AICPA Conference Recap - Investor Info & Audit Quality

January 2013

MHMMessenger
TM

M AY E R H O F F M A N M C C A N N P. C . – A N I N D E P E N D E N T C PA F I R M

A publication of the Professional Standards Group
From the AICPA’s Annual SEC/PCAOB Current Events Conference:
Investor Information and Audit Quality
A goal of keeping markets safe for investors Challenge: What are the best ways to leverage the
PCAOB’s inspection findings and promote the
Keynote speakers SEC Commissioner Luis Aguilar high level of audit quality that investors want and
and PCAOB Chairman James Doty set the tone need?
for the conference by calling upon accountants, as
financial statement preparers and auditors, to step up Commissioner Aguilar pointed out that, since its
to their special responsibility to strengthen investor inception in 2002, the PCAOB has accumulated a
confidence in financial reporting and thereby help wealth of information about audits conducted by the
keep the markets trustworthy and safe for investors. firms registered with the Board. He suggested this
knowledgebase could be used to help identify areas
As a background for the discussions, Commissioner for improvements in audit quality, and he said it was
Aguilar cited studies showing startling declines in important for the PCAOB to continue exploring a wide
market statistics: Only 17% of Americans trust the range of potential approaches for improving audit
stock market. Average daily trades in US stocks quality for the benefit of investors.
are only about half their 2008 peak. US initial public
offerings of smaller companies have never fully What to expect: Several speakers commented on
recovered following the bursting of the technology initiatives underway in these areas.
bubble in 2000.
a. PCAOB Chief Auditor Martin Baumann noted
To restore the vitality of the markets, Commissioner that inspections in the US and other countries
Aguilar said, individual investors must have confidence have indicated a lack of professional skepticism
that the markets are fair, the rules are enforced in independent audits. Initiatives in this area
effectively, and the information available is meaningful, are a priority in today’s complex and rapidly
accurate and complete. There can be no doubt in the changing environment. The independent auditor’s
hearts and minds of investors about the reliability and questioning mind and critical approach to audit
integrity of the audited financial statements. evidence are especially important in view of
the increasing judgment and complexity in
financial reporting and the issues posed by the
current economic environment, with the result
that regulators are trying to encourage and
enforce higher levels of professional skepticism.

What will this mean for auditors and preparers of
financial statements?

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MHMMessenger
• For auditors of financial statements, an the consulting practices of major accounting
increased emphasis on professional skepticism firms could be helpful. Mr. Beswick said this
may lead to more scrutiny of their firm’s growth weakens the appearance of auditor
internal quality control systems so as to ensure independence and does little to promote audit
corrective actions are taken when necessary. quality, and there is a risk that this trend could
weaken public trust in the capital markets.
• For preparers of financial statements, (including
controllers, those in accounting policy or • The challenge for accounting firms that are
operations and other corporate executives), an faced with stagnating audit fees is to effectively
increased emphasis on skepticism may lead to manage conflicting objectives and balance
more rigorous questioning of management’s any revenue and profit pressures with the
assertions and estimates. “When your auditor accountant’s obligation to the public trust.
questions your assertions,” said Mr. Baumann,
“he or she is not being difficult. They’re just d. SEC Deputy Director Brian Croteau reinforced
doing their job.” the need for stronger linkage between inspection
results and audit quality improvement and
b. PCAOB Chairman Doty said companies and firms supported initiatives designed to provide a “more
can expect to see more summary reports on robust performance feedback loop.” He pointed out
insights gleaned from inspections in the coming that the PCAOB has incorporated this goal into its
months and years. A key objective is to better 2012-2016 strategic plan. He also suggested that
equip audit committees of boards of directors to audit committees should encourage audit firms to
serve as champions of audit quality. The PCAOB compete on quality by making engagement quality
will also initiate a project in 2013 to identify audit considerations a key element of every hiring or
quality measures with a longer-term goal of retention decision. He added that he expects the
tracking such measures over time and across project aimed at improving the standard auditor’s
firms and networks of firms. Chairman Doty said report will gain momentum in 2013, and public
he has already seen dramatic improvements in input will be important as the PCAOB hones in on
audit quality in response to inspection findings a potential approach in 2013.
when firms accept the findings and undertake a
rigorous root cause analysis. e. Cindy Fornelli, Executive Director of the Center for
Audit Quality (CAQ) said the CAQ is firmly opposed
c. Acting SEC Chief Accountant Paul Beswick made to mandatory auditor rotation as a way to improve
several observations and suggestions about audit quality. But it supports other approaches,
approaches that would be especially valuable for particularly those related to enhancing audit
investors. committee effectiveness, fostering good-auditor-
audit committee communications, promoting
• Potential changes in the content and form of professional skepticism, and developing
the auditor’s report could help to improve audit measures of audit quality. Together with the
quality by providing more relevant, tailored, and National Association of Corporate Directors and
useful information for investors. other organizations, the CAQ provides webinars
and other resources that are described in the
• An analysis of the risks related to growth in appendix to this Messenger.

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MHMMessenger
Challenge: What are the best ways to manage model, audit transparency or identification of the
risks that threaten to undermine audit quality? audit partner, and the auditor’s responsibilities
with respect to other accounting firms, individuals,
Commissioner Aguilar expressed concern that any and specialists.
efforts to roll back or limit the requirement for auditor
attestation of internal control over financial reporting b. PCAOB Chief Auditor Martin Baumann discussed
could dilute the effectiveness of reforms put in place PCAOB Auditing Standard No. 16 (AS 16) on
by the Sarbanes-Oxley Act. In particular, the Dodd- “Communications with Audit Committees.” At the
Frank Act has permanently exempted smaller reporting time of the conference, AS 16 had not yet been
companies from the auditor attestation requirement, approved by the SEC, but approval was expected
and the JOBS Act has exempted emerging growth by the end of 2012. The standard is intended to
companies. He suggested the SEC and PCAOB be effective for public company audits of fiscal
should monitor the financial reporting and internal periods beginning after Dec. 15, 2012. But Mr.
controls of issuers that have already been exempted, Baumann said some firms are planning to adopt
and the Commission should not hesitate to call for its communications principles early, starting with
the reinstatement of that obligation if necessary to audits of financial statements for calendar year
promote capital formation and protect investors. 2012.

What to expect: Several regulators commented on c. Helen Munter, Director of the PCAOB’s Division
initiatives underway to manage the risks. of Registration and Inspections summarized
the PCAOB’s report on Findings related to the
a. PCAOB Board member Jeanette Franzel application of PCAOB Auditing Standard 5, An
summarized the PCAOB’s near-term priorities Audit of Internal Control Over Financial Reporting
for auditing standard-setting. She said these that is Integrated with An Audit of Financial
priorities include the goal of assessing and Statements. She noted that management plays a
responding to audit risk as a way to enhance key role in internal control over financial reporting,
investor protection. Toward this end, the PCAOB and she encouraged dialogue between auditors
issues staff audit practice alerts and other and preparers on the controls that exist, how
publications. Concurrently with the conference, they are documented, and how they address the
the staff issued an alert on professional identified risks.
skepticism during the audit process. This alert is
described in the Attachment to the Messenger. d. David Landsittel discussed COSO’s project
to update its “Internal Control Integrated
Franzel added that the PCAOB has a “substantive Framework.” Mr. Landsittel serves as Chair of
and ambitious standard-setting agenda” for the COSO, a leading provider of guidance to public
first six months of 2013 and this will likely result in and private companies and other organizations
an unusually high volume of PCAOB publications on internal control, enterprise risk management,
in 2013. The Board plans to issue and maintain and fraud deterrence. He said the updated
standard-setting work plans for six months Framework incorporates 17 principles to describe
intervals. The work plan for the first half of 2013 the components of internal control. Discussions at
includes projects on related parties, reorganization the conference indicated that these principles will
of PCAOB standards, the auditor’s reporting likely affect a company’s documentation of internal

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MHMMessenger
control, for example, to show how the company’s In addition, there has been turnover in several senior
controls reflect the principles. Although there is no staff positions. Chief Accountant James Kroeker
required adoption date, panelists said companies left the SEC in July 2012. Paul Beswick has been
that do not adopt the updated Framework may well serving as Acting Chief Accountant. Subsequent to
be asked why they haven’t done so. Releases of the conference, the SEC announced Mr. Beswick’s
the Framework and several important companion appointment as the agency’s Chief Accountant. The
documents are expected in the spring of 2013. The SEC also announced that Division of Corporation
companion documents include a compendium of Finance Director Meredith Cross will be leaving the
approaches and examples and an illustrative tool SEC. Lona Nallengara was appointed Acting Director
for assessing the effectiveness of a system of of the Division. He replaced Ms. Cross after her
internal control. departure from the SEC at the end of 2012.

Practical advice for 2012 reporting Practical tip: Don’t overlook any last-minute
rulemaking or interpretations for recently enacted
The presenters at the conference provided practical laws with near-term effects.
advice on how to make financial reporting more useful
to investors. Highlights of the personnel changes The Division of Corporation Finance responded
announced, advice offered, and resources mentioned quickly with the initial guidance needed for the JOBS
throughout the conference are recapped below, and Act and the lion’s share of the Dodd-Frank Act. But
a reference guide to key contacts and documents is some rulemaking and interpretations related to
provided in the appendix. these wide-reaching laws remained unfinished at the
time of the conference, and the Office of General
Practical tip: Stay flexible. Changes in leadership Counsel was still compiling interpretive guidance on
at the SEC could influence policy and rulemaking compliance with the Iran Threat Reduction and Syria
in the coming months. Human Rights Acts of 2012. The advice provided at
the conference included the following:
There have been a number of important departures
from the leadership of the SEC. The decisions about a. Iran Act. The Iran Threat Reduction Act requires
when and how the resulting vacancies will be filled new disclosures of certain business activities
may have an impact of the direction of future policies related to Iran by issuers and affiliates. The
and the pace of rule-making activities. reporting requirement takes effect with periodic
reports required to be filed after February 6, 2013.
Most notably, Chairman Mary Schapiro left the It requires issuers to disclose the nature and extent
Commission in December 2012. Commissioner Elisse of the activity, the gross revenues and net profits
Walter has been appointed by President Obama to attributable to the activity, and whether the issuer
take the Chair for an interim period until the empty or affiliate intends to continue the activity. The SEC
seat on the Commission is confirmed by Congress. staff provided a number of clarifications about
This leaves only four Commissioners, including two compliance with this Act during the conference.
from each major political party, making it more difficult But participants raised many additional questions,
to achieve a majority vote on contentious issues. some of which were addressed to former Director
of the Division of Corporation Finance, Brian
Lane, who provided the insights of a corporate

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MHMMessenger
securities lawyer as part of a panel discussion on qualify as Emerging Growth Companies (EGCs).
MD&A. Here are some of the clarifications and The staff advises EGC registrants that they need
open questions: to continuously monitor their filing status. This
is important because loss of EGC status will
• Clarification by SEC staff: Companies cannot result in more extensive and more costly filing
avoid the disclosures by filing their reports requirements, and once a company loses its EGC
before February 6, 2013. status for any reason, it generally cannot come
back into the filing system for EGCs. Several
• Clarification by SEC staff: An “affiliate” refers clarifications about the accommodations for EGCs
to a person or entity that is directly or indirectly were provided at the conference:
controlled by the registrant.
• EGCs are permitted to delay the adoption of
• Open question: How is “controlled” defined for new or revised accounting standards by using
purposes of this Act? Does it include a company the effective dates for non-issuers rather than
that is only 10 or 20 percent owned by the issuers. This permission is limited to accounting
registrant? Mr. Lane indicated that, based on standards issued by the FASB after April 5,
his discussions with SEC staff, the Act includes 2012. It provides flexibility in determining when
affiliates that are less than 51% owned, but more a standard may be adopted, but not which
clarification is needed from the SEC. standards may be adopted. This flexibility does
not mean an EGC can apply private company
• Clarification by Mr. Lane: The disclosure accounting standards.
requirements apply to the period covered by
the report. For example, they would apply to • Delays in adoption dates of accounting
all 2012 activity in a Form 10-K for a calendar- standards are voluntary. If an elective decision
year company with a December 31, 2012 year- is made to adopt this accommodation, that
end. But there would not be a required three- policy needs to be prominently disclosed. Once
year lookback to prior periods presented in the made, the election applies across-the-board
financial statements. to the adoption dates for all new accounting
standards. If the EGC elects private company
• Clarification by Mr. Lane: The Iran Act applies adoption dates, it can switch to public company
to foreign private issuers as well as domestic adoption dates at a later time. However, once
registrants. an EGC elects to use public company adoption
dates, that election is irrevocable.
The SEC incorporated answers to some of
the open questions in the CD&Is on December • EGCs are also provided with an election to opt
4, 2012. A link to the CD&Is is provided in the out of the requirement for auditor attestation over
appendix to this Messenger. internal control. It is possible that a company
may meet the definition of an accelerated filer
b. JOBS Act. A panel of staff members of the and also qualify as an EGC. In these cases, the
Division of Corporation Finance summarized the registrant is not required to have an audit of its
key provisions of the JOBS Act, which provides internal controls.
certain accommodations to companies that

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MHMMessenger
• When an EGC crosses a disqualifying threshold guidance on other aspects of the rule would be
(such as $1 billion in annual revenues), it will forthcoming from the SEC staff, perhaps as FAQs
lose its EGC status immediately and it will need or C&DIs.
to obtain an audit of its internal controls in the
year it crosses the threshold. For example; if a Additional interpretations of the above laws and rules
calendar-year company passes the threshold are available on the SEC’s website. Links are provided
on December 31, 2012, it must file as a non- to key documents on the appendix to this Messenger.
EGC and it will be required to have an audit of
its internal controls for 2012. If the registrant Practical tip: Be mindful of the “frequent areas
feels this requirement is impossible to meet, it of comment” in filing reviews by the Division of
can contact the SEC staff to discuss a possible Corporation Finance.
exemption for the reporting period during which
the threshold is passed. The Director of the Division of Corporation Finance
and a panel of SEC staff members provided the
c. Dodd-Frank Act. The conflict minerals rules are following advice based on an analysis of topics
arguably the highest-profile and most controversial mentioned frequently in SEC comment letters and
rules related to the Dodd-Frank Act. The staff advised responses from registrants.
participants that the applicable audit standards
are those of the GAO’s “yellow book” standards. a. Responses to comment letters. Corporation
Finance Director Meredith Cross said the
Companies have several options for obtaining the comment letters from the SEC to registrants
required audits of conflict minerals reports. One are getting more targeted, more meaningful,
option is to use the same auditor that audits the and harder for the companies to respond to. At
company’s financial statements. The staff said the same time, the comment letters are getting
this would not be inconsistent with independence posted to the SEC’s website faster, but no
requirements, but the company must disclose earlier than 20 days following the completion
the fee in the “all other” category of its proxy of the filing review. These factors are focusing
statement. Another option is to use a firm other more attention on the correspondence and the
than the company’s audit firm. The yellow book wording of the registrant’s replies in the media.
standards will also permit a non-CPA to perform
the required independent private sector audit of the In view of this expanded visibility, Ms. Cross
conflict minerals report provided the auditor uses cautions that companies need to exercise an
performance audit standards as opposed to the appropriate amount of care when wording their
attestation engagement standard in the yellow book. responses. Some companies may want to obtain
legal reviews that are every bit as rigorous as those
The staff has issued a small entity compliance obtained for their filings. Federal law (18 U.S.C.
guide for conflict minerals. But they are still getting § 1001), in effect, makes it a crime to lie to the
many inquiries, including complicated chemical government. This law could expose the company
questions. The staff respectfully suggests that the to liability if any of the statements in its replies are
chemistry questions be directed to an appropriate inconsistent with other statements made as part of
expert rather than the SEC staff. The expectation the company’s disclosure record or are not 100%
at the time of the conference was that more accurate.

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MHMMessenger
b. MD&A. A panel discussion on MD&A provided • In light of the current economic environment,
insights from corporate executives. The some companies are being asked to disclose
executives noted that the MD&A can be a the effects of events in Europe on the results of
challenge to write for several reasons, including operations, including segment sales, margins,
the need to find the right balance between and any effects on significant suppliers or
transparency and information overload and the customers that may have a material impact
fact that the guidance is spread across multiple on results of operations. If there are material
sources. In effect, writing a good MD&A, said offsetting impacts, the staff advises that all
one corporate participant, is more a matter of material impacts should be discussed, even if
complying with the “spirit” of the regulations the net effect on a line item is immaterial.
than one of complying with the letter of the law.
• The staff recommends the use of metrics to help
Perhaps, not surprisingly, a panel of SEC staff companies tell their story. The metrics should
members from the Division of Corporation Finance not be measures that would be considered non-
noted that MD&A is at the top of the list of frequent GAAP measures, but they may be industry-
topics for SEC staff comment letters. Since it is specific, such as comparable store sales in the
the single most frequent area of comment, MD&A retail industry.
was the subject of a number of observations and
advice, including the following: • The MD&A has a forward-looking focus, and
registrants are required to disclose any known
• Within MD&A, the SEC staff comments focus trends and uncertainties that the company
most frequently on the company’s results of reasonably expects will have a material effect
operations, followed by liquidity and critical on income, either favorable or unfavorable. The
accounting estimates. staff points out that this is sometimes the most
informative disclosure in the MD&A.
• The staff notes that information in the MD&A
sometimes repeats information presented in • The table of contractual obligations provides
the financial statements or it uses boilerplate some flexibility in the handling of items involving
language. As a result, many SEC comments ask uncertainties. However, the footnotes to the
for more information. For example, companies table should discuss what is included in the table
may be asked to identify, quantify and discuss and what is not, and the commentary should link
the factors that led to changes in financial back to the liquidity discussion.
statement line items.
• Recommended reference materials include
• The SEC believes it is critical for companies to the SEC’s 2003 MD&A Interpretive Release
answer the question “Why?” For example, “Why and Topic 9 of the SEC’s Financial Reporting
did revenues increase?” The disclosures should Manual.
identify the underlying causes of any increase
in the volume of sales. The reasons for any c. Segment reporting. Another frequent area of
changes in the mix of revenues by segment may comment involves the identification of operating
also need to be discussed. segments and their aggregation into reporting
segments. Registrants are urged to tell a complete

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MHMMessenger
story when responding to comment letters to allowances for deferred tax assets should
provide an understanding of the judgments consider their reliability by taking into account
involved. For example, the discussion of segments an assessment of how management’s forecasts
might include information about how the chief have compared with actual results in the past
operating decision maker makes allocation and whether the forecast used to evaluate the
decisions or assesses performance. Companies DTA is consistent with the other forecasts used
are also advised to continually monitor the facts in the registrant’s financial statements, including
and circumstances that affect segment reporting. forecasts used to evaluate impairment of goodwill,
The FASB and IASB are currently conducting long-lived intangible assets or to assess the going
post-implementation reviews of their standards concern uncertainty.
for segment reporting. The SEC staff said it is too
soon to comment on what effect this might have on e. Loss contingencies. In recent years, SEC staff
their filing review or their future comment letters. comments have focused on both the content and
the timing of disclosures about reasonably possible
d. Income taxes. The SEC staff noted that a decision ranges of losses. These comments relate to the
to establish or reverse a valuation allowance requirement that companies must disclose an
for deferred income tax assets often requires estimated loss or range of losses when it is at least
considerable judgment including an evaluation of reasonably possible that a loss has been incurred.
the relevant facts and circumstances. However, This is another area of accounting that involves
they reminded registrants of their view that it significant judgment and the SEC comments are
would be difficult to conclude that losses due to intended to ensure the company tells the full story.
an economic downturn would be an aberration The staff cautioned registrants to keep in mind
that did not justify a need to establish a valuation that, even if the SEC clears a loss contingency in
allowance. They also reminded registrants that one year, it may make comments in future years
cumulative losses in recent years represent if there are changes and the disclosures do not
significant negative evidence that is difficult (but appear to be evolving in a timely manner.
not impossible) to overcome when assessing
the realizability of deferred tax assets (DTA). f. Revenue recognition. The SEC staff comments
on revenue recognition have been focusing on
As more registrants have returned to profitability the question of whether collection is reasonably
this year, questions have arisen about when a assured, which may not be the case for certain
valuation allowance can be reversed. The short transactions, including revenues from sales to
answer is that it can be reversed when the positive customers in the Eurozone. In addressing this
evidence outweighs the negative. Because this can question, registrants should consider a number
be a difficult determination, the staff’s comments of factors, including their historical past-due
often focus on the question of “Why now?” collection practices and write-off history, as well
as any track record of unfavorable resolutions
Factors to consider in weighing the evidence in collection disputes or any history of modifying
include the magnitude and duration of past losses, payment terms or of not enforcing liens.
magnitude and duration of current profitability,
whether the current profitability is sustainable, and g. Goodwill impairment. Recent SEC staff
management’s forecast. It is important to choose comments about goodwill impairment have focused
factors that are independently verifiable, and on a perceived gap in disclosures from period to
any forecasts used in connection with valuation period, particularly in the period of impairment.
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MHMMessenger
Reasons such as “soft market conditions” or disclosures about cybersecurity, and Rule 3-10
an “economic downturn” are considered overly issues involving disclosure requirements for
vague in light of the number of periods spanned guarantors of registered securities and the effect
by the weak economy. If the company conducted of subsidiary guarantee release provisions.
an interim impairment test, that fact should be They also include various issues related to
disclosed, along with the factors that triggered the specific industries and auditor considerations.
interim test, even if no impairment was identified.
Additionally, the staff expects disclosures from The SEC has issued guidance on the
companies that are at risk of failing step 1 of the MD&A disclosures related to cybersecurity
goodwill impairment test and they expect reasons risks and the circumstances that may
for impairment that answer the question of “Why?” constitute customary subsidiary release
Specifically, registrants should consider the provisions. Links to these resources are
following questions: What happened in a specific provided on the appendix to this Messenger.
period that gave rise to the impairment charge in
that period rather than earlier or later? How were The staff discussed two issues related to auditor
key assumptions affected? Why did those changes considerations:
occur? Is the impairment a result of known trends
that are expected to affect income? • Registrants should consider including
risk factors in their filings when they have
h. Non-GAAP measures. The staff continues to issue material operations in non-PCAOB inspected
comments about the use of non-GAAP measures. jurisdictions.
Registrants are reminded that presentation of
misleading non-GAAP income statements is • References to the “standards of the PCAOB”
prohibited in earnings releases furnished to the in auditors’ reports for issuers should not be
SEC on Form 8-K, as well as in filings with the termed simply “auditing standards.” This term
SEC. Misleading non-GAAP measures violate is too limiting and does not include the other
Regulation S-K, even if the measure is reconciled PCAOB standards, such as independence
to a GAAP measure. Use of non-GAAP measures standards, with the result that the term may
with adjustments for pension-related items can imply the auditor did not comply with the
be especially troublesome. This practice was standards other than auditing standards.
discussed at the June 2012 joint meeting of the References to auditing standards may,
AICPA’s CAQ SEC Regulations Committee, and however, be appropriate in auditors’ reports
additional information is available in the meeting for non-issuers conducted in accordance with
highlights on the CAQ’s website. standards issued by the AICPA and known as
US Generally Accepted Auditing Standards
i. Other areas. Additional areas of advice from the (US GAAS). These standards might be
SEC staff include pro forma financial information, applicable in certain situations when the
consolidation of variable interest entities, financial statements of an acquired entity are
presented under Rule 3-05 of Regulation S-X.

The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation.
Please contact your MHM service provider to further discuss the impact on your financial statements.

9

AICPA Conference Recap - Investor Info & Audit Quality

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