Audit regulators are putting auditors on notice to take a careful look at the work companies have done to implement the new revenue recognition standard, including what they've done to guard against fraud risk.
The Public Company Accounting Oversight Board issued a staff audit practice alert to assure auditors know how to apply PCAOB standards, both in interim periods and year-end audits, to the new revenue recognition guidance. The standard takes effect in 2018, directing companies to follow a new, five-step method for determining when and in what amounts to recognize revenue in financial statements.
The Financial Accounting Standards Board adopted the new revenue recognition standard in 2014, but set a 2017 effective date to allow companies time to prepare. As implementation efforts sputtered amid questions over how to apply the massive new requirements, the board extended the effective date to 2018 and issued a handful of clarifications to the standard. The board also permitted a 2017 adoption for companies that were ready to move forward, which a handful of companies have done.
Regulators and accounting experts alike have raised numerous alarms over the pace of preparation and the overall state of readiness for the new standard. While the standard is not yet effective, companies will be expected to demonstrate to auditors that they have followed a sound process for preparing to comply with the requirements.
Martin Baumann, the PCAOB’s chief auditor and director of professional standards, says the PCAOB has been monitoring implementation of the new standard and has heard requests for guidance. The alert calls out PCAOB requirements as they pertain to the implementation effort, addressing not only the recognition of revenue itself, but a number of other issues as well.
The staff points out, for example, that auditors need to scrutinize management’s transition disclosures and footnotes. The Securities and Exchange Commission has been on a mission to assure companies are giving investors plenty of advance notice through required disclosures about how their financial statements will be affected by the new standard when it goes into effect.
The PCAOB alert also reminds auditors to pay attention to transition adjustments, or adjustments companies will make to financial statements to transition their reporting from old GAAP to new GAAP. Auditors will be expected to understand the accounting principles companies are adopting to conform to the new accounting so they can assess whether transition adjustments and disclosures are appropriate and adequate.
Internal control over financial reporting, which has been a trouble spot in audit inspections for about the past five years, is another area of concern for the PCAOB staff. The new alert reminds auditors in the context of the new revenue standard that they are expected to identify the types of potential misstatements that could occur, assess the factors that affect the risks of material misstatements,a and design their audit procedures accordingly.
The PCAOB staff is also concerned about fraud risk, according to the alert. “The auditor should presume that there is a fraud risk involving improper revenue recognition and evaluate which types of revenue, revenue transactions, and assertions may give risk to such risks,” the alert says. The alert even directs “key engagement team members, including the engagement partner” to brainstorm how and where they believe the company’s revenue could be susceptible to fraud, taking into account incentives, opportunities, and cultural factors that could act as an invitation to fraud.
“As companies implement the new revenue standard, they may need to change their systems, processes, and controls, or to develop new ones,” the PCAOB points out. “Done poorly, such changes could pose heightened risks of material misstatement, including fraud risks.”