Auditing World Braces: More ICFR Attention, Big Rule Changes

The full-court press on internal controls and related documentation will not let up in 2016, although companies will have to answer those demands while also bracing for other big accounting and auditing changes on the horizon.

“Internal control over financial reporting will remain on everyone’s radar,” says Cindy Fornelli, executive director of the Center for Audit Quality. “We will continue to hear that in 2016.” The Public Company Accounting Oversight Board and the Securities and Exchange Commission are not expected to change their approach to internal controls, she says, despite some pushback from the corporate community.

Pat Voll, vice president at consulting firm RoseRyan, says the approach to internal controls is “getting a lot crisper” as the PCAOB continues to demand more rigor and more precision in the audit of internal control through its inspection process. “We’ve been evolving in that area the past couple of years, and that will continue,” she says.

At audit firm Friedman, partner Chris Smith says he’s expecting no change in the audit approach around internal control either. “We’re going to be asking for more information for our files to satisfy the PCAOB’s comments with respect to the quality of our work,” he says. “The documentation demands are strongest as it relates to management review of controls and whether those controls are operating at a level of precision sufficient to take care of the objectives.”

Michael Scanlon, a partner at law firm Gibson, Dunn & Crutcher, says he expects auditors only to increase documentation demands. “Companies have done a very good job,” he says. “Declining percentages of restatements demonstrate that internal controls and Sarbanes-Oxley are working, but the PCAOB in particular is looking for enhanced evidence of what auditors have done to test the effectiveness of controls. That’s not slowing down.”

From an enforcement perspective, Mike Scudder, a partner at law firm Skadden, Arps, Slate, Meagher & Flom, says he can’t think of an investigation he’s seen in the past few years that didn’t involve questions of audit evidence and documentation. “We see it in every single matter,” he says. “We see situations that get pretty serious." Companies should continue to expect auditors to demand documentation and to focus on robustly documenting audit work, perhaps most especially in areas of high audit risk."

Kevin Wydra, a partner at Crowe Horwath, says many companies will have work to do this year to shore up controls in business units they acquired after heavy merger and acquisition activity in 2015. “There are some completed acquisitions where companies have not integrated the controls structure or exposed them to the complete [Sarbanes-Oxley Section] 404 process,” he says.

“Declining percentages of restatements demonstrate that internal controls and Sarbanes-Oxley are working, but the PCAOB in particular is looking for enhanced evidence of what auditors have done to test the effectiveness of controls. That’s not slowing down.”

Michael Scanlon, Partner, Gibson, Dunn & Crutcher

Let’s Get Standard

Looking ahead to new accounting requirements, experts say the pressure on adopting the new revenue recognition standard will get more serious into 2016. “It’s not effective until 2018, but it’s almost two years old now,” says Dee Mirando-Gould, executive director at MorganFranklin Consulting. “We are starting to see a lot more questions and requests for training. I think people are a little behind on this one. They’re going to have lots of catching up to do.”

Erik Bradbury, senior accounting fellow at Financial Executives International, says companies are starting to recognize that the implementation will not be just a technical accounting exercise. “There are systems implementation that will be needed and contract review that needs to be done,” he says. “Revenue recognition has a lot of tentacles to it that touch everything.”

Close on the heels of revenue recognition, companies will also have to start pondering how to adopt new requirements for leases and financial instruments, says Diana Gilbert, senior consultant at RoseRyan. “We hope they are going to be paying more attention to what this really means and getting their arms around it in 2016,” she says. “We’ll be saying, ‘You should start now’.”

FASB PROJECTS

Below, FASB explains the objectives of its various projects including revenue recognition, leases, and financial instruments.
Revenue Recognition
The new guidance:

Removes inconsistencies and weaknesses in existing revenue requirements

Provides a more robust framework for addressing revenue issues

Improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets

Provides more useful information to users of financial statements through improved disclosure requirements, and

Simplifies the preparation of financial statements by reducing the number of requirements to which an organization must refer.
Next Steps: Public organizations should apply the new revenue standard to annual reporting periods beginning after Dec. 15, 2017. Non-public organizations should apply the new revenue standard to annual reporting periods beginning after Dec. 15, 2018.
Leases
The objective of the project is to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements.  This represents an improvement over existing leases standards, which do not require lease assets and lease liabilities to be recognized by many lessees.
A lessee would recognize assets and liabilities for leases with a lease term of more than 12 months.
Next Steps: The Board decided that it has received sufficient information and analysis to make an informed decision on the perceived benefits and related costs of the changes to GAAP that will result from the final leases standard. The Board concluded that the benefits of those changes justify the related costs and directed the staff to draft a final Accounting Standards Update for vote by written ballot.
Financial Instruments – Impairment
This project addresses issues related to the impairment of financial assets. The objective of this project is to significantly improve the decision usefulness of financial instrument reporting for users of financial statements. The Boards believe that simplification of the accounting requirements for financial instruments should be an outcome of this improvement. The Boards’ goal is to develop a single credit loss model for financial assets that enables more timely recognition of credit losses.
Next Steps: The staff will discuss with the Board, at a future public meeting, any sweep issues identified during the drafting of final guidance, cost-benefit and complexity of the decisions reached to date, effective date, and permission to ballot.
Financial Instruments – Classification and Measurement
This project reconsiders the classification and measurement of financial instruments. The objective of this project is to significantly improve the decision usefulness of financial instrument reporting for users of financial statements. The Boards believe that simplification of the accounting requirements for financial instruments should be an outcome of this improvement.
Next Steps: The staff will draft a final Accounting Standards Update for vote by written ballot.
Source: FASB.

More immediately, companies will face new requirements around the going concern analysis that may prove more challenging than expected, says James Comito, national director of professional standards for audit firm Mayer Hoffman McCann. “For years, going concern was in the auditing literature, but now management has to take this on,” he says. “It’s no longer something management can look to the auditor and say: that’s your problem.”

Peter Bible, chief risk officer at audit firm EisnerAmper, says the shift will be bigger than some companies expect. “It’s one thing when an auditor says to the CEO: substantiate why you’re going to be here in a year,” he says. “When a CFO goes in and says that, he’ll get thrown out on his can.”

A new standard on consolidation, Accounting Standards Update No. 2015-2, is also “a bit of a sleeper,” Comito says. “The standard changes some things that won’t impact a whole lot of folks, but it also makes some fundamental changes that are applicable to all entities.” Companies dealing with variable interest entities should assure they are up to speed on the new requirements, he says.

Related-party transactions and other significant unusual transactions might also become a big focus in public company audits, says Jeff Burgess, national managing partner of audit services for Grant Thornton. The PCAOB adopted Auditing Standard No. 18 to give auditors some new requirements around scrutinizing related-party arrangements, a hot spot for fraud.

“With the knowledge that regulators are putting more focus on this, that tells us we need to take a fresh look at how we approach it,” he says. That includes not only assuring the accounting and disclosure requirements are met, but also the management controls around related-party activities. “We need to make sure we have a great understanding of the client’s processes and controls around identifying related parties.”

Help Wanted

Across the profession, leaders in accounting and auditing also should commit themselves to joining the conversation about how to address a talent shortage, Fornelli says—especially as the importance of technology accelerates across accounting and auditing. “With big data and data analytics, there’s a whole host of exciting new areas where we can use technology,” she says. “It behooves all of us to make sure the financial function is viewed as exciting and vibrant.”

That’s a high priority for internal audit functions as well, says Jason Pett, U.S. internal audit services leader for PwC. “There continues to be a transition from traditional financial auditors to more business-oriented, sector-specific, tech-savvy auditors,” he says.

Finally, experts are advising companies to pay closer attention to taxes in 2016. Companies that may not have been profitable in recent years may not have paid close attention to their tax positions, Bible says. Now as the economy improves, companies may find that the methods they used to acquire capital when lending was tight are affecting the net operating loss they can use to offset taxable income. “That’s a sleeper issue,” he says. “As you go into bad times, impairments go up. As you come out of them, taxes are the focus.”