Accounting and Auditing
Update
December 6, 2012
1
3

ASB Clarity Project (SAS No. 122-125)
◦ Including AU-C 600 Group Audits

ARSC Update
2
5


SAS Nos. 122-125 resulted from the Auditing
Standards Board’s (ASB) “Clarity Project”
The Clarity Project had two primary objectives in
the Codification of Statements on Auditing
Standards:
◦ To make the standards easier to read, understand and
apply
◦ To converge the standards with those of the
International Auditing and Assurance Standards Board
(IAASB)
3

Each standard is presented with the following
format:
◦
◦
◦
◦
◦

Introduction
Objective
Definitions (if applicable)
Requirements
Application and Other Explanatory Material
The application and other explanatory material
section of each clarified standard helps make
the standards easier to understand and apply.
◦ Provides guidance for the required audit procedures,
cross-referenced to the relevant requirement.
◦ Many AU-C topics include “Considerations Specific to
Smaller, Less Complex Entities”
4

Existing AU sections are being reorganized and
renumbered
◦ To converge with IAASB
◦ Currently “AU-C” section numbers are being used in
as a temporary identifier to avoid confusion with
references to previous “AU” sections
◦ The previous AU’s remain in effect through 2013
 When SAS Nos. 122-125 becomes fully effective for all
engagements in 2014, the “AU-C” identifier will revert to “AU”
Most sections of SAS Nos. 122-125 are
effective for audits of financial statements
for periods ending on or after December
15, 2012.
 Refer to the specific AU-C section to
determine if a different effective date
applies.
 Early adoption is not permitted.

5

SAS Nos. 122-125 impact engagements at all
phases – planning/engagement acceptance,
fieldwork and reporting
◦ Shifts some prior implicit understandings in the
existing auditing standards to an explicit requirement –
one that often requires documentation

Most significant change is AU 600 – Group Audit
Standards
Little-Some change
210 – Terms of Engagement
560 – Subsequent Events
250 – Laws and Regulations
620 – Auditor’s Specialist
265 – Communicating Int. Controls
700 – Forming an Opinion
320 – Materiality
706 – Emphasis of Matter & Other
Matter
330 – Performing Audit Procedures in
Response
708 – Consistency
402 – Auditing Considerations for
Entity Use of Service Organizations
800 – Special Purpose Framework
501 – Audit Evidence Selected Items
805 – Single F/S
505 – External Confirmations
810 – Summary F/S
510 – Opening Balances
905 – Restricted Use
550 – Related Parties
6
Essentially No/little change
220 – Quality Control
585 – Omitted Procedures
230 – Audit Documentation
705 – Modifications to Opinion
240 – Consider Fraud
720 – Other Information
260 – Comm with Governance
725 – Suppl Information
300 - Planning
730 – Required Suppl Information
315 – Understanding the Entity
806 – Reports on Compliance
450 – Evaluate Misstatements
910 – Repts of Another Country
500 – Audit Evidence
915 – Repts Appl of Acctg Principles
520 – Analytical Procedures
920 – Underwriters
530 – Audit Sampling
925 – SEC Filings
540 – Auditing Estimates
930 – Interim Fin Info
570 – Going Concern
935 – Compliance Audits
580 – Written Representations
BUT WHETHER THERE IS SOME, LITTLE, OR
EVEN NO CHANGE, YOU STILL NEED TO GO
THROUGH ALL OF THE NEW CLARIFIED AU
SECTIONS BECAUSE WITH CLARITY….
YOU MAY FIND THAT YOU NEED TO CHANGE
OR TWEAK HOW YOU DO THINGS!!!
7

Let’s get started on some of the significant
changes
What’s Different?

The term “preconditions for an audit” is
introduced. Requires us to:
• Determine whether the financial reporting framework used
by management in preparation of the financial statements is
acceptable, and
• Obtain management’s agreement that it acknowledges and
understands its responsibilities.

“Financial reporting framework” is new
terminology.
• Formerly basis of reporting (such as GAAP or OCBOA)
8
What Changes for Us?

Need to modify engagement letters to clearly
communicate management’s responsibilities.

Applies to client’s compliance with laws and regulations in two
categories:
◦ Those recognized to have a direct and material effect on the
amounts and disclosures in the financial statements (e.g. tax and
pension laws and regulations)
◦ Those that are not recognized to have a direct effect on the
amounts and disclosures in the financial statements, but where
noncompliance may have a material effect on the financial
statements (e.g. environmental regulations).


Stages of the audit affected: Planning and Reporting
Effective for periods ending on or after December 15, 2012
9
What’s Different?

New required procedures:
• Obtain an understanding of the client’s
legal and regulatory framework.
• Inquire of management about how the
entity is complying.
• Inspect correspondence with licensing
and regulatory authorities.
• Determine compliance with laws and
regulations that may not have a direct
effect on the amounts and disclosure
but may have a material effect on the
financial statements.
What’s Different?
 “Inherent limitations” concept defined
• Some material misstatements in the financial statements
may not be detected, even though the audit is properly
planned and performed in accordance with GAAS
• Replaces the “no assurance” concept in existing
standards, which means that an audit performed in
accordance with GAAS provides no assurance that all
noncompliance with laws and regulations will be detected
• No material change in practice
10
What’s Different?

Now required to include an explanation of the potential
effects in the written communication of Significant
Deficiencies (SDs) and Material Weaknesses (MWs)
• Effect does not need to be quantified, just explained

Now required to communicate to management other
deficiencies (ODs) in internal controls not previously
communicated by us or others. Can be oral or written.
• Previously, we could choose to do so, but this wasn’t
required.

Materiality: Factors to consider
◦ Users of the financial statements
◦ Financial stability and capital structure
◦ External environmental factors, including industry and
economic factors
◦ Business strategies of the company
◦ Related party transactions
11

Performance Materiality defined:
The amount or amounts set by the auditor at less than
materiality for the financial statements as a whole to reduce
to an appropriately low level the probability that the
aggregate of uncorrected and undetected misstatements
exceeds materiality for the financial statements as a whole.
If applicable, performance materiality also refers to the
amount or amounts set by the auditor at less than the
materiality level or levels for particular classes of
transactions, account balances, or disclosures.
Performance materiality is to be distinguished from
tolerable misstatement.

Performance materiality
◦ (50-75% of Materiality)

Factors - Table L1 in Appendix L (Risk
Assessment Guide)
◦
◦
◦
◦
◦
Misstatements
Propensity to adjust
Number of accounts subject to estimation
Locations or subsidiaries to be combined
Initial audits (not in Guide)
12



Applies to audits of clients that use a service
organization to provide outsourced functions
Stages of audit affected: Planning, Fieldwork and
Reporting
Effective for periods ending on or after December 15,
2012
What’s Different?

The user auditor (the auditor of an entity that uses a
service organization) is now required to ask client
management about whether their service organizations
have reported:
• Any fraud
• Noncompliance with laws and regulations
• Uncorrected misstatements affecting the financial
statements of the entity

If the answer to any of these questions is yes, the
auditor is required to evaluate the impact on their audit
procedures.
13
What’s Different?

Additional guidance on determining the appropriateness
of audit evidence provided by a service auditor’s report
• Is the service auditor competent and independent of the service
organization?
• Are the standards under which the report was issued
adequate?
- Is the period of the report appropriate for our purposes?
- Does the report provide sufficient appropriate audit evidence?
Includes the scope, services covered, controls tested and how,
and their relation to the client controls
• Whether the user auditor’s work will change depends on
what level of evaluation was performed in prior audits


If the audit procedures performed indicate that no actual
or potential litigation, claims, or assessments exist that
may give rise to a risk of material misstatement, the
auditors are no longer required to send a legal inquiry
letter.
If segment or division financial information is disclosed,
the auditor is required to:
◦ Understand the methods used by management in
determining segment information, and
◦ Perform analytical procedures/other audit procedures
appropriate in the circumstances
14
What’s Different?
 Explicitly requires confirmations to be:
• a written direct confirmation (an oral confirmation alone is
not acceptable), and
• obtained directly from the confirming source
- It can be electronic through direct access to the
confirming source or facilitated by a third-party service
provider

If management refuses to allow us to send a
confirmation request we are now required to
communicate with those charged with governance
if:
◦ We conclude that management’s refusal is unreasonable,
or
◦ We are unable to obtain relevant and reliable audit
evidence from alternative audit procedures
15



Applies to opening
balances in an initial audit
engagement, including
reaudits
Stages of audit affected:
Planning and Fieldwork
Effective for periods
ending on or after
December 15, 2012
What’s Different?
 Reading a predecessor auditor’s report and simply reviewing the
audit documentation cannot be the only procedures performed
regarding opening balances.
• The auditor’s risk assessment of opening balances will determine
audit procedures necessary to obtain sufficient appropriate audit
evidence.


Now required to perform audit procedures to determine whether:
• Opening balances contain material misstatements
• Accounting policies have been consistently applied, appropriately
accounted for, presented and disclosed
If sufficient evidence can’t be gathered, may result in a qualified or
disclaimed report.
16
What Changes for Us?
 Now required to perform additional audit
procedures on opening balances
• May increase the time and cost of the
audit



Applies to situations in which the auditor uses
the work of a specialist, either internal to the
auditor’s firm or external to the firm, with
expertise in a field other than accounting or
auditing
Stages of the audit affected: Planning and
Fieldwork
Effective for periods ending on or after
December 15, 2012
17
What’s Different?
 The existing standard only applied when
the auditor used the work of an specialist
outside the auditor’s firm
 The requirements now apply regardless
of whether the auditor’s specialist is an
internal specialist or an external
specialist.
What’s Different?
 The format of the auditor’s report is different as
follows:
• Management responsibilities have not changed but are
clarified and described in more detail than was previously
required
• Headings that distinguish each section are now required
throughout the report
• Introduces emphasis-of-matter (EOM) and other-matter
(OM) paragraphs to replace the explanatory paragraph
18
Headings and Subheadings
Management’s Responsibilities
Opinion
(Basis for qualified, adverse, or
disclaimer)
Emphasis of Matter
• Matters appropriately
presented or disclosed
Other Matter
• To understand audit matters
Other auditor reporting
responsibilities



Applies to the evaluation of the consistency of
the financial statements between periods,
including changes to previously issued financial
statements
Stages of audit affected: Planning, Fieldwork
and Reporting
Effective for periods ending on or after
December 15, 2012
19
What’s Different?

Requires the auditor to evaluate material changes in
financial statement classifications from previously issued
financial statements to determine whether each change
is also either:
• A change in accounting principle, or
• An adjustment to correct a material misstatement in
previously issued financial statements


If either exists, include an emphasis of matter paragraph
in the auditor’s report and refer to the disclosure
Existing standards do not require such an evaluation
What Changes for Us?
 May require additional work if this has not
been our practice under the existing
standard.
 Added to Summary of Uncorrected
Misstatements
20



Applies to the audit of
financial statements
prepared in accordance
with a special purpose
framework, such as cash,
tax, regulatory or
contractual basis financial
statements
Stages of audit affected:
Planning and Reporting
Effective for periods ending
on or after December 15,
2012
What’s Different?
 Replaces the phrase “other comprehensive basis of
accounting” (OCBOA) with “special purpose framework”
 Eliminates the “catchall” category of financial reporting
frameworks and only applies to financial statements
using cash (including modified cash), tax, regulatory or
contractual bases of reporting
21

Now required to obtain the agreement of
management in the engagement letter
acknowledging their responsibilities including:
◦ Determining that the financial framework used is
acceptable
◦ Providing all information and disclosures necessary to
achieve fair presentation, possibly beyond those required
by the applicable framework

The format of the auditor’s report is different as
outlined in AU-C 700 – Auditor’s Reports
◦ Includes a reference to management's responsibility for
determining that the choice of financial reporting
framework is acceptable
◦ Describes the purpose of the financial statements if
prepared on a regulatory or contract basis of accounting
◦ Includes an emphasis-of-matter paragraph highlighting the
special purpose framework
◦ Includes an other-matter paragraph restricting the use of
the report when the special purpose framework is
contractual or regulatory
22
Cash Basis
Tax Basis
Regulatory
Contractual
Restricted
General
Opinion
Single
Single
Single
Single
Dual
Use
EOM?
Yes
Yes
Yes
Yes
No
Describe
Purpose
No
No
Yes
Yes
Yes
Restrict
use?
No
No
Yes
Yes
No



Applies to an auditor in the U.S. reporting on financial
statements that have been prepared in accordance with
a financial reporting framework generally accepted in
another country for use outside the U.S.
Stages of the audit affected: Planning (engagement
acceptance) and Reporting
Effective for periods ending on or after December 15,
2012
23

If the financial statements are to be used only
outside the U.S., an auditor should issue either:
• A U.S. form of a report with a statement that:
- The financial statements have been prepared under a framework
generally accepted in another country; and
- Refers to the note in the financial statements describing the basis of
presentation used, including identification of the country of origin of
the accounting principles;
or
• A report with the form and content of the other country
• This is similar to the existing standard, with the primary changes
being due to the new report language under AU-C Section 700

If the report is to be used both within the U. S. and outside the
U.S., the auditor should report using the U.S. form of report
and is required to include an emphasis-of-matter paragraph
that:
◦ Identifies the foreign financial reporting framework used in the
financial statements;
◦ Refers to a note that describes the framework; and
◦ Indicates that the framework is different from U.S. GAAP

Under the existing standard, if the financial statements were to
be used both within and outside the U.S., a modified U.S. form
of the report was required.
24
49

Got these?
◦ Subsidiaries
◦ Divisions
◦ Different business
activities/locations
◦ JVs
◦ Equity and cost
method investments
◦ VIEs
◦ Investment in REITs
25

Existing Standard = AU 543
◦ Codified in 1972 as part of SAS 1
◦ Very basic approach with few requirements (only 17
paragraphs)
◦ Approach is based on principal auditor responses when
another auditor participates in an engagement

Can the auditor act as a principal?
◦ Decision based on the significance of the audit performed
◦ Coverage: how much of the revenue or how much of the
balance sheet being audited by principal auditor
 SEC: “Generally, the principal auditor is expected to have
audited or assumed responsibility for reporting on at least
50% of the assets and revenues of the consolidated entity”
 Many firms adopted this guidance as a threshold issue

If other auditors are involved, two decision points:
◦ Make reference
◦ Do not make reference
26

In all cases:
◦ Determine professional reputation of other auditors
◦ Obtain representation as to independence
◦ Determine through communication with other auditor
 That they are aware their work on the component will be
included in the financial statements
 That they are familiar with US GAAS and will conduct their
audit in accordance with those standards
 Knowledge of relevant reporting requirement
 A review will be made with respect to the elimination of
intercompany transactions and accounts and other matters

Decision to not make reference can be made
when:
◦ Audit performed by associate firm whose work is deemed
to be acceptable; or
◦ The other auditor was hired by the principal auditor and
performed procedures at the direction of; or
◦ Principal auditor takes steps to satisfy himself that the
work was adequately performed; or
◦ The portion of the financial statements audited by others
was not material
27

When not making reference
◦ Meet with other auditor to discuss procedures
◦ Review programs, and provide additional instructions if
necessary
◦ Review working papers of the other auditor
◦ In some cases, perform additional procedures on the
accounts of the entity

When making reference
◦ Disclose in the report that certain components were
audited by others
◦ Disclose the magnitude of the components audited by
others
◦ Do not imply that the division of responsibility somehow
is construed as a qualified opinion (i.e. somehow inferior
to standard auditors’ report)
28








Traditionally has not been difficult to apply
Many firms made reference to the other auditors
and limited procedures to required
correspondence and tying out intercompany
accounts
Globalization has changed the marketplace and
the demands placed on auditors; the number of
audits involving multiple auditors has increased
dramatically.
Clients are less likely to accept reference to other
auditors in their reports
Intended to supersede (rather than amend) AU
543
While retaining the concept of divided
responsibility; it represents a significant change in
the scope of work required in a group audit setting
Exposure draft consists of 61 paragraphs plus 91
paragraphs of guidance and exhibits
The Standard is 76 pages long versus 7 pages in
the extant
29

Convergence
◦ The starting point for the ED was ISA 600; language
changes were required to be limited on the guidance
from the ASB

Main issue of divergence
◦ SAS retains the ability to make reference to the work of
the other auditor (not referred to as a component auditor)

Why permit making reference?
◦ Basically the ASB determined there was no compelling
reason to change current practice and were satisfied that
the current divided responsibility provides high quality
audits
◦ Also there were issues with certain large governments
(including the federal government) which made divided
responsibility necessary
◦ Seems to be commonly used in investment entity audits
◦ If the group auditor does not make reference, there are
no substantive differences with ISA 600
30
Current AICPA
(AU 543)
Clarified AICPA
AU-C 600
•
•
•
•
Focus: Auditors
Basic Approach
Principal Auditor
Other Auditor
• Focus: Group
• Risk Assessment
& Effectiveness
• Group Auditor
• Component
Auditor

New Concepts:
◦ A group – all the components whose financial information
are included in the group financial statements
◦ A component – an entity or business activity, whose
financial information should be included in group financial
statements
◦ Group engagement partner – replaces “principal auditor”
and refers specifically to the individual responsible for the
group audit performance and report
◦ Group engagement team – partners and staff that
establish audit strategy, communicate with component
auditors, perform work on the consolidation and evaluate
conclusions drawn from the audit evidence
31

Responsibilities of the group engagement partner:
◦ Direction, supervision and performance of the group audit
engagement in compliance with audit standards and legal
requirements
◦ Determining whether the auditors’ report is appropriate in
the circumstances

Meeting the responsibilities
◦ The group engagement team can assist the group
engagement partner in meeting the requirements
◦ However, if other auditors do not meet the definition of a
member of the group engagement team, then they are
considered component auditors
◦ Thus, a component auditor can be a network firm or even
a different office of the same firm
 Example: National firm audits a consolidated financial
statement which includes a subsidiary in LA. If the firm
delegates the auditor of the subsidiary to its LA office, it is
likely the LA office would be considered a component auditor
and this standard would apply.
32

Change in Focus
◦ The group audit itself rather than the interactions with
other auditors
◦ Moves toward a more unified approach focusing on the
group financial statements rather than pieces of it.
Moves away from the coverage concept.

Changes the terminology from a decision whether
to make reference to other auditor to one of
responsibility.
Current AICPA
AU 543
• Decision based on
significance of the
audit performed
• Coverage: >50% of
total assets and
revenues
Clarified AICPA
AU-C 600
• “Group” auditor has
responsibility
• Focus is on group
itself, rather than
auditors
• Decision based on
ability to obtain
sufficient appropriate
audit evidence
33
Current AICPA
(AU 543)
International
Standards
Clarified AICPA
(AU-C 600)
• Make reference
to work of
others
• Divided
responsibility
• “Group” auditor
has
responsibility
• No making
reference
• Group tells
other auditors
what to do
• “Group” auditor
has
responsibility
• Making
reference is
basis for
evidence
• Group assumes
responsibility
for components
not referenced



Determine whether to act as a group auditor
Communicate clearly with component auditors
Obtain sufficient appropriate audit evidence
◦ Related to the components
◦ The consolidation process
◦ Group financial statements prepared in accordance with
the applicable financial reporting framework

Determine whether to make reference to the audit
report of the component auditor
34
Acceptance and continuance - group auditor;
identify components; preconditions
Understanding - group; components;
component auditors; make reference?
Materiality decisions and responding to risks
of material misstatement
Other procedures - consolidation process;
subsequent events; evaluating evidence
Communications - with component auditors;
with group governance and management
Purpose:
“Determine whether sufficient appropriate audit
evidence can reasonably be expected to be obtained
regarding the consolidation process and the financial
information of the components on which to base the
group audit opinion” (AU-C 600.14)
35

Obtain understanding of
◦ Group
◦ Components, including sufficient information to determine
likely significant components
◦ Group wide controls
◦ Consolidation process
◦ Use of component auditors
◦ Consider any restrictions by group management or for
other reasons


Significant equity method investments
Significant cost method investments when:
◦ Work and reports of other auditors constitute a major
element of evidence for such investments
36
Significa
nt
“BIG”
Not
Significant
• CAN STILL DO “TOP-DOWN”
AUDIT
• If only one auditor for all
components, less need for special
considerations
Significant
“BAD”
Facts: Company X has inventory located at a
remote location (e.g. warehouse in another state),
but does not have prepare separate financial
information for that remote location.
Question: Does the use of another auditor to
observe the inventory count mean the audit is a
group audit?
37
Audit
Report
Holding
Company
Sub 1
Sub 2
Sub 3
Audit
Report
Company
A
Division
1
Division
2
Division
3
38
All facilities
distribute the
same product.
No individual
financial
information
prepared.
Toronto
Facility
All facilities
distribute the
same product.
No individual
financial
information
prepared.
Toronto
Facility
Audit
Report
Company A
(Roanoke)
Roanoke
Facility
Memphis
Facility
Audit
Report
Company A
(Roanoke)
Roanoke
Facility
Memphis
Facility
Other Auditor
performs inventory
observation
39
All facilities
distribute the
same product.
No individual
financial
information
prepared.
Toronto
Facility
Audit
Report
Company A
(Roanoke)
Roanoke
Facility
Memphis
Facility
Other Auditor
performs limited
procedures
All facilities
distribute the
same product.
Individual
financial
information
prepared.
Toronto
Facility
Audit
Report
Company A
(Roanoke)
Roanoke
Facility
Memphis
Facility
40
All facilities
distribute the
same product.
Individual
financial
information
prepared.
Toronto
Facility
Audit
Report
Company A
(Roanoke)
Roanoke
Facility
Memphis
Facility
Other Auditor
Audits & issues
stand-alone
statements
Acceptance and continuance - group auditor;
identify components; preconditions
Understanding - group; components;
component auditors; make reference?
Materiality decisions and responding to risks
of material misstatement
Other procedures - consolidation process;
subsequent events; evaluating evidence
Communications - with component auditors;
with group governance and management
41




Must be a group focused plan and strategy
Determine use of component auditors
Determine whether to assume responsibility
Group Engagement Partner
◦ Required to review and approve the overall group audit
strategy and audit plan

The group engagement team is required to gain an
understanding of the component auditors and
determine the extent of involvement in the work of
the component auditors, then choose to either:
◦ Assume responsibility for the work of component
auditors, in which case the group engagement team would
perform additional procedures and issue the standard
report, or
◦ Not assume responsibility for, and accordingly make
reference to, the audit of a component auditor in the
auditor’s report on the group financial statements
42

Required regardless of whether making reference:
◦ Understands and will comply with relevant ethical
requirements, in particular independence
◦ Professional competence
◦ Extent of involvement with the work of the component
auditor
◦ Whether the group team can obtain information with
respect to the consolidation process
◦ Whether the component auditor operates in a regulatory
environment that actively oversees auditors

Preconditions to making reference to others’
work
◦ Component F/S prepared on same GAAP basis*
◦ Component auditor followed same GAAS
◦ Component auditor report is not restricted as to use
*exception in application paragraphs for GASB and
FASAB, which address this
43

Allow reference to F/S prepared using a different
financial reporting framework if:
◦ Measurement, recognition, presentation, and disclosure
criteria are comparable, and
◦ Group engagement team can obtain sufficient
appropriate audit evidence to take responsibility for
auditing conversion adjustments

Considerations
◦ Evaluating appropriateness of conversion adjustments
usually requires depth of understanding of component’s
financial statements commensurate with assuming
responsibility
◦ Rare circumstances may be able to obtain
44

Considerations
◦ Greater the differences, less comparable
 Number and significance
◦ IFRS and IFRS for SMEs as issued by IASB
 Generally more comparable to US GAAP than local country
GAAP
◦ Special purpose frameworks are not comparable to US
GAAP

Report should clearly indicate
◦ Financial reporting framework used by component, and
◦ Group auditor is taking responsibility for auditing the
conversion adjustments
45

Clarifies application of same GAAS:
“the group engagement partner has
determined that the component auditor has
performed an audit on of the financial
statements of the component in accordance with
the relevant requirements of GAAS or, when
required by law or regulation, with auditing
standards promulgated by the Public Company
Accounting Oversight Board (PCAOB)”


When different GAAS in component auditors’
report and additional procedures applied to
conform to GAAS
Group Audit report should clearly indicate:
◦ Additional procedures were applied
46

Comments due: October 31, 2012

Proposed effective date:
◦ Same as AU-C 600

Increases auditor responsibilities (and their
involvement with the component auditor) with
respect to
◦ Significant components
◦ Subsequent events
◦ Communications with the component auditor
47

Required audit procedures exceed those of the old
standard, including:
◦ Requiring the group engagement team to be involved in
the risk assessment of the component
◦ Determining the type of work to be performed on the
financial information of the component
Acceptance and continuance - group auditor;
identify components; preconditions
Understanding - group; components;
component auditors; make reference?
Materiality decisions and responding to risks
of material misstatement
Other procedures - consolidation process;
subsequent events; evaluating evidence
Communications - with component auditors;
with group governance and management
48

The group engagement team must determine:
◦ Materiality including performance materiality for the group
financial statements as a whole
◦ If necessary, separate materiality for significant classes of
transactions or accounts
◦ Component materiality for those components where an audit
or audit procedures will be performed
◦ Thresholds for recording passed adjustments

If the group engagement partner is assuming
responsibility for component auditors’ work, the group
engagement team should determine the
appropriateness of performance materiality for the
component.

Component materiality should be determined for
all components regardless of whether reference is
being made to component auditor
Component materiality and performance
materiality should be lower than group materiality
and performance materiality
A threshold for trivial misstatements should also
be established for each component.


49






Different materiality may be established for
different components
The aggregate of component materiality may
exceed group materiality
Component materiality should be allocated to the
components where reference is being made; this
is likely to differ that what is actually used
Allocating component materiality can effectively
lead to efficiencies
No specific methodology provided in the SAS
Helpful article in Journal of Accountancy,
December 2008
◦ “Component Materiality for Group Audits”
http://www.journalofaccountancy.com/Issues/2008/Dec/C
omponentMaterialityforGroupAudits.htm
◦ Uses probability concepts similar to theory for allocating
materiality to elements of the financial statements
50
51
52

Follow AU-C 330 (clarified SAS 107)
◦ Apply to group financial statements
◦ Group-wide controls
◦ Appropriate responses may be at the group level rather
than component level
Acceptance and continuance - group auditor;
identify components; preconditions
Understanding - group; components;
component auditors; make reference?
Materiality decisions and responding to risks
of material misstatement
Other procedures - consolidation process;
subsequent events; evaluating evidence
Communications - with component auditors;
with group governance and management
53







Obtain an understanding of the process
Respond to risk of material misstatements
Test operating effectiveness of controls when
efficient or deemed necessary
Evaluate completeness and appropriateness of
consolidating entries
Fraud risk factors or indicators of bias
Perform basic subsequent events procedures on
group
Request the component auditor to notify us of any
relevant subsequent events
54
Acceptance and continuance - group auditor;
identify components; preconditions
Understanding - group; components;
component auditors; make reference?
Materiality decisions and responding to risks
of material misstatement
Other procedures - consolidation process;
subsequent events; evaluating evidence
Communications - with component auditors;
with group governance and management

Obtain confirmation
◦ Cooperation with group engagement team
◦ Ethical requirements including independence

Inform component auditors
◦ List of related parties
◦ Significant RMMs of group relevant to components
55

Request from component auditors
◦ Independence
◦ Identification of financial information on which component
auditor is reporting
◦ Overall findings, conclusions, or opinion

Significant components
◦ Discuss business activities significant to the group
◦ Discuss RMM due to error or fraud
◦ Review component auditors’ documentation of identified
significant RMMs
 Evaluate appropriateness of further audit procedures
 Determine need for more involvement
56

Planning
◦ Component materiality
◦ Other communications previously discussed

Requests from component auditor:
◦ Whether they have complied with the group engagement
team’s requirements.
◦ Information on instances of noncompliance with laws or
regulations

Requests from component auditor:
◦ Significant risks of material misstatement of the group
financial statements, due to fraud or error
◦ Component auditor’s responses to such risks
57

Requests from component auditor:
◦
◦
◦
◦

Corrected and uncorrected misstatements
Indicators of possible management bias
Material weaknesses or significant deficiencies
Other significant findings or issues or matters of
relevance
Additional procedures related to:
◦ Acceptance and continuance considerations
◦ Group engagement team’s process to assess risk
◦ Determination of materiality to be used to audit the
components and group financial statements
58

Additional procedures related to:
◦ Selection of components and account balances for audit
testing
◦ Communications between the group engagement team
and component auditors
◦ Assessing how adequate and appropriate audit evidence
is in forming an opinion on the financial statements

If we are assuming responsibility for the work of
component auditors, the enhanced responsibilities
will require additional work
◦ Considered when managing audit scope, pricing and
client expectations.
59

Address communication challenges in evaluating
subsequent events.
◦ The component auditor may issue the report on the
subsidiary prior to us, as the group engagement team,
issuing the report on the parent company.
◦ We, as the group engagement team, are assuming
responsibility for the events that take place through the
date of the group audit opinion.

Equity method components
◦ Component auditor may not be appointed by group
management, which may create additional difficulties for
us to be involved with or communicate with the
component auditors
60

If we are the component auditors, consider the
impact of
◦ Additional communication requirements and
◦ Increased involvement with the group engagement team
On the audit scope and fees

SAS 126 – Going Concern Considerations
◦ Issued July 2012
◦ Effective for audits of financial statements for periods
ending on or after 12/15/12.

Use of Internal Audit – not yet clarified
◦ Discussed proposed SAS in July/August 2012 ASB
meeting
◦ No effective date yet.
61



Familiarize yourself with the Clarified Standards –
including application material, appendices, and
exhibits
Go to www.aicpa.org/SASClarity for other
resources
Read summary of changes between extant
standards and new clarified standards
◦ www.aicpa.org/interestareas/auditattest/downloadabledo
cuments/clarity/clarity_sas_summary_of_differences.pdf

Begin “project management”
◦
◦
◦
◦
Appoint a person or team to be in charge
Consider small task forces of staff at different levels
Training, training, training
Review your types of auditees to determine who will be
affected first
◦ Explain to auditee management how the engagement
may change

Add, tweak, move, change audit guidance and
methodology
62
125



Similar to the ASB’s Clarity Project
All audit, review, compilation and attest literature will
be in same format
Unlike ASB standards, will not use international
standards as a “base”
◦ Extant SSARS will be used as base
◦ Will look to harmonize review literature with ISRE 2400
Tied to proposed revision to Ethics Interpretation
101-3

◦ Preparation of financial statements as a nonattest service
◦ Compilation would become a reporting service
63

Submission of financial statements

Association SSARS

Signed engagement letter

June 2012 – Proposed clarified comp and association
SSARS exposed for public comment
September 2012




◦ “Trigger” for compilation engagement would change from
“prepare and present financial statements” to being
engagement to compile
◦ New Association standard when the accountant is associated
with unaudited financial statements that the accountant did not
compile or review (including submission)
◦ Required to read financial statements that the accountant is
associated with
◦ Report or request that the entity clearly indicate that the
unaudited information were not compiled or reviewed by the
accountant
◦ Proposed clarified review, framework, and comp of proforma
f/s SSARS exposed for public comment
◦ Comments due on proposed clarified comp and association
SSARS
December 2012 – Comments due on proposed
clarified review, framework, and comp of proforma f/s
SSARS
May 2013 – ARSC to consider voting to issue clarified
SSARS
Proposed applicability – for financial statements for
periods ending on or after 12/15/14.
64
129




Technical Hotline is open Monday-Friday from
9am – 8pm EST (excluding major holidays)
Direct line is 1-877-242-7212
You can submit questions online at
www.aicpa.org/Hotlineform
Technical Hotline pages on aicpa.org at
http://www.aicpa.org/Research/TechnicalHotline
have additional information, including recently
issued TIS Questions and Answers
65

If we discover an adjustment during our audit that
should have been made in the prior year, do I
always have to restate, even if the adjustment is
not material?
◦ You would always consider materiality in making that
assessment, but typically would not be required to restate
financial statements for immaterial adjustments

We discovered that an item on the cash flows
statement for the prior year should have been
classified as an investing activity rather than an
operating activity, do we need to restate the
financials (assume classification is material)
◦ Typically, yes, misstatements would include adjustments,
reclassifications, as well as footnote disclosures.
66

If the client discovers a material adjustment
related to the prior year, but the auditors plan to
issue comparative financials in the next 30 days,
do the auditors have to go back and reissue the
prior year report?
◦ Typically if the issuance of comparative financial
statements is imminent, you would not need to go back
and adjust previously issued reports. Of course, use
professional judgment, may also depend on who
received and relied on those reports.

If the client finds an adjustment to the financials
after issuing an audit report, can I dual date, or do
I need to have a new report date?
◦ Typically, you can dual date, see AU section 530 for
examples. You may also want to obtain an updated
representation letter.
67

We are doing a first time compilation for a client
for the years ended 12/31/11, 12/31/10 &
12/31/09. Would we use SSARS 19 guidance and
report format if the client wants 3 year
comparative financials?
◦ You could. Since the client is requesting comparative
financial statements, and SSARS 19 was effective for
periods ending on or after 12/15/10, it would be okay to
apply one consistent standard since you are presenting
comparative financial statements.

A client has asked us to compile financial
statements for the year ended 12/31/09. Can we
use SSARS 19?
◦ No. SSARS 19 did not allow for early implementation, so
you should refer to the pre-SSARS 19 literature and
report formats.
68

If I am doing a review for a client and they instruct
us not to assess VIEs, is this a scope limitation?
◦ No. Because management is required to perform the
assessment in accordance with US GAAP, the failure to
perform such an assessment is a departure from GAAP,
not a scope limitation. You would modify your report by
adding an explanatory paragraph. AICPA has sample
wording in TIS section 9150.29.

Inquiry—A client and his wife who are co-owners
and co-managers of a business are involved in
divorce proceedings. The auditor believes a
divorce will adversely affect the business's credit
rating. Is it necessary to include a reference in the
financial statements to the divorce proceedings
and their potentially adverse effects?
69

Reply—The auditor should not include references in his
report to currently litigated divorce proceedings. The
independent auditor should refrain from mentioning the
client's involvements of a personal nature which might
effectively disparage (or even stimulate the slander of) his
business reputation or credit standing. It is possible that a
divorce settlement could adversely affect the credit
standing of the client, but in the absence of a final
determination of the litigation or a determinative event
which directly affects the financial condition of the entity
under audit, the rule of informative disclosure does not
compel the independent accountant to contribute in
advance to a possible adverse effect on the client's credit
standing.
Inquiry—Is an explanatory paragraph in the auditor's report for a going
concern uncertainty always required for a development stage
enterprise because there is doubt as to recovery of costs from future
operations?
Reply—No. A going concern uncertainty does not automatically arise
because an enterprise is in the development stage.
If the auditor concludes that substantial doubt about the entity's ability
to continue as a going concern for one year after the balance sheet
date remains after considering conditions, events and management's
plans, the going concern issue should be adequately disclosed in the
financial statements, and the auditor's report should include an
explanatory paragraph to reflect this conclusion.
70
Inquiry—When a CPA requested a client to send a letter of inquiry to the
client's attorney, the client objected because the attorney would charge for
answering the letter of inquiry. The client also believed that an inquiry about
legal matters was not necessary because it had not used the services of its
attorney in the current year for any matters concerning litigation, claims or
assessments. Do generally accepted auditing standards require that a letter
of inquiry be sent to the attorney?
Reply—No. SAS No. 12, Inquiry of a Client's Lawyer Concerning Litigation,
Claims and Assessments (AU 337), requires that a letter of inquiry be sent
to those attorneys with whom management consulted concerning litigation,
claims, and assessments.
Inquiry—A CPA gets numerous requests from clients for
a set of unbound financial statements along with the
usual bound sets. The unbound copy is usually
reproduced on their copying machines for periodic
distribution to suppliers and others. Should the CPA
continue to provide these unbound statements?
Reply—This practice is dangerous because the CPA is
assisting in the reproduction of his or her report
without control over such reproduced copies. It would
be preferable if he or she agreed to provide any
additional copies of the report that may be required,
thus controlling the assembly of the reproduced
reports
71

Inquiry—An entity wants to present consolidating
information in order to present the separate financial
statements of the components of the consolidated
group. Does the auditor’s reporting responsibility
change depending on whether the consolidating
information is presented on the face of the financial
statements in separate columns or whether the
consolidating information is shown outside the basic
consolidated financial statements?
Reply—An entity may present consolidating information
either on the face of the statements or outside the
basic financial statements.
When the auditor is engaged to express an opinion
only on the consolidated financial statements, and
consolidating information is included on the face of the
financial statements, such consolidating information
would be considered supplementary information, the
same as if the information was presented outside the
basic financial statements. In either case, the auditor
should be satisfied that the consolidating information
is suitably identified.
72

Disclosure of Agreement Between Corporation and Its
Shareholders
Inquiry—Corporation A, a closely held entity, has an
agreement with its shareholders under which Corporation A
could become obligated to purchase a certain number of
shares of stock of deceased shareholders at book value.
Should Corporation A disclose this agreement in its
financial statements?
Reply—Corporation A should disclose the terms of the
agreement in a note to its financial statements since it is a
contingent liability.
ACCOUNTING UPDATE AND
EMERGING ISSUES
73




Goodwill Impairment Testing
Revenue Recognition – Exposure Draft
Leases Project – Emerging Standards
Various Other Topics
Goodwill Impairment
74

Background for ASU No. 2011-08
◦ During FASB’s private company roundtables and other
forums, preparers of nonpublic company financial
statements asked FASB to explore alternative
approaches to reduce costs
◦ Many expressed concerns about the cost and effort
required to perform Step 1 of the two-step impairment
test
◦ Stated objective: Simplify goodwill impairment
testing



Step 0 – Evaluate qualitative factors (events and
circumstances) existing at the time of the impairment
test that may suggest that it is more-likely-than-not
that the goodwill recorded on the balance sheet is
impaired
Step 1 – Compare the fair value of a reporting unit to
its carrying amount, including goodwill. If fair value <
carrying amount, go to Step 2.
Step 2 – Compare the implied fair value of goodwill to
its carrying amount. Implied fair value equals the
amount of goodwill if the unit were being purchased
today. If carrying amount > implied value, impairment
loss.
75
• Current examples of triggering events in ASC Topic 350
replaced with examples of events and circumstances to
consider in making the more likely than not determination
 Macroeconomic conditions such as a deterioration
in general economic conditions, limitations on
accessing capital, fluctuations in foreign exchange
rates, or other developments in equity and credit
markets

Examples of events to consider (continued)
◦ Industry and market considerations such as a
deterioration in the environment in which an entity
operates, an increased competitive environment, a
decline in market dependent multiples or metrics,
change in the market, or a regulatory or political
development
◦ Cost factors that have a negative effect on earnings
and cash flows
76

Examples of events to consider (continued)
◦ Overall financial performance such as negative or
declining cash flows or a decline in actual or planned
revenue or earnings compared with actual or projected
results of relevant prior periods
◦ Other relevant entity-specific events such as changes
in management, key personnel, strategy, or customers
◦ Sustained decrease in share price (consider in both
absolute terms and relative to peers)

Events and circumstances to consider in
qualitative assessment
◦ Not intended to be all inclusive
◦ Consider positive and mitigating events and circumstances
◦ Consider how each of the adverse factors identified could affect
the fair value of a reporting unit and how significantly
◦ Evaluate, on the basis of the weight of evidence, the significance
of all identified events and circumstances
◦ If an entity has a recent fair value calculation for a reporting unit,
whether the fair value exceeded the carrying amount by a
substantial margin may be included as a factor
77

Other factors to consider in the determination
◦ Federal Reserve Board has issued a statement that
there is significant downside risk in the economy
◦ FASB acknowledged that in an unfavorable economic
environment many entities likely may determine that
they must proceed to step 1 because “it may be more
likely than not that the fair value of a reporting unit is
less than its carrying amount”
 “Greater cost relief in a more stable or favorable economic
environment”

Use of a Template:
◦ A description of mitigating factors used in forming a
conclusion.
◦ Explanations of the impact and relative impact (high,
medium or low) assigned to each item, including
quantitative support.
◦ A conclusion reflecting the totality of all events and
circumstances considered that further analysis for
purposes of testing goodwill for impairment is not
necessary because it is more likely than not the fair value
of the reporting unit exceeds its carrying value.
78
Assessment Effect
Events and Circumstances
Factors
Macroeconomic Conditions
General Economic Conditions
Access to Capital
Equity-Credit Market Factors
Interest Rate Environment
Other
Industry and Market
Considerations
Operating Environment
Competitive Environment
Changes in Market for the
Entity's Products or Services
Regulatory or Political
Developments
Other
Impact on Fair
Value of the
Reporting Unit Positive Neutral Negative
Comments
Assessment Effect
Impact on Fair
Events and Circumstances
Value of the
Factors
Reporting Unit Positive Neutral Negative
Cost Factors
Cost of Material, Labor, etc.
Affecting Earnings or Cash
Flows
Other
Overall Financial Performance
Cash Flows
Earnings
Actual or Projected Results for
Recent Periods
Consistency of Revenues,
Margins, or Earnings
Other
Comments
79
Assessment Effect
Impact on Fair
Events and Circumstances
Value of the
Factors
Reporting Unit Positive Neutral Negative
Other Relevant Entity-Specific
Events
Changes in Management or Key
Personnel
Changes in Strategy
Comments
Changes in Product or Sales Mix
Changes in Planned Capital
Expenditures or Working
Capital Requirements
Changes in Market Share
Changes in Customers
Litigation
Contemplating Bankruptcy
Other
Assessment Effect
Impact on Fair
Events and Circumstances
Value of the
Factors
Reporting Unit Positive Neutral Negative
Events affecting Reporting Unit
Changes in Composition or
Carrying Amount of Assets
Changes in Life Cycle Stage of
the Reporting Unit
Possible Disposable of All or
Part of the Reporting Unit
Potential Impairment of a
Significant Asset Group
Recognition of a Goodwill
Impairment Loss in the
Financial Statements of a
Subsidiarythat is a Component
of the Reporting Unit
Other
Comments
80
Assessment Effect
Impact on Fair
Events and Circumstances
Value of the
Factors
Reporting Unit Positive Neutral Negative
Trends in Other Key Inputs
Used in Most Recent Valuation
Earnings Multiples
Discount Rates
Inflation Factors
Key Industry Averages
Other

Comments
Effective date
◦ Annual and interim goodwill impairment tests
performed in fiscal years beginning after December
15, 2011
◦ Early adoption is permitted, including for annual and
interim goodwill impairment tests performed as of a
date prior to September 15, 2011, as long as
applicable interim or annual financial statements have
not been issued or, for nonpublic entities, are not
available for issuance
81


Public companies– First quarter of 2012
Private companies– Years ending after December
15, 2012 and interim/annual thereafter
82


Eliminates option to present OCI in statement of
shareholders’ equity
Single statement of income and comprehensive
income
Or
Separate statement of income and separate
statement of comprehensive income
 Under
single or separate statement
presentation, must present therein
reclassification adjustments from AOCI to net
income [DEFERRED BY 11-12]
 Does not change
Items to be reported in AOCI
When items reclassified from AOCI to
earnings
83




Public companies– First quarter of 2012
Private companies– Years ending after December
15, 2012 and interim/annual thereafter
Eliminates option to present OCI in statement of
shareholders’ equity
Single statement of income and comprehensive
income
Or
Separate statement of income and separate
statement of comprehensive income
84

Items of OCI can be presented
Gross, with one line item for aggregate tax effect
Individually net of tax

Footnotes should show the gross amount and tax
effect of each component
Entity XYZ
Consolidated Statement of Comprehensive Income
Year Ended December 31. 201X
$
Revenues
$
Expenses
Amortization of prior service cost reclassified from other
comprehensive income
Oilier gains and losses
(133)
Gain on sale of securities
Gains reclassified from other comprehensive income
140,000
(24,900)
(25,033)
8,000
500
2,000
2,500
Income from operations before tax
125,467
Income tax expense
(31,367)
Income before ex1raordinary item
94,100
Extraordinary item, net of tax
(30,500)
Net income
63,600
Less: net income attributable to the non-controlling interest
(12,720)
Net income attributable to Entity XYZ
50,880
Earnings per share
Basic and diluted
0.46
Other comprehensive income, net of tax:
Foreign currency translation adjustments(a)
8,000
Unrealized gains on securities
Unrealized holding gains arising during period
Less: reclassification adjustment for gains included in
net income
Defined benefit pension plans:
13,000
(1,500)
Prior service cost arising during period
(1,600)
Net loss arising during period
Less: amortization of prior service cost included in net periodic pension
cost
(1,000)
11,500
100
(2,500)
Other comprehensive income
17,000
Comprehensive income
80,600
Less: comprehensive income attributable to the non-controlling interest
Comprehensive income attributable to Entity XYZ
(a)
(16,120)
$
64,480
It is assumed that there was no sale or liquidation of an investment in a foreign entity. Therefore there Is no reclassification adjustment
for this period.
85
Entit y X YZ
Consolida ted St at ement o f C omprehensi ve Income
Year Ended December 31, 201 X
Revenues
$
Expenses
Amortization of prior service cost reclassified from
other comprehensive income
Other gains and losses
$
140,000
(24,900)
(133)
(25,033)
8,000
Gain on sale of securities
500
Gains reclassified from other comprehensive income
2,000
2,500
Income from operations before tax
125,467
Income tax expense
(31,367)
Income before extraordinary. item
94,100
Extraordinary item, net of tax
(30,500)
Net income
Less: net income attributable to the
interest
63,600
non-controlling
(12,720)
Net income attributable to Entity XYZ
50,880
Earnings per share
Basic and diluted
0.46
Other comprehensive income before tax:
Foreign currency translation adjustments (a)
10,666
Unrealized gains on securities:
Unrealized holding gains arising during period
Less: reclassification adjustment for gains
included
Defined benefit pension plans:
17,333
(2,000)
Prior service cost arising during period
15,333
(2,133)
Net loss arising during period
(1,333)
Less: amortization of prior service cost
included in net periodic pension cost
133
(3,333)
Other comprehensive income. before tax
22,666
Income tax expense related to items of other
comprehensive income
(5,666)
Other comprehensive income, net of tax
17,000
Comprehensive income
80,600
Less: comprehensive income attributable to the non-controlling interest
(16,020)
$
Comprehensive income attributable to Entity XYZ
(a)
It is assumed that there was no sale or liquidation of en investment in a foreign entity. Therefore. there is
adjustment for this period.
64,480
no reclassification
Entity XYZ
Consolidated Statement of Income
Year Ended December 31, 201X
$
Revenues
$
Expenses
Amortization of prior service cost reclassified from
oilier comprehensive income
(133)
(25,033)
Other gains and losses
8,000
500
Gain on sale of securities
2,000
Gains reclassified from other comprehensive income
2,500
Income from operations before tax
125,467
(31,367)
Income tax expense
Income before extraordinary hem
94,100
(30,500)
Extraordinary item, net of tax
Net income
63,600
Less: net income attributable to the noncontrolling interest
(12,720)
Net income attributable to Entity XYZ
Earnings per share
Basic and diluted
140,000
(24,900)
$
50,880
0.46
86
Entity XYZ
Statement of Consolidated Comprehensive Income
Year Ended December 31, 201X
$
Net Income
63,600
Other comprehensive income, net of tax:
8,000
Foreign currency translation adjustment (a)
Unrealized gain on securities:
Unrealized holding gains arising during period
13,000
Less: reclassification adjustment for gains included in net
income
(1,500)
11,500
Defined benefit pension plans:
Prior service cost arising during period
(1,600)
Net loss arising during period
(1,000)
Less: amortization of prior service cost included in net
periodic pension cost
(2,500)
100
17,000
Other comprehensive income
80,600
Comprehensive income
Less: comprehensive income attributable to the
noncontrolling interest
Comprehensive income attributable to Entity XYZ
(a)
(16,120)
$
64,480
It is assumed that there was no sale or liquidation of an investment in a foreign entity. Therefore, there is
no reclassification adjustment for this period.
Revenue Recognition
Exposure Draft
87
Do you have revenue
 Do you ever plan to have revenue
 Retrospective application by 2015


Main Principle – to recognize revenue to depict
the transfer of goods or services to customers in
an amount that reflects the consideration that it
expects to receive in exchange for those goods or
services
88

Criteria
• Has commercial substance
- Affects risk, timing or amount of future cash flows
• Parties have approved the contract and are committed to
fulfilling their obligations
• Can identify each party’s rights regarding goods or
services transferred
• Can identify payment terms
 Unilateral
right to terminate unperformed
contract without compensation
89

Combining Contracts
◦ Negotiated as a package with a single commercial
objective
◦ Amount of consideration in one contract is dependent on
the other contract
◦ Goods or services in the contracts are a singly
performance obligation
A separate contract if it results in:
• Distinct promised goods or services
• Right to receive consideration reflecting the entity’s
stand alone selling price of the promised good
/service
If not a separate contract:
• If goods/services distinct, then treat as termination of
old contract and creation of a new contract
• If goods/services not distinct, then treat new terms
as though part of the original contract, recognizing
changes in price on a cumulative catch-up basis
90
Distinct if:
• Vendor regularly sells the good or service separately
• Customer can benefit from the good/service on its own or
together with other resources that are readily available to
the customer
Not distinct if:
• Promised goods/services are highly interrelated and requires
significant service of integrating the goods/services into the
combined item per the contract
• Bundle of goods or services is significantly modified or
customized to fulfill the contract
Goods/Services may be combined if they share the
same pattern of transfer to the customer



Amount of consideration vendor expects to be
entitled to.
Excludes amounts collected on behalf of 3rd
parties (e.g. sales tax)
Credit risk not factored into transaction price.
91
Generally in proportion to standalone selling prices
Evidence
• Observable price for separate sale
• Estimated based on
- Adjusted market assessment
- Expected cost plus a margin
- Residual approach (only if standalone selling
price is highly variable or uncertain and prices of
other performance obligations are observable)
• Maximize observable inputs
Discounts
• Allocated to all performance obligations unless:
- Vendor regularly sells each good/service (or
bundle) on a standalone basis, and
- Observable selling prices provide evidence of
which performance obligation the discount
relates to
92
Satisfied over time


Vendor’s performance creates or enhances an asset that
the customer controls as it is created or enhanced, or
Vendor’s performance does not create an asset with an
alternative use to the vendor and (one of the following):
- Customer simultaneously receives and consumes the
benefits as the vendor performs each task
- Another vendor would not need to substantially reperform
work the vendor has completed in order to fulfill the performance
obligation
- Vendor has a right to payment for performance to date and
vendor expected to fulfill contract as promised




Collectability is no longer an explicit revenue
recognition criterion, although expectation of
collection at inception would seem to be part of
the “commercial substance” requirement of a
contract
Credit risk is not factored into transaction price
Bad debt (different between revenue and financing
income less expected collections) presented as
contra-revenue
Net revenue should ultimately match amount
received, unless there is a financing component
93





Disaggregating revenue
Tabular reconciliation of changes in contract
assets and liabilities
Analysis of remaining performance obligations
Information on onerous performance obligations
Tabular reconciliation of contract costs
Proposed Lease
Accounting Standard
94



Joint project with the IASB
ED issued August 2010
Re-exposure planned for 2012
**Decisions could change**

No effective date indicated

Current model criticized for failing to meet the
needs of financial statement users
◦ Do not provide a faithful representation of leasing
transactions.
◦ omit relevant information about rights and obligations
that meet the definitions of assets and liabilities in the
boards’ conceptual framework.
◦ lead to a lack of comparability and undue complexity
because of the sharp bright-line distinction between
capital leases and operating leases.
95
ASB Chairman Leslie Seidman announced on November 14, 2011 that the
FASB and IASB expect to publish a new Exposure Draft of lease
accounting rules in 2012.
The Exposure Draft will subsequently be open for public comment for a
period of four months from the date of publication.
Chairman Seidman also stated that businesses would not have to apply
the new accounting standards earlier than 2015. These announcements
were made as part of a panel discussion at the accounting conference of
Financial Executives International.
The Boards defined a lease as a contract in
which the right to use a specified asset (the
underlying asset) is conveyed, for a period of
time, in exchange for consideration.
96
The Boards tentatively decided the following in
relation to applying that definition, having
considered feedback received from targeted
outreach meetings held during March 2011 as well
as feedback received in comment letters and
through other outreach:
An entity would determine whether a contract
contains a lease on the basis of the substance of
the contract, by assessing whether:

The fulfillment of the contract depends on the use
of a specified asset; and
97

The contract conveys the right to control the use
of a specified asset for a period of time.
◦ A contract would convey that right to control the use if the
customer has the ability to direct the use, and receive the
benefit from use, of a specified asset throughout the
lease term.
Proposed Model Will Apply to Lessors As Well as
Lessees
◦ Problems associated with existing guidance relate to
operating leases
◦ Keeping the existing lease guidance for lessors would
be inconsistent with the proposed approach to lessee
accounting.
◦ Would also be inconsistent with proposed ASU on
Revenue Recognition
98

Plain vanilla leases

Real estate leases

Right of use assets in a sublease

Leases of non-core assets

Long-term leases of land

Leases of intangibles

Lease for the right to explore for or use minerals,
oil, natural gas and similar non regenerative
resources

Leases of biological assets, including timber
99

The Boards affirmed the decision to apply a rightof-use model to all lease arrangements.

Under that model, a lessee in an arrangement that
is a lease would recognize an asset representing
its right to use an underlying asset during the
lease term and a liability representing its obligation
to make lease payments during the lease term.

Initially recognize a liability to make lease payments
and a right-of-use asset, both measured at the present
value of the lease payments.

Subsequently measure the liability to make lease
payments using the effective interest method.

Amortize the right-of-use asset on a systematic basis
that reflects the pattern of consumption of the expected
future economic benefits.
100
The lease term is defined, for both lessees and
lessors, as:
 the non-cancellable period for which the lessee has
contracted with the lessor to lease the underlying
asset, together with any options to extend or
terminate the lease when there is a significant
economic incentive for an entity to exercise an
option to extend the lease, or for an entity not to
exercise an option to terminate the lease.
The Boards discussed the receivable and residual
approach and tentatively decided that for all lease
contracts within the scope of that approach, a lessor
should:
1. Initially measure the right to receive lease payments
at the present value of the lease payments, discounted
using the rate the lessor charges the lessee, and
subsequently measure at amortized cost applying an
effective interest method.
101
2.
Initially measure the residual asset as an
allocation of the carrying amount of the underlying
asset. The initial measurement of the residual
asset comprises two amounts:
a. The gross residual asset, measured at the present value of
the estimated residual value at the end of the lease term
discounted using the rate the lessor charges the lessee
and,
b. The deferred profit, measured as the difference between
the gross residual asset and the allocation of the
carrying amount of the underlying asset.
3.
Subsequently measure the gross residual asset by
accreting to the estimated residual value at the
end of the lease term using the rate the lessor
charges the lessee. The lessor would not
recognize any of the deferred profit in profit or loss
until the residual asset is sold or re-leased.
4. Present the gross residual asset and the deferred
profit together as a net residual asset.
102
Variable lease payments that depend on an index or a
rate


Should be initially measured using the index or rate
that exists at the date of commencement of the lease
Should be reassessed using the index or rate that
exists at the end of each reporting period.

Lessees should reflect changes in the measurement of
lease payments that depend on an index or a rate (a) in
net income to the extent that those changes relate to the
current reporting period and (b) as an adjustment to the
right-of-use asset to the extent that those changes relate
to future reporting periods.

Lessors should recognize changes in the right to receive
lease payments due to reassessments of variable lease
payments that depend on an index or a rate immediately
in profit or loss.
103
APPLICATION EXAMPLES
Lessee enters into a lease agreement for 15,000
square feet of office space in downtown. The
lease team is for 10 years with two renewal
options of five years.
If Lessee does not renew for the first renewal
option, they are required to refund ½ of the upfit
cost paid by the lessor, which is $150,0000.
104
The lease payment is $22,000 per month
Lessee’s borrowing rate is 3%.
Because of the economic incentive associated with
the renewal option, it is more likely than not that
Lessee will exercise the option.
Right to use asset(PV of Lease
Payments) Dr. 3,620,000
Lease liability
Cr. 3,620,000
Amortize asset over 15 years (241,333 annually);
amortize lease liability using interest rate method
as payments made
105

“Receivable and Residual” Model
◦ Assets:
 Lease receivable: right to receive payments
 Residual asset (portion retained by lessor)
◦ Recognize profit, if reasonably assured, or loss at date of
commencement of lease

Basic Entry – if profit assured
Dr. Lease Receivable (B/S)
Dr. Residual Asset
(B/S)
Dr. Cost of Sale (P&L)
Cr. Revenue (P&L)
Cr. Lease Asset (B/S)
106

Lease Receivable
Initial Measurement: PV of lease payments discounted
using the rate lessor charges lessee
Subsequent Measurement: Recognize interest income
from right to receive payments

Residual asset (profit reasonably assured)
Initial Measurement: Allocate carrying amount of the
underlying asset between right of use granted and
portion retained
Carry amt – (Carry amt x Rec’l/FV)
Subsequent Measurement: Accrete over the term of the
lease using the rate the lessor charges the lessee
107

Residual asset (profit not reasonably assured –
recognize over the lease term)
Initial Measurement: Difference between
carrying amount of underlying asset and right to
receive lease payments
Subsequent Measurement: Accrete using
constant rate of return to asset’s carrying value
(as if depreciated) at the end of the lease term

Basic Entry (profit not assured)
Dr. Lease Receivable (B/S)
Dr. Residual Asset
(B/S) – equals asset-rec’l
Dr. Cost of Sale (P&L) – equals revenue
Cr. Revenue (P&L)
Cr. Lease Asset (B/S)
108
The Boards tentatively decided that for
capital/finance leases existing at the beginning of
the earliest comparative period presented, a lessee
would not be required to make any adjustments to
the carrying amount of lease assets and lease
liabilities and should reclassify those lease assets
and lease liabilities as right-of-use assets and
liabilities to make lease payments.
For operating leases existing at the beginning of
the earliest comparative period presented, a
lessee should:

Recognize liabilities to make lease payments at
transition measured at the present value of the
remaining lease payments, discounted using the
lessee’s incremental borrowing rate as of the
effective date for each portfolio of leases with
reasonably similar characteristics.
109

Recognize right-of-use assets equal to the
proportion of the liability to make lease
payments at lease commencement calculated
on the basis of the remaining lease payments.

Record to retained earnings any difference
between the liabilities to make lease payments
and the right-of-use assets at transition
The Boards tentatively decided that for
finance/sales-type and direct finance leases
existing at the beginning of the earliest
comparative period presented, a lessor would
not be required to make adjustments to the
carrying amount of the assets associated with
those leases
110
Operating Leases:

Recognize a right to receive lease payments, measured at the
present value of the remaining lease payments, discounted using
the rate charged in the lease determined at the date of
commencement of the lease, subject to any adjustments required to
reflect impairment.

Recognize a residual asset consistent with the initial measurement
of the residual asset under the receivable and residual approach,
using information available at the beginning of the earliest
comparative period presented.

Derecognize the underlying asset.



A reconciliation of the opening and closing balance of
right-of-use assets, disaggregated by class of
underlying asset
A reconciliation of the opening and closing balance of
the liability to make lease payments
A maturity analysis of the undiscounted cash flows
that are included in the liability to make lease
payments.
111
The maturity analysis should show, at a minimum,
the undiscounted cash flows to be paid in each of
the first five years after the reporting date and a
total of the amounts for the years thereafter. The
analysis should reconcile to the liability to make
lease payments.
All expenses relating to leases recognized in the reporting
period, in a tabular format, disaggregated into
(a) amortization expense,
(b) interest expense,
(c) expense relating to variable lease payments not
included in the liability to make lease payments, and
(d) expense for those leases for which the short-term
practical expedient is elected, to be followed by the
principal and interest paid on the liability to make lease
payments.
112







Qualitative information to indicate if
circumstances or expectations about shortterm lease arrangements are present that
would result in a material change to the
expense in the next reporting period as
compared with the current reporting period.
Present or disclose separately interest
expense and interest paid relating to leases .
The discount rate used to calculate the liability to
make lease payments.
The range of discount rates used to calculate the
liability to make lease payments.
The fair value of the liability to make lease
payments.
The existence and principal terms of any options for
the lessee to purchase the underlying asset, or initial
direct costs incurred on a lease.
Information about arrangements that are no longer
determined to contain a lease.
113


Statement of financial position or disclose in the notes
to the financial statements right-of-use assets and
liabilities to make lease payments. If right-of-use
assets and liabilities to make lease payments are not
separately presented in the statement of financial
position, the disclosures should indicate in which line
item in the statement of financial position the right-ofuse assets and liabilities to make lease payments are
included.
Present the right-of-use asset as if the underlying
asset were owned.
A table of all lease related income items recognized in
the reporting period disaggregated into:
(a) profit, recognized at lease commencement (split
into revenue and cost of sales if that is how the lessor
has presented the amounts in the statement of
comprehensive income);
(b) interest income on the lease receivable;
(c) interest income on the residual asset;
(d) variable lease income; and
(e) short-term lease income.
114

A qualitative description of purchase options in
leasing arrangements, including information about
the extent to which the entity is subject to such
agreements.

A reconciliation of the opening and closing
balance of the right to receive lease payments
and residual assets.
A maturity analysis of the undiscounted cash flows that are
included in the right to receive lease payments.

At a minimum, the undiscounted cash flows to be
received in each of the first five years after the reporting
date and a total of the amounts for the years thereafter.
The analysis should reconcile to the right to receive
lease payments.
115

Present the lease receivable and the residual asset
separately in the statement of financial position,
summing to a total “lease assets”; or

Present the lease receivable and residual asset in
the statement of financial position as “lease assets,”
with those two amounts disclosed in the notes to the
financial statements.

The accretion of the residual asset as interest income.

The amortization of initial direct costs as an offset to
interest income.

Lease income and lease expense (for example, revenue
and cost of sales) in the statement of comprehensive
income either in separate line items (gross) or in a single
line item (net), on the basis of which presentation best
reflects the lessor’s business model.
116
Comment deadline was January 17, 2012
Scope: All reporting entities that are required to
evaluate whether they should consolidate another
entity


The proposed amendments are expected to most
significantly affect the financial reporting of entities
that are involved with variable interest entities.
The proposed amendments also would change
the evaluation of whether an entity is a variable
interest entity.
117


Entities that historically were not evaluated under
the Variable Interest Entities Subsections of
Subtopic 810-10 may be required to be evaluated
for consolidation under that guidance, while other
entities may no longer be required to be evaluated
under that guidance.
The proposed amendments would change the
requirements for determining whether a general
partner controls a limited partnership and,
therefore, could affect reporting entities that are
involved with partnerships and similar entities.
Under the proposed amendments, the evaluation to
assess whether a decision maker is using its
power as a principal or an agent would focus on:
 1. Purpose and design of the entity
 The rights held by other parties
 2. The compensation to which the decision maker
is entitled in accordance with its compensation
agreement(s)
 3. The decision maker’s exposure to variability of
returns from other interests that it holds in the
entity.
118



Consolidation is appropriate if a reporting entity
has a controlling financial interest in another entity
and a specific scope exception does not apply
The usual condition for a controlling financial
interest is ownership of a majority voting interest,
and, therefore, ownership by one reporting entity,
directly or indirectly, of more than 50 percent of
the outstanding voting shares of another entity is a
condition pointing toward consolidation.
However, the power to control may also exist with
a lesser percentage of ownership, for example, by
contract, lease, agreement with other
stockholders, or by court decree
119
Questions or Comments?
120