Pin the tail on the auditor

November 16, 2011

By James D. Gottfried, CPA, Chair, The Ohio Society of CPAs

As CPAs, we are charged with defending the public interest. We are responsible for conducting ourselves according to professional standards and ethics. But how far does that responsibility extend? Are we now blindly assigning responsibility beyond what is appropriate?

There is increasing pressure from the Public Company Accounting Oversight Board (PCAOB) to have auditors be responsible for more than opining on financial statements and internal control over financial reporting. Last June, the PCAOB unveiled a proposal outlining a major overhaul of the auditor’s reporting model that represented the most significant changes in more than 50 years. It is intended to increase the value and transparency of the report for investors, but there is room for it to go far beyond that. PCAOB Chair James R. Doty has been outspoken in his opinion that the audit report is not offering enough to protect investors. But is that the primary function of the audit and auditor? As a profession, we are charged with providing a level of assurance, but we aren’t detectives.

The PCAOB Investor Advisory Group went even farther, calling the current audit report “deficient as a communications vehicle.” They called for the auditors to include their assessment of the judgment of management and the quality of the accounting practices.

As more judgment is employed on behalf of corporate management, the PCAOB Investor Advisory Group would like auditors to give their opinion on the validity of those judgments and the completeness of the information shared.

In August, the PCAOB issued a concept release calling for mandatory audit firm rotation, arguing that such a change would enhance “auditor independence, objectivity and professional skepticism.”

I understand the issues around the call for greater transparency, and I am not saying that maintaining the status quo is the only acceptable answer to this. Some changes might be appropriate, but I would like to see specific solutions that don’t create bigger ancillary problems than the issues they are intended to solve. The PCAOB identifies issues with certain audits, and those need to be addressed. But is it appropriate to extrapolate these concerns as broad based issues that require changes across the board, as suggested by the PCAOB? Do the actions of a few needs to impact all?

Beyond the impact on auditors and our profession, such changes will sharply increase the cost of an audit.

In a struggling economy, is it prudent to increase the cost of doing business? Do the long-term additional costs really provide a greater or even corresponding benefit?

Let’s also make sure that we aren’t mixing issues. Some issues I see appear to be financial disclosure issues and not audit issues. If greater financial disclosure issues need to be addressed, then let’s address them as such. In doing so, let’s make sure the market place is driving the needs and not the perception of a small group of regulators.

These are important issues for our whole profession. Do not ignore public company issues and changes driven by regulators under the premise that they don’t impact non-filers or privately held entities. History shows the likelihood that such changes will eventually be forced on non-filers or privately held directors or the market place is almost guaranteed.

There is still time to comment on the PCAOB Concept Release on Auditor Independence and Audit Firm Rotation (deadline: Dec 14, 2011) and the Proposed Rule to Improve Transparency Through Disclosure of Engagement Partner and Certain Participants in Audits (Deadline: Jan 9, 2012). Comment now at Also, OSCPA’s Accounting & Auditing Public Company Subcommittee is submitting comments on behalf of all of us. One of the benefits of OSCPA membership is the clout that comes from all of us speaking as an organization on issues that impact our profession. Please direct any comments you would like included to OSCPA staff liaison Laura Hay, CPA at


IFRS still a reality

March 2, 2010

By Pete Margaritis, CPA

The news from the SEC last week wasn’t earth shattering, it was still a commitment by the Shapiro administration to the converging of U.S. GAAP and IFRS that was originally the SEC plan in November 2008, with a slight modification. In the original SEC roadmap, there was a timeline of 2011 to make the IFRS transitioning determination. This date, although not concrete, has not changed. The milestones set out in the original plan are for the most part not changed. What did change is that the mandatory implementation date for large accelerated filers has been pushed back one year from 2014 to 2015. This should not be a surprise because of a couple of reasons. The change in administration, the economic crisis, and the overwhelming comment letters stating that companies will need more time all support the SEC’s decision.

I have always believed that this process is more about converging standards than adopting IFRS. The original goal set out between the FASB and the IASB in the Norwalk Agreement was toward convergence of IFRS and U.S. GAAP, not the adoption of IFRS. The convergence of standards has been put on a fast track because of calls from the G20 and this can be seen on the IASB project page. Many of the joint projects are set for converged standards by 2011.

The SEC established a work plan team that will issue its first report by October 2010. This will be the group to keep an eye on this coming year because they will be the pulse of when a “date certain” is set.

I do believe that we will ultimately have one set of high quality, country-neutral standards that will be used globally, including the U.S., in the next 3 – 5 years. It will just take a little longer than many wish.

However, that doesn’t mean that we should put off the process of IFRS education until the “date certain” has been set. During this time, we as CPAs need to become bilingual because we will be dealing with IFRS sooner than we think. For example, a German company gains “control” of a U.S. company and the U.S. company has to consolidate its financials into the German parent company. The U.S. company will have to adopt the same accounting policies (IFRS) as its parent. This adoption is usually done in a very short time frame and this situation is happening more and more today.

What if this happens to your client and you don’t have the knowledge to assist them in their transition to IFRS? That client will find a firm who has the knowledge and expertise. Or think about the other side of this situation. You could begin to develop a new line of business in IFRS consulting so you can be the firm that new client seeks.

In conclusion, being bilingual today might just be the right business move for you to make while the SEC goes through their due process.

IRS will require practitioners to advocate for disclosure of return positions

February 4, 2010

An editorial from E. Lynn Nichols, CPA

The heat is on tax practitioners! Regulators and lawmakers responding to irresponsible tax advice from CPAs and attorneys who were believed to be reputable have produced a steady stream of new rules and regulations regarding disclosure and responsibility for tax return information.

The temperature increased exponentially on Jan. 26, 2010. That’s when IRS Commissioner Shulman announced a proposal to require “large corporations” to disclose uncertain tax positions using a new schedule that will be required to be attached to their annual federal income tax returns.

The proposed rules will apply to all business taxpayers with assets in excess of $10 million who prepare financial statements that require an analysis of such positions in order to comply with Financial Accounting Standards Board Interpretation #48 (FIN 48).

From the return preparer’s point of view, making such a disclosure part of the tax return brings the preparer penalty rules of IRC Sec. 6694 into play. That could mean if my client does not disclose an uncertain return position, I could be subject to a preparer penalty. And, by the way, that penalty is not confined to the returns of large taxpayers.

Outrageous, you say. Not at all, given the mood in Washington related to so-called tax professional’s involvement in bogus tax shelters. At least 12 partners, from three different national firms have either pled guilty or been convicted of conspiracy to defraud the IRS in connection with such activity.

Karen Hawkins, who heads the office of professional responsibility, has spoken very forcefully on the subject. She intends to enforce the rules in Circular 230. Among other things, those rules require a federally authorized tax practitioner to exercise “due diligence” with respect to tax positions.

At least one other federal functionary said, in a speech to members of the AICPA Tax Division, “We intend to leverage tax practitioners to improve compliance.” Once again, it does not matter whether the taxpayer is large or small; the offense is in failing to apply well informed professional judgment to questionable items in a federal income tax return.

That can mean only one thing. The pressure is on those of us who give tax advice and/or prepare income tax returns. The federal tax authorities have the tools and the motivation to punish us.

Exactly what is that authority?

  • Treasury Circular 230. Establishes rules for conduct of anyone who practices before the IRS, including requirements to advise a client of an uncertain return position, to exercise “due diligence” in advising clients on such matters, and to document our support giving any advice.
  • Code Section 6694. Imposes penalties on paid return preparers who sign returns or give advice claiming a return position that is not supported by substantial authority or, if a position has only a reasonable basis, is disclosed using Form 8275.

What must we do?

First, we must impose quality control standards on our tax practice. Client acceptance and retention is an important piece of any quality control system. There are some clients whose attitudes about tax compliance are simply not compatible with professional standards. Second, we must maintain an attitude of “professional skepticism” when dealing with our clients often wishful thinking with regard to federal tax laws. Finally, we must be sure to stay “up-to-date” on tax law, regulations, and court decisions. The price of incompetence can be as much as $5,000 per return. According to Hawkins, that penalty can be followed by action to censure, fine, or suspend the practitioner for violation of Treasury Circular 230.

So, if we plan to stay in the business of preparing federal income tax returns, it makes sense that we invest the time and effort in staying up to date on tax developments, AND we need to take a hard look at the client list with an eye toward terminating any relationship that exposes us to increased risk.

Let’s Make a Deal That Makes Sense for Small Business

August 6, 2009

Listening to wiser-than-me OSCPA Accounting & Auditing Committee members shape a response to the AICPA Accounting and Review Services Committee’s Reliability exposure draft, I’ve noticed that we often circle back to the same discussion: relevance of standards for the smallest of business entities.

Micro-entities comprise more than 50% of the U.S. gross domestic product, and numerous CPAs specialize as trusted advisors to the smallest businesses that collectively drive a significant portion of our economy. Part of our mission in serving the public interest includes looking out for the relevance of the profession’s rules to this important, overlooked segment of the economic picture.

The proposed “reliability” SSARS is a good step in allowing financial statement users to distinguish between independence impairments caused by helping the client prepare more reliable statements and impairments caused by other relationships.  (Whether independence impairments for assisting the client should be allowed in a review is a separate debate, and the primary concern of the committee’s response.) In many cases, users of small business financial statements will be better served knowing that the statements were prepared by a CPA, even if the CPA is not independent due to their level of involvement in the underlying accounting.

The discussion of usability arose again in a review of the FASB preliminary views document on financial statement presentation – a joint IASB/FASB vision of the future of what financial statements will look like. While organization of financial statements by type of business activity may prove useful to analysts of the largest public companies, the committee’s perception was that the benefit to the vast majority of users by no means justifies the costs of conversion and ongoing preparation (The standard should be optional for private companies.)

Reliability, consistency, independence, comparability, relevance –what’s most important in determining the applicability of accounting standards? Most important to that decision is the usefulness to the consumers of the information. As we consider the future of accounting for small business, let’s look behind the doors of three of the most common options under debate.

Behind Door #1: GAAP

Supporters of U.S. generally accepted accounting principles for small business cite research findings that the marketplace values GAAP for its consistency and comparability. An increase in GAAP departures, due to users and preparers frustrated by the irrelevance of requirements such as FIN 48 or FIN46(R) to their specific situation, indicates that some alternative version of GAAP may be preferable for private entities. Whether that will be exceptions to existing GAAP requirements, or a separate “little GAAP” for small business, some users continue to ask for GAAP – as a “known” standard (after all, it’s “generally accepted!”) or “gold standard” (although the U.S. may be losing that status as the rest of the world adopts a combined alternative).

Behind Door #2: IFRS for SMEs

In July 2009, the International Accounting Standards Board issued long-awaited International Financial Reporting Standards for Small and Medium Entities. In issuing a separate set of standards for small business, the IASB recognized the cost/benefit imbalance of more complex disclosures for this segment’s users. IFRS for SMEs presents another alternative for small business owners who:

  • Desire separate standards for private entities
  • Have no need for more complex disclosures required by U.S. GAAP or full IFRS
  • Recognize that sources for capital are increasingly global
  • Recognize the potential for future business growth or acquisition internationally

And Lastly, Door #3: The OCBOA Option

One argument for IFRS, presented particularly by accountants in business and industry, is reducing the necessity to maintain separate sets of books when conducting business internationally. For many micro entities, the only set of books maintained is for the purpose of internal business management (possibly a modified cash basis) or tax compliance. Reporting under an Other Comprehensive Basis of Accounting (OCBOA) is an option for the small business user to maintain only one set of books and prepare financial statements on that basis (such as cash, modified cash, or tax basis).

Arguments against OCBOA include a lack of market recognition (the market “values GAAP”) and a lack of consistency, due to the absence of “generally accepted” standards. A frequent discussion of the OSCPA committee is the opportunity to provide greater education and consistency/comparability in OCBOA reporting to maximize value to the profession’s many micro- business clients.

Many lenders to the smallest of businesses would benefit more, the discussion goes, from tax basis financial statements and an agreed-upon procedures engagement verifying cash, accounts receivable and inventory balances, for instance. Such statements would be far more relevant to business owners, for whom the two overriding questions about any action are, “How will this affect my taxes?” and “How much cash do I need?” Many CPAs who serve micro-businesses state that increasing education to lenders and the user public regarding such alternatives would be a public service.

Achieving acceptance of OCBOA statements would be responsive to the “standards overload” issues for practitioners serving small business, and, frankly, address many frequent peer review findings. As the number of practitioners performing attest services continues to decline, directing the full attention of small business specialists to the needs of their clients and the third parties with whom those clients deal would be a win for all.

The profession can serve a role providing presentation and disclosure guidance to practitioners to provide greater comparability and consistency in practice regarding OCBOA engagements. Current professional guidance in this area is dated, and in the absence of such guidance, we run the risk of PPC, CCH or other provider becoming the “standard-setter” in this arena. More importantly, it would help resolve the very real, and very stubborn, application problems many firms face on a daily basis.

The micro-business market and current trends in practice should not be overlooked in shaping the future of private company accounting – we have multiple choices to make in what best serves our public.

The Politicization of Accounting Standard Setting

April 3, 2009

At one time I would have smacked myself for saying “Amen, Arthur Levitt!” In a Washington Post OpEd, “Weakening A Market Watchdog: An Accounting Rule Change’s Real Costs,” Levitt observes that FASB’s action on fair value measurement in inactive markets and other-than-temporary-impairment is a first erosion of the independence of the accounting standard setting process.

With the passage of Proposed FASB Staff Positions FSP FAS 157-e, “Determining Whether a Market is Not Active and a Transaction is Not Distressed,” and FSP FAS 115-a, FAS 124-a and EITF 99-20-b, “Recognition and Presentation of Other-Than-Temporary Impairments,” the question many are asking is “has the FASB bowed to political pressure on fair value measurement, compromising investor transparency?”

Many have called for further guidance on mark-to-market accounting in illiquid markets (see discussion of “investor views”), and FASB members had asserted that these staff positions clarify much of the intent of the original standards. However, as Levitt observes, while the theory of the latest FASB staff positions may be arguable (not by him,) that doesn’t resolve his fundamental concerns about (1) responding to Congressional pressure to act quickly, and (2) a rush to action without the typical due process of an independent standards setting process.

In a press conference following the FASB decision, Board members responded to criticism that they had succumbed to political pressure, insisting that due process had been achieved, judging from the number of comment letters received during the two-week comment period. A Board member also defended the FASB’s continued role as an independent standard setter, noting however, that it was not immune to observing the current turmoil in the markets.

The CPA profession has long defended the necessity for independence in the standard setting process. In December 2008, outgoing SEC Chair Christopher Cox appealed to the new administration to understand that:“

Accounting standards should not be viewed as a fiscal policy tool to stimulate or moderate economic growth, but rather as a means of producing neutral and objective measurements of the financial performance of public companies.”

Responding to those who advocate setting aside independence in abnormal periods for quick fixes, Cox stated:

“The truth is that the value of independent standard setting is greatest when the going gets tough. The more serious the stresses on the market, the more important it is to maintain investor confidence.”

FASB Chair Robert Herz made the same argument in 2003, citing the lasting truth of a 1978 Journal of Accountancy quote from Professor David Solomons:

“if it ever became accepted that accounting might be used to achieve other than purely measurement ends, faith in it would be destroyed just as faith in speedometers would be destroyed once it were realized that they were subject to falsification for the purpose of influencing driving habits.”

This plea is being lost, as the U.S. House of Representatives considers a non-independent governmental accounting oversight board under HR 1349 — the Federal Accounting Oversight Board Act. This “regulatory reform” would truly be an expansion of government authority over what has historically been an independent process.

Will the SEC bow to political pressure as FASB may have done? Observers state that application of the new rules will be dependent on whether they are supported by auditors and those who regulate the auditors. As a new administration calls for increased scrutiny of large institutions, particularly the financial sector, and also for relaxing of accounting rules, who will be blamed when balance sheets are overly optimistic? The auditors, perhaps?

Rarely will there be an accounting standard that is perfect for all users, but adequate due process provides the opportunity for all voices to be part of the debate. Opening the standard setting process to political interference does not protect the public interest, but instead provides protection for those best able to exert political influence.

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