 2013). Since PCC does not have authority to issue GAAP, their recommendations are sent to FASB in order to be rejected, further researched and reviewed, or approve the recommendation and issue a revision to GAAP (Roth, 2013). The three recommendations that PCC presented to FASB in August 2013 were simplified standards for accounting for identifiable intangible assets in a business combination, accounting for goodwill, and accounting for certain receive variable, pay-fixed interest rate swaps (Roth, 2013). The new principle for accounting Goodwill subsequent to business combination will also private companies to elect a straight-line basis for amortizing goodwill in addition to applying a simplified impairment model (Bannon, 2014). As for accounting for certain interest rate swaps, this will allow private companies to qualify certain interest rate swaps for hedge accounting more easily (Bannon, 2014). These recommendations will simplify reporting for private businesses that own real estate outside of the operating business (Newby, 2014). Recently, FASB voted to issue PCC’s initiatives for public exposure (Merklin, 2014). These initiatives are expected to be effective beginning after December 15, 2014 (Bannon, 2014).  The PCC will be under the process of finalizing other recommendations to FASB and plans to expect to submit these recommendations in the near future (Newby, 2014).

Another possible route towards Little GAAP is that SEC to implement International Financial Reporting Standards (IRFS) in the United States (Merklin, 2014).  IFRS has specific standards for small to medium sized companies, IFRS for SMEs. The likelihood of IRFS coming to the United States is very slim. The possibility of IRFS coming to the U.S. is very slim because this discussion has been going on for several years with no effort on merging U.S. GAAP and IRFS.  IFRS will not merge to U.S. GAAP because it would cause more confusion and complex for the company’s owners and financial reporters.

In the future, I expect that Little GAAP will be established in addition to having several options for private companies to implement if this type of improvement continues The only thing that I can predict that would prevent this advancement is FASB no longer on board with simplifying reporting standards for private companies.  Another thing that could possibly diminish the advancement of Little GAAP is that the public and financial reports will start losing interest similar to what happen to the IFRS merging with U.S. GAAP debate. My hope for the future is that Little GAAP will be shortly established in order to lift off the burden of financial reporting for private companies.

References

Bannon, M. (2014, February 6). Welcome Little GAAP. Retrieved from Fahrenheit Group: http://thefahrenheitgroup.com/finance-news/welcome-little-gaap/

Merklin, J. E. (2014). Big GAAP vs. Little GAAP vs. No GAAP. Retrieved from Bober Markey Fedorovich: http://www.bobermarkey.com/client_advisor/frf_for_smes_0713

Newby, J. (2014, June 24). No “BIG GAAP” “LITTLE GAAP” on the Horizon for Privately Held Companies. Retrieved from Redpath and Company: http://redpathcpas.com/2014/06/24/no-big-gaap-little-gaap-on-the-horizon-for-privately-held-companies/

Roth, E. A. (2013, October 25). Trends & dEvelopments – October 2013 – Auditing Standards – Is ‘Little GAAP’ Finally Here? Retrieved from EisnerAmper: http://www.eisneramper.com/Trends_and_Developments/GAAP-Financial-Accounting-1013.aspx

Blue-Ribbon Panel Kicks Off the Process Creating Little GAAP

On February 2009, the Financial Accounting Foundation, FAF, American Institute of Certified Public Accountants, AICPA, and the National Association of State Boards of Accountancy, NASBA, created the Blue-Ribbon Panel (Campbell, 2011).  The purpose of the Blue-Ribbon Panel was to explore the needs of private company financial statement users and make recommendation on how to improve the process for setting standards for private companies (Campbell, 2011). The Blue Ribbon Panel consisted of financial reporting constituencies, financial statement preparers, auditors, and regulators (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).

The Blue-Ribbon Panel’s found several weaknesses in the current standard-setting process. The first weakness is that “current standard-setting process is flawed and has an insufficient understanding of the needs of users of private company financial statements and an insufficient weighing of the costs and benefits of GAAP for use in private company financial reporting” (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).   Blue-Ribbon Panel’s believe that the current standards are lacking relevance to private companies such as variable interest entities, uncertain tax positions, fair value measurements, and goodwill impairment which I believe to be true (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).  Besides talking within the panel, the Blue-Ribbon Panel also reached out to several preparers and users of private company financial statements. These individuals were concerned with “private company financial statements often lack relevance to users, standards have become increasingly complex, the pace of the standard-setting process has increased, costs often exceed benefits, there has been an increase in qualified opinions and the use of other comprehensive basis of accounting (OCBOA) where possible” which I also believe that these concerns need to be address (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).

I personally believe that Blue-Ribbon Panel’s recommendations would be extremely helpful to private business if implemented. Their recommendations were that “U.S. GAAP should have exceptions and modifications for private companies and those exceptions and modifications should be determined by a separate private company accounting standards board” (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011). According to the Blue-Ribbon Panel, the private company standards-setting board would have the ultimate authority to approve the exceptions and modifications (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).  Besides the recommendations, the Blue-Ribbon Panel’s members thought that the industry “should be allowed to dictate whether private entities chose to follow” the new private company’s standards determined by the panel or FASB GAAP (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011). I also believe that industry that the private company does business in should  have the ability to determine what standards companies must compile to since the industry would know what is useful than the standard setters.  In my opinion,  having a separate accounting standard board for private companies will make the process of monitoring FASB’s projects and giving feedback would become more efficient and effective.

The report issued by the Blue-Ribbon Panel has had a positive effect on the financial reporting for private companies. In my opinion, the most influential effect  is that the recommendations started a new phase of reviewing the “adequacy and effectiveness of the FASB’s efforts in setting standards for the private company and non-profit sectors in the United States” (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).  To start off this new phase, the FAF established the Trustee Working Group in 2011 (Campbell, 2011). The Trustee Working Group is responsible for addressing the accounting standards for private entities in addition to non-for-profit entities (Campbell, 2011).  The AICPA President also mentioned that there has been several changes in place to make the standard setting process be more responsive to private companies by correcting the issues that the panel stated were insufficient (Accounting Battle for the Ages – Big GAAP, Little GAAP, 2011).

References

Accounting Battle for the Ages – Big GAAP, Little GAAP. (2011, April 6). Retrieved from Accounting Research Mangaer : http://tax.cchgroup.com/downloads/files/email/pfx/aasolutions-temp/CloserLook-BigLittleGAAP-Apr-2011.pdf

Campbell, B. (2011, September 20). Big GAAP VS Little GAP – Where are we at? Retrieved from CPA’s Calculating the Latest in Audit & Accounting News: http://www.hhcpa.com/blogs/audit-accounting/big-gaap-vs-little-gaap-where-are-we-at/

Process of Developing “Little GAAP”

In 2005, AICPA preformed a study regarding to “Big GAAP” versus “Little GAAP” debate.  This report discovers several deficiencies in GAAP’s ability to fulfill the financial reporting demands of private companies. As a consequence of the report being released, the accounting profession recommended that there should be a committee to evaluate changes made to GAAP to ensure that the changes will not be burdensome for private companies (Rothberg, 2012).  As a response to the AICPA’s report, FASB created the Private Company Financial Reporting Committee (PCFRC) in 2007 (Rothberg, 2012).  This committee was responsible for creating standards for private companies that “would improve the quality and consistency of reporting” (Rothberg, 2012).  With exceeding expectations, PCFRC issued a statement in 2010 “recommending the use of the International Financial Reporting Standards for Small Medium Entities (IFRS for SMEs)” (Rothberg, 2012).

If smaller companies adopted IFRS for SMEs, they would be capable to cut down the time and costs associated with preparing financial statements (Rothberg, 2012).  Another result of using IFRS for SMEs is that this change may possibly influence the U.S. to switch over to IFRS (Rothberg, 2012). Besides reducing resources for financial reporting, the switch to IFRS for SMEs will generate both positive and negative effects. The first problem is that there is a possibility of inconsistency in financial reporting. As a result this will cause a problem for investors when assessing financial statements (Pologeorgis, 2014).   On the plus side, investors will have more credible information (Pologeorgis, 2014). With mandating IFRS standards, all accounting professionals involved with small and medium sized companies will sustain to learn new standards but this will go to more consistency in reporting (Pologeorgis, 2014).

AICPA listened to PCFRC recommendation and established a new framework called Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs) in 2012. A link to the AICPA’s draft of the FRF for SMEs is located at the bottom. FRF for SMEs is similar to IFRS for SMEs but FRF for SMEs is created to be aligned with the U.S. Tax code (Use of Financial Reporting Framework for Small – and Medium – Sized Entities, 2012). This framework is for companies that have certain characteristics such as “for-profit business, no regulatory requirement to use GAAP, users of the financial statement have direct access to the entity’s management, does not operate in an industry involved in transactions that require highly specialized accounting guidance, and the entity is owner-managed”(Vozar, 2013).  FRF for SMEs will make reporting simpler by using historical cost, not requiring consolidation of variable interest entities, using reasonable lease accounting, amortizing goodwill, and reducing disclosure requirements (Use of Financial Reporting Framework for Small – and Medium – Sized Entities, 2012).

Switching to FRF for SMEs will create several problems and benefits to the companies and individuals affected. One of the problems with switching to FRF for SMEs is that this promising framework is not mandated since no other authoritative bodies has approved, disapproved, or acted upon FRF for SMEs (Vozar, 2013). This would cause inconsistency in reporting between private companies. A restriction of using FRF for SMEs is that there is a possibility that this framework will not be accepted by financial statement users such as banks and bonding companies (Roth, 2013). A benefit of switching to FRF for SMEs is that third parties, such as banks and investors, will receive more precise information regarding a company’s cash flow, liquidity, and financial position (Vozar, 2013). The primary benefit of switching to FRF for SMEs is that companies will be capable to cut down their reporting/accounting expenses in addition to reducing the complexity of preparing financial statement  (Vozar, 2013).

Link to AICPA’s Proposed FRF for SMEs: http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/PCFR/DownloadableDocuments/FRF-SME/FRF-SME-Exposure-Draft.pdf

References

Pologeorgis, N. (2014). The Impact of Combing the U.S. GAAP and IFRS. Retrieved from Investopedia: http://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp

Roth, E. A. (2013, October 25). Trends & Developments – October 2013 – Auditing Standards – Is ‘Little GAAP’ Finally Here? Retrieved from Eisner Amper: http://www.eisneramper.com/Trends_and_Developments/GAAP-Financial-Accounting-1013.aspx

Rothberg, A. F. (2012). Generally Accpeted Accounting Principles: The Big GAAP vs. Little GAAP Debate. Retrieved from CFP Edge, LLC: http://www.cfoedge.com/resources/articles/cfo-edge-generally-accepted-accounting-principles-gaap.pdf

Use of Financial Reporting Framework for Small – and Medium – Sized Entities. (2012, November 3). Retrieved from Accounting and Auditing INformation for Certified Public Accountants : http://cpa-scribo.com/tag/little-gaap/

Vozar, R. (2013, October). Briding the GAAP. Retrieved from Smart Business Clevelan : http://cpa.skodaminotti.com/images/uploads/resources/Cle_SkodaMinotti_1013_.pdf