As companies begin preparing now for the year-end close, audit experts are warning them to take these final few months of the year to double check documentation. With the Public Company Accounting Oversight Board putting pressure on audit firms to scrutinize internal controls and other areas, that scrutiny is likely to trickle down to issuers.

Although no broadly applicable accounting standards took effect this year, auditors are under a fresh round of orders from their regulators to get tougher and demand more evidence in a number of areas, especially internal controls over financial reporting, revenue recognition, and accounting estimates. “It’s been a fairly quiet year in terms of new accounting standards taking effect,” says Pat Durbin, a partner with PwC. “The big focus this year is more on internal control.”

The PCAOB has alerted auditors once again to pay closer attention to internal controls, especially whether companies have demonstrated that controls are operating effectively and at a level of precision that would mitigate any identified risk of misstatement. The PCAOB is asking auditors why they don’t have more evidence to support that. “Auditing practice has continued to evolve and mature in terms of how we audit internal control,” says Durbin. “It’s about increasing our understanding of how a company’s controls are implemented through their specific financial reporting risk and then designing our audit tests accordingly.”

On top of the PCAOB’s focus, most public companies are adopting a new framework for internal control after COSO indicated its Internal Control — Integrated Framework, updated last year, would take the place of its 1992 framework at the end of 2014. The bones of the updated version are familiar, but the 2013 framework explicitly requires companies to demonstrate that all 17 principles of internal control are present and functioning. “Registrants should carefully consider how their established policies and procedures, standards, processes, structures, and controls demonstrate that the principles are present and functioning in the organization’s system of internal control,” says Angela Storm, a partner with KPMG.

Sara Lord, a partner at McGladrey, says she sees companies taking a bit longer than anticipated to work through the new framework. With the new framework and the PCAOB’s alert to auditors, companies can expect auditors to search for evidence that shows controls are operating at a particular level of precision. “We’re still seeing companies working through whether the documentation is where it needs to be to provide that level of understanding and that detail,” she says. “The PCAOB is really focused on making sure the documentation and testing procedures are where they need to be.”

“Registrants should carefully consider how their established policies and procedures, standards, processes, structures, and controls demonstrate that the principles are present and functioning in the organization’s system of internal control.”
Angela Storm, Partner, KPMG

Kevin Wydra, a partner at Crowe Horwath, says he just wrapped up work with the PCAOB on the firm’s inspection, and inspectors are as focused as ever on precision. “Above and beyond the simple sign-off, how did the review occur and what was the depth of that review?” he says. “Within that, how does that person know the information being relied upon is complete and accurate? If you haven’t buttoned it down yet, you should really focus on it and be aware that those questions are coming.”

Recognizable Scrutiny

The PCAOB also warned auditors recently to dig in more on revenue recognition, with an alert in September telling auditors to look more closely at testing of revenue from contractual arrangements, evaluating gross vs. net presentation of revenue, testing whether revenue was recognized in the correct period, and evaluating revenue-related disclosures. Companies are well aware that the Financial Accounting Standards Board issued a brand new standard for how to recognize revenue that doesn’t take effect until 2017, but they might be less aware that auditors have been warned to look more closely at revenue recognition now under present standards, says Kelley Wall, a director at consulting firm RoseRyan. “I think it’s going to come as a little bit of a surprise to them,” she says. “The alert was directed to auditors, not to registrants. I think most companies are unaware that this is going to be a hot ticket item for year-end.”

THE SEC’S PLAN

Below, Keith Higgins, director of the SEC Division of Corporation Finance, discusses the SEC’s plan to make disclosures more effective.
So what is the Division’s plan for the disclosure project? As you know, the Commission released a staff report that presents an overview of Regulation S-K and the Commission’s initiatives over the years to review and update the disclosure and registration requirements. The report was mandated by Congress under the JOBS Act and, although the mandate focused on emerging growth companies, the report is intended to facilitate the improvement of disclosure requirements applicable to companies at all stages of their development. In addition to serving as a comprehensive source for the regulatory history of Regulation S-K, the report identifies specific areas that the staff believes could benefit from further review.
The report was a springboard for further action, and I couldn’t be more pleased that the Chair asked the Division to lead the effort to develop specific recommendations for updating the disclosure requirements. Our goal is to review specific sections of Regulation S-K and S-X to determine if the requirements can be updated to reduce the costs and burdens on companies while continuing to provide material information and eliminate duplicative disclosures. At the same time, while always mindful of the costs and burdens of our regulation, we will ask whether there is information that is not part of our current requirements but that ought to be. While looking for ways that we can streamline our disclosure requirements is an important element of our review, reducing the volume of disclosures is not the sole end game. You may be surprised to learn that there are many investors who have expressed an appetite for more information, not less. If we identify potential gaps in disclosure or opportunities to increase the transparency of information, we may very well recommend new disclosure requirements.
A successful outcome for this project will require a team effort. A key component of our plan will include considerable public outreach to participants, and this process has already begun. We are launching a spotlight page on sec.gov, and we are asking companies, investors and other market participants to give us their views on how we can make disclosure more effective. We will continuously update this page with details about roundtables and other news, although don’t expect hourly updates of our “status” a la Facebook or other social media. We are particularly interested in learning what information investors find most useful. As a few examples, we are considering questions such as whether there is information that we require companies to include in their filings that those investors routinely get elsewhere. Is there information that they routinely ignore? What information do they think is missing? And in the age of smartphones and tablets, how can information be easier to access and use? And do technological advances lend themselves to a “one-size-fits-all” approach, or should companies have flexibility to determine how they can convey information more effectively?
Source: SEC.

Chris Wright, managing director at Protiviti, says companies would be well advised to review their documentation around revenue recognition. “Companies may need to either fortify their present policy and position papers around revenue, or create them,” he says. The silver lining: The effort now might prove insightful later in adopting the new standard as companies begin to prepare for that implementation, he says. “Anytime there’s more documentation, you are in a better position to determine the proper accounting under the new rules.”

In addition, companies should be prepared for questions from auditors about what they’ve done so far to prepare for the new standard, says Wendy Hambleton, national director at BDO USA focused on financial reporting issues. “It is not impacting the current audit, but in the future what direction will you be going?” she says. “Will you do a full or modified retrospective adoption? How does that affect your policies, your data, your systems? Auditors will want to know.”

Polish That Crystal Ball

Another area of focus for auditors, although not necessarily new for 2014, is any accounting assertion that involves estimating or forecasting. “It could be contingent liabilities, a goodwill impairment analysis, fair value of accounting reserves—anything that requires estimates or judgment,” says Wall. Auditors have heard plenty from the PCAOB to be more skeptical, demand more documentation, and do more testing around such areas. Companies need to show sound basis for their judgments, and they need to be applied consistently, she says. “Auditors are going to be pushing back more on those,” she says.

Companies might also want to take a fresh look at their disclosures, says Robert Uhl, a partner with Deloitte & Touche. Securities and Exchange Commission staff speeches in recent months have focused not just on SEC initiatives to improve disclosures, but measures companies can take even ahead of any new rules that might be developed to improve their disclosures, says Uhl. “The focus is on making sure that disclosures are relevant and material, eliminating or reducing redundancies, tailoring disclosures to the company’s specific circumstances, and eliminating boilerplate,” he says.

Other items that may crop up include any asset and liability allocations associated with a business combination, says Wright, as merger and acquisition activity is picking up with the economy, and any large, subjective accruals. The SEC comment letter process is driving some scrutiny not only around the amounts of such accruals, but also the timing, he says.

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