Author: andymintzercpa

Advocate for ethical conduct and betterment of the CPA profession. Chair of CalCPA 2016-2017. Forensic Accountant - Hemming Morse, LLP, Los Angeles.
Featured

Coronavirus/COVID-19… impacts accounting, auditing and financial reporting.

Andy Mintzer, CPA

The Coronavirus pandemic has caused considerable damage to the health and security of people all over the world.  The substantial harm of the pandemic is yet to be measured.  But while worldwide efforts to stem the growth of the virus continue there are still required financial reports that must be issued within deadlines.

This posting discusses some of resources and relief available to accountants, financial statement preparers and auditors as a result of the COVID-19 pandemic.  I will also discuss some accounting and auditing-related issues that have been raised. Keep in mind, of course, that this situation is evolving, and the information is subject to change or extension.  This posting includes sections on:

  • Public Companies – and guidance issued by the SEC and SEC staff
  • Audits of financial statements – and the resources made available by the AICPA
  • Going Concern Considerations – an update to my posting in 2019 on this topic

Public Companies – SEC offers both guidance and potential to extend deadlines for required financial reporting.

Annual Form 10-K filing deadlines pushed back to provide relief for companies and auditors in completing calendar 2019 annual reports.

Worldwide securities markets saw significant drops in late February which caused significant uncertainty and constrained the resources of those with upcoming filing deadlines.  The first major deadline for the annual Form 10-K for was for Large Accelerated Filer (companies with a public float of more than $700 million) – and it was March 2, 2020.  The Securities and Exchange Commission (SEC) provided financial reporting relief on March 4, 2020 which generally pushed back the deadlines for all filers for 45 days; thus any filer who did not file its form timely had an additional 45 days (or until April 16, 2020) to timely file its Form 10-K.  Here is what happened to the rest of the 10-K deadlines:

Filer CategoryOriginal Form 10-K DeadlineRevised deadline with SEC relief
   
Accelerated FilerMarch 16, 2020April 30, 2020
Non-Accelerated Filer and othersMarch 30, 2020May 14, 2020
Summarized potential impact of SEC deadline relief

This relief is not automatic and without conditions.  Among other conditions, companies must convey through a current report a summary of why the relief is needed in their particular circumstances. The On March 25, 2020 the Commission issued an order that, subject to certain conditions, provides public companies with a 45-day extension to file certain disclosure reports that would otherwise have been due between March 1 and July 1, 2020.  The SEC encourages companies and their representatives to contact SEC staff with questions or matters of particular concern in this regard.

In providing this deadline extension, SEC Chairman Clayton said:

“How companies plan and respond to the events as they unfold can be material to an investment decision, and I urge companies to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements.”

Companies should consider the need for COVID-19-related disclosures. 

On March 25 the Division of Corporation Finance (Division) published disclosure guidance related to Coronavirus/COVID-19 consequences affecting SEC registrants while recognizing that the impact on companies is evolving rapidly and its future effects are uncertain (March 25 SEC Release).  The Division is monitoring how companies are reporting the effects and risks of COVID-19.  

In the March 25 SEC Release the Division encouraged timely reporting while recognizing that it may be difficult to assess or predict with precision the broad effects of COVID-19 on industries or individual companies.  Although the Division acknowledged that the actual impact depends on many factors that are beyond a company’s control and knowledge, the effects COVID-19 has had on a company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties can be material to investment and voting decisions.

SEC disclosure requirements apply to a broad range of evolving business risks even in the absence of a specific line item requirement that names the particular risk presented; for example, the SEC has highlighted that although no existing disclosure requirement specifically refers to cybersecurity risks and cyber incidents, a number of requirements may impose an obligation on companies to disclose such risks and incidents (See Release No. 33-10459 (Feb. 26, 2018))

In addition, a number of long-standing existing accounting related rules or regulations require disclosure about the known or reasonably likely effects of and the types of risks presented by COVID-19.  As a result, disclosure of these risks and COVID-19-related effects may be necessary or appropriate in one or more of the following portions of a Form 10-K:

  • Management’s discussion and analysis, 
  • Business section, 
  • Risk factors, 
  • Legal proceedings, 
  • Disclosure controls and procedures, 
  • Internal control over financial reporting
  • Financial statements

Assessing and Disclosing the evolving impact

The March 25 SEC Release also provides guidance to companies as they assess the evolving effects of COVID-19 and related risks will be a facts and circumstances analysis – not a boilerplate one-size-fits-all disclosure.

Disclosure about these risks and effects, including how the company and management are responding to them, should be specific to each company.  As companies assess COVID-19-related effects and consider their disclosure obligations, the SEC has provided questions to consider, including:

  • How has COVID-19 impacted  financial condition and results of operations?  What are expected impacts to future operating results and near-and-long-term financial condition?  Is the expected impact to future operations different than how it affected the current period?
  • How has COVID-19 impacted capital and financial resources, including the overall liquidity position and outlook?  
  • Is there a material uncertainty about the ongoing ability to meet the covenants of credit agreements?  
  • If a material liquidity deficiency has been identified, what course of action has the company taken or proposed to take?  (Consider the requirement to disclose known trends and uncertainties)
  • Does the company expect to disclose or incur any material COVID-19-related contingencies?
  • Will COVID-19 issues affect assets or the company’s ability to timely account for those assets?  (For example, will there be significant changes in judgments in determining the fair-value of assets)
  • Are material impairments anticipated (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities)? 
  • Are increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on the financial statements anticipated?
  • Have COVID-19-related circumstances adversely affected financial reporting systems, internal control over financial reporting (ICFR) and disclosure controls and procedures?  If so, what changes in controls have occurred during the current period that materially affect or are reasonably likely to materially affect ICFR?  
  • Is there an expectation that demand for products or services will be adversely affected?
  • Is a material adverse impact to the supply chain or the methods used to distribute products or services anticipated? 
  • Are travel restrictions and border closures expected to have a material?

As published by the SEC, the above list is illustrative but not exhaustive and each company will need to carefully assess COVID-19’s impact and related material disclosure obligations.  The Division encourages disclosure that is tailored and provides material information about the impact of COVID-19 to investors and market participants.  

SEC Registrants…Reporting Earnings and Financial Results

“The ongoing and evolving COVID-19 impact will likely make it more difficult for companies and their auditors to complete the work required to maintain timely filings and we encourage companies to proactively address financial reporting matters earlier than usual.  For example, to the extent a company or its auditors will need to consult with experts to determine how the evolving COVID-19 situation may impact its assets, including impairment of goodwill or other assets, it should consider engaging with those experts promptly so that its reporting remains as timely as possible, as well as complete and accurate.”

According to the March 25 SEC Release

In this section I will summarize some of the highlights from the March 25 SEC Release as it relates to reporting earnings and financial results.

Although not required to do so, companies often release earnings estimates and other financial results in advance of finalizing the required financial reporting for the relevant period.  There may be instances where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by COVID-19-related adjustments that may require additional information and analysis to complete.  In these situations, the Division disclosed that it would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results.  For example, under this position, if a company intends to disclose on an earnings call its earnings before interest, taxes, depreciation and amortization (EBITDA), it could reconcile that measure to either its GAAP earnings, a reasonable estimate of its GAAP earnings that includes a provisional amount, or its reasonable estimate of a range of GAAP earnings.  The provisional amount or range should reflect a reasonable estimate of COVID-19 related charges not yet finalized, such as impairment charges.  A non-GAAP financial measure should not be disclosed more prominently than the most directly comparable GAAP financial measure or range of GAAP measures.  In addition, in filings where GAAP financial statements are required, such as filings on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.

To the extent a company presents a non-GAAP financial measure or performance metric to adjust for or explain the impact of COVID-19, it would be appropriate to highlight why management finds the measure or metric useful and how it helps investors assess the impact of COVID-19 on the company’s financial position and results of operations.  

In addition, if a company presents non-GAAP financial measures that are reconciled to provisional amount(s) or an estimated range of GAAP financial measures in reliance on the above position, it should limit the measures in its presentation to those non-GAAP financial measures it is using to report financial results to the Board of Directors.  The SEC’s release reminds companies that it does not believe it is appropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.  Rather, if used, companies should use non-GAAP financial measures and performance metrics for the purpose of sharing with investors how management and the Board are analyzing the current and potential impact of COVID-19 on the company’s results.  If a company presents non-GAAP financial measures that are reconciled to provisional amount(s) or an estimated range of GAAP financial measures, it should explain, to the extent practicable, why the line item(s) or accounting is incomplete, and what additional information or analysis may be needed to complete the accounting.

Companies may consider presenting metrics related to COVID-19, or changing the method by which it calculates a metric as a result of COVID-19.  In these cases, the SEC reminds companies of the principles explained in recent Commission guidance related to metrics, specifically Release No. 33-1075

Does the COVID-19 crisis affect audits of financial statements?

I am aware that many are asking how audits…those in-process or those yet-to-begin…might be impacted by the COVID-19 crisis.  

I will give this subject a very light touch in this posting, as this may be a very broad issue. Since many have asked about it I wanted to at least get the conversation started. The AICPA has published many resources which can be found here:

https://www.aicpa.org/interestareas/frc/covid19.html

This link includes an accounting and auditing FAQ document.  The FAQ document addresses many accounting questions and the possible impact on the audits for a wide range of topics.  Some of the topics addressed are:

  • Access to Books and Records
  • Asset Impairments
  • Emphasis‐of‐Matter Paragraphs and Types of Auditor’s Reports
  • Fair Value of Investments
  • Fraud Inquiries
  • Going Concern
  • Internal Control
  • Inventory Observations
  • Management Representation Letters
  • Risks and Uncertainties
  • Subsequent Events

Going Concern Considerations

One of my prior posts included a discussion on going concern considerations.  Since I have seen many questions about how going concern considerations might be affected by COVID-19 I felt it appropriate to include this update.

GAAP (FASB ASC 205‐40) requires management to evaluate an entity’s ability to continue as a going concern within one year after the date the financialstatements are issued (or available to be issued, when applicable). Substantial doubt about an entity’s ability to continue as a going concern exists whenconditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due withinone year after the date that the financial statements are issued.  Disclosures in the notes to the financial statements are required if management concludes thatsubstantial doubt exists or that its plans alleviate that substantial doubt.

The ability of an entity to continue as a going concern is affected by many factors and the consequences of COVID‐19 may impact those factors as they relate to the particular audit client’s facts and circumstances.

Since the relevant period is generally one year from the date the financial statements are issued, the evolving effects of the COVID‐19 crisis may affect the evaluation of the audit client’s going concern evaluation.  These effects might impact some industries (restaurants, entertainment, airlines, etc.) more than others – but might also affect the customers and vendors of these industries as well.

The ability of an entity to continue as a going concern is affected by many factors, including the industry and geographic area in which the entity operates, thefinancial health of customers and suppliers of the entity, and the accessibility to financing that is available for the entity. The consequences of COVID‐19 mayimpact the factors in evaluating the ability of an entity to continue as a going concern.  They may cause a decline in an entity’s operating results and financialposition. As such, entities and auditors may need to evaluate the latest relevant information related to their assessments of going concern.  Consideration of liquidity received from government relief programs may also factor into the assessment.

Sources:

https://www.sec.gov/investment/staff-statement-im-covid-19

https://www.sec.gov/corpfin/coronavirus-covid-19#_ftn2

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

This article discusses GAAP and professional standards in general – I have not consider any specific situations.  The application of GAAP or auditing standards to a particular situation depends on the specific facts and circumstances and analysis of the applicable accounting or auditing standards.  Therefore this article is educational in nature and does not represent professional accounting or auditing advice or services

Cybersecurity risk – the CPA profession’s response — AICPA develops Cybersecurity Risk Framework

In the olden days crooks had to break into a business to rob it…not anymore. Cyberattacks are spreading.  Cyberattacks are an attempt by hackers to damage or destroy a computer network or system or to misappropriate information from one.  Companies are under increasing pressure to protect the assets and the confidential information they possess.  Historically a company’s internal controls were the procedures to prevent, detect and correct errors – and also reduce the risk that assets will be misappropriated.  Management is under pressure to demonstrate to owners and customers that they are effectively managing cybersecurity threats and that they have effective controls and procedures in place to detect, mitigate, respond to and recover from cybersecurity threats.

To address this need, the AICPA has developed a “cybersecurity risk management reporting framework (Framework)” that assists management develop effective control process.

black and grey device
Photo by Pixabay on Pexels.com

 

The Framework provides senior management, boards of directors and other interested parties with useful information for decision-making about an organization’s cybersecurity risk management program. And it provides organizations with a context for communicating about the effectiveness of their cybersecurity risk management program to build trust and confidence.

What types of issues does the Framework address?

  • Communication procedures
  • Processes and programs to evaluate the program’s effectiveness
  • Policies, processes, and controls to detect, respond to, mitigate, and recover in the event of a cybersecurity breach
  • Communication
  • Responses to breaches at relevant vendors and businesspartners
  • Cyber event simulation
  • Mitigation and risk transfer options (including cyber insurance coverage)
  • Staffing and access to internal and external skills

The Framework is a key component of a new System and Organization Controls (SOC) for Cybersecurity engagement, through which a CPA reports on an organizations’ enterprise-wide cybersecurity risk management program.  This information can help senior management, boards of directors, analysts, investors and business partners gain a better understanding of organizations’ efforts.

CPAs and management can use the cybersecurity criteria to help benchmark their evaluation of the entity’s cybersecurity framework.  CPAs can use the framework to provide advisory engagements to help their clients strengthen their cybersecurity risk management programs. Ultimately, the CPA can offer a cybersecurity risk management examination engagement and provide an opinion on the entity’s description of its efforts, and the effectiveness of its controls.

CPAs can use the cybersecurity framework to provide attestation services by performing an examination of management’s program or as non-attest consulting services where they give information and recommendations to management.

CPAs will consider the criteria from the perspective of these categories:

  1. Nature of Business and Operations. Disclosures about the nature of the entity’s business and operations.
  2. Nature of Information at Risk. Disclosures about the principal types of sensitive information the entity creates, collects, transmits, uses, and stores that is susceptible to cybersecurity risk.
  3. Cybersecurity Risk Management Program Objectives (Cybersecurity Objectives). Disclosures about the entity’s principal cybersecurity objectives related to availability, confidentiality, integrity of data, and integrity of processing and the process for establishing, maintaining, and approving them.

Use of the Framework

The framework may prove to be a valuable resource for CPA firms to enhance their own cybersecurity risk management programs and to provide professional services to clients – both consulting services and attestation services.

Enhancing the CPA firm’s programs

Prior to providing professional services to clients, CPA firms may find the framework suitable for strengthening and enhancing its own cybersecurity risk management programs.  CPA firms are often targets of cyberattacks due to the sensitive nature of client data processed – such as social security number, birth dates and banking information.

Consulting services

Perhaps the first engagements CPAs will provide their clients are consulting engagements where the practitioner gives recommendations and assistance to their clients in strengthening their cybersecurity risk programs.  Companies may turn to their CPA firms for assistance – and CPAs may be in a good position to suggest a consulting engagement while performing other professional services for their clients.  As with other non-attest consulting services, however, CPAs may need to consider threats to independence, if applicable. CPA firms also need to be sure that they have sufficient qualified personnel to perform the services and that they carefully communicate the scope of the proposed services and reach an understanding with the client on the services they agree to deliver.

Examination of management’s cybersecurity program

Should the entity engage the CPA practitioner to examine its assertion about its cybersecurity program, the presentation will have three components:

The first component is a management-prepared narrative description of the entity’s cybersecurity risk management program. Management’s description is intended to provide users with information that will help them better understand the entity’s cybersecurity risk management program.

The second component is an assertion provided by management, which may be as of a point in time or for a specified period of time. Specifically, the assertion addresses whether (a) the description is presented in accordance with the description criteria and (b) the controls within the entity’s cybersecurity risk management program were effective to achieve the entity’s cybersecurity objectives based on the control criteria.

The third component is a practitioner’s report, which contains an opinion. Specifically, the opinion addresses whether (a) the description is presented in accordance with the description criteria and (b) the controls within the entity’s cybersecurity risk management program were effective to achieve the entity’s cybersecurity objectives based on the control criteria.

What’s next?

Cybersecurity threats and managements response to those threats may be relatively new.  But this is a growing concern that will not disappear. The CPA professional has developed tools and techniques that CPAs may use in their own practice and to provide professional services to clients.  This article provided a very brief overview of the new AICPA framework and how CPAs can become involved.  If you are interested in a deeper dive, more resources can be found the AICPA’s website, “SOC for Cybersecurity: Information for CPAs”.

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

This article discusses professional services in general – I have not considered any specific situations.  The application of standards to a particular situation depends on the specific facts and circumstances and analysis of the applicable accounting standards.  Therefore this article is educational in nature and does not represent professional accounting advice or services.

GAAP Matters – When the Going “Concern” Gets Tough…

Andy Mintzer, CPA

Going Concern

According to the Financial Accounting Standards Board (FASB), under generally accepted accounting principles (GAAP), continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. This is often referred to as the “going concern assumption”.

Why is the “going concern assumption” important?

If and when an entity’s liquidation becomes imminent, financial statements should be prepared under the liquidation basis of accounting.  Finding a financial statement prepared under the liquidation basis of accounting has been said to be about as rare as a unicorn sighting.  Nevertheless there is often news surrounding “going concern” issues of a particular company.  This article will touch on some of the background and overarching concepts necessary to understand this important area.

gray scale photo of gears
Photo by Pixabay on Pexels.com

Financial statements prepared using the liquidation basis of accounting present relevant information about an entity’s expectedresources in liquidation by measuring and presenting assets at the amount of the expected cash proceeds from liquidation. The entity should include in its presentation of assets any items it had not previously recognized under U.S. GAAP but that it expects to either sell in liquidation or use in settling liabilities (for example, trademarks).

Are disclosures about the entity’s ability to continue as a going concern important even if liquidation accounting is not used?

Yes!

There is a generally a wide range of potential financial statement disclosures that are expected before an entity is required to adopt a liquidation basis of accounting – and it is these disclosures (or lack thereof) that financial statement readers should be on alert for.

For example:

There is substantial doubt about the entity’s ability to continue as a going concern but liquidation is not imminent.

Even if an entity’s liquidation is not imminent, there may be conditions or events that nevertheless raise substantial doubt about the entity’s ability to continue as a going concern. In those situations, financial statements should continue to be prepared under the going concern basis of accounting, but relevant conditions and events should be disclosed and described.

“We’ve got it covered”

And in fact, if conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should nevertheless disclose information that enables users of the financial statements to understand (1) principal conditions or events that raised substantial doubt (2) Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations, and (3) Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

It is often misunderstood that the going concern assumption deals with the entity’s ability to “continue as a going concern“…not merely continue in business.  I have heard claims that if the company can expect to keep the lights on they can avoid the disclosures about the substantial doubt to continue.

Not so.

According to the FASB, ordinarily, conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern relate to the entity’s ability to meet its obligations as they become due.  Management’s evaluation shall be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued.

Management shall evaluate whether relevant conditions and events, considered in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. The evaluation initially shall not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented  as of the date that the financial statements are issued (for example, plans to raise capital, borrow money, restructure debt, or dispose of an asset that have been approved but that have not been fully implemented as of the date that the financial statements are issued). If these potential mitigating effects are underway – but not fully implemented – this initial evaluation cannot take them into account as described by the FASB guidance.

Going Concern Disclosures – a brief history

Prior to the issuance of ASC 2014-15 by the FASB in 2014there was no guidance in authoritative “FASB GAAP” about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures.

But if you recall hearing about going concern issues before 2014 your memory is not failing you. U.S. auditing standards and federal securities law require that an auditor evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern for a “reasonable period of time”. Thus, the source of what financial statement preparers considered “generally accepted” had its origin in the auditing standards.  As a side note this was also true for the financial statement concept of subsequent events – this accounting concept appeared in authoritative auditing literature before the FASB adopted a standard.  I was a member of the AICPA’s Accounting Standard Executive Committee from 2001 through 2005 – during that time we considered a project to issue Accounting Statement of Positions to codify in authoritative GAAP some of these accounting concepts that resided in the auditing standards – that is, move the concepts to accounting literature.  Before we could undertake this project, however, the FASB indicated that it would be picking up this project…which they ultimately did.

So back to the auditing standards…under these auditing standards a “reasonable period of time” was defined as a period not to exceed one year beyond the date of the financial statements being audited. So if the entity’s fiscal year is a calendar year-end – the going concern evaluation period was through the following December 31.  This meant that the length of the period of time that the entity evaluated varied with the date the financial statements were issued.  For example, calendar year-end financial statements issued in March had an evaluation period of time lasting about nine months – but financial statements issued in July only required an evaluation period for the remainder or the year – or about five months.

One of the ways the recent FASB authoritative GAAP standard changed the going concern evaluation is by redefining the time horizon.  No longer will the time horizon be limited to one year after the date of the financial statements – the new requirement is for the horizon to generally consider whether facts and circumstance raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Thus, a calendar-year financial statement issued in June, for example, which prior to this new standard only needed to consider the time horizon through the next December 31, will not need to consider whether there are facts and circumstances which raise substantial doubt through the next twelve months.  Many years ago I was involved in a matter where the entity’s financial statements were not issued until ten months after its year – thus the going concern evaluation period was comparatively short.  Had this new GAAP standard been in effect the going concern evaluation period would have extended an additional ten months past the next calendar year-end.

For readers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS) please consider the evaluation under those standard as “In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the end of the reporting period.”

U.S. auditing standards also require an auditor to consider the possible financial statement effects, including footnote disclosures on uncertainties about an entity’s ability to continue as a going concern for a reasonable period of time and to possibly modify its auditor’s report. The U.S. Securities and Exchange Commission (SEC) also has guidance on disclosures that it expects from an entity when an auditor’s report includes an explanatory paragraph that reflects substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. Auditing standards have evolved somewhat with the development that financial accounting frameworks, such as US GAAP, now contain authoritative accounting guidance – as a result auditing standards now look to the applicable financial reporting framework’s guidance on going concern.  Auditing standards require the auditor to evaluate going concern considerations even if the financial statements are prepared under a special purpose financial reporting framework which does not have explicit going concern disclosure guidance.

Disclosures (and sometimes the lack of disclosures) about issues that raise or respond to doubt about an entity’s ability to continue as a going concern are often significant with important implications to the evaluation of the financial condition.  This article touched on just some of the background as an introduction to understanding this topic.

 

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

This article discusses GAAP and professional standards in general – I have not considered any specific situations.  The application of GAAP to a particular situation depends on the specific facts and circumstances and analysis of the applicable accounting standards.  Therefore this article is educational in nature and does not represent professional accounting advice or services.

GAAP Matters – will debt classification change…will AICPA independence rules change?

Groups oppose the change proposed by the FASB, and…

New Lease GAAP accounting prompts a change in the AICPA’s auditor independence standard

Both the Private Company Council (PCC) and the Investor Advisor Committee (IAC) have recommended that the FASB reconsider and change its decision on a proposed GAAP standard dealing with debt classification (ASC Topic 470)

money coins finance cash
Photo by Tookapic on Pexels.com

The FASB has proposed and considered a change to GAAP that would affect the classification of debt. This proposal affects when debt can be classified as a non-current liability.  Classification as current vs non-current affects some key financial statement measures.

Generally, classification of debt as “long-term” is not available to instruments which will mature and become due within one year of the balance sheet date.  Under the proposal, debt “should” be classified as long-term (i.e. noncurrent) if “The entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date. If, before the balance sheet date, an arrangement is in place with a third party (for example, a line of credit) that would result in the entity avoiding the transfer of current assets within 12 months from the balance sheet date, the debt should be classified as noncurrent because the entity has a contractual right to defer settlement.”

The PCC requested that the FASB reconsider its prior decision to allow companies to classify debts due within 12 months as long-term debt if the company has unused long-term financing arrangements at the balance sheet date.  The PCC stated that the FASB decision to consider unused long-term financing arrangements adds complexity and is therefore not in line with its intent to simplify balance sheet classification of debt.

The IAC recommended the Board change its tentative decision to reclassify current debt as a non-current liability based sole on unused long-term financing arrangements – such as a line of credit.  The groups consider the analysis of whether the entity can use the line of credit to effectively extend the repayment of the debt to be somewhat complex as it could potentially include assessing the reasonableness that the line of credit will not be needed for other liquidity needs along with an assessment of terms and conditions of the credit line.

We have here an example where both the PCC and IAC, despite their varying  stakeholders and perspectives, have provided somewhat similar feedback to the FASB. According to the FASB website, the PCC is the primary advisory body to the FASB on private company matters. The PCC uses the Private Company Decision-Making Framework to advise the FASB on the appropriate accounting treatment for private companies for items under active consideration on the FASB’s technical agenda. According to the FASB’s website, the IAC is a standing committee that is expected to work closely with the FASB in an advisory capacity to ensure that investor perspectives are effectively communicated to the FASB on a timely basis in connection with the development of financial accounting and reporting standards.

And speaking of debt…AICPA Code of Conduct interpretation change is on the horizon for CPAs who have lease arrangements with clients

At its upcoming meeting the AICPA’s Professional Ethics Executive Committee (PEEC) will consider adopting a change to the independence interpretation that affects CPAs who have lease arrangements with their clients. This proposed revision was originally considered and exposed for comment by PEEC while I was a member of the PEEC.

The existing “Leases” independence interpretation provides that a lease between the CPA and the attest client does not impair independence if the lease is an operating lease – and – the lease terms are comparable with leases of a similar nature, and all amounts are paid in accordance with the lease terms and provisions. This existing interpretation also provides that a capital lease impairs independence because it is considered be a prohibited loan with the attest client.

The FASB has since adopted authoritative GAAP that when effective will significantly affect the operating versus capital lease interpretation which iscodified in ASC 842, Leases. Calendar year-end public business entities will adopt the new leases standard on January 1, 2019. Thus, PEEC determined it needed to consider how that GAAP change affects the Code of Professional Conduct.

The proposed revision to the Code of Conduct replaces the extant GAAP categorization approach with a conceptual framework approach, allowing for the consideration of factors that PEEC believes truly affect the CPA’s objectivity and professional skepticism. PEEC has stated that it does not believe that objectivity and professional skepticism are affected by whether a lease is an operating lease or a capital lease, per se, but believes that other factors related to the lease and the relationship should be considered in arriving at a conclusion on independence.

While the GAAP lease categorization requirements have been proposed to be eliminated from the revised interpretation, the other requirements remain in the proposed revised interpretation as minimum safeguards. Once these minimum safeguards are met (where applicable), the CPA is required to use a threats and safeguards approach, evaluating any other threats identified and applying safeguards when necessary.

PEEC is set to take up the final adoption of its proposal in the summer of 2018…I will follow its progress and provide additional analysis as information becomes available.

GAAP Matters! Do you know where your debt covenants are?

New GAAP standard might impact covenants…are you ready?

GAAP are the rules companies are supposed to use when preparing their financial reports. Although leasing is a fundamental concept that one might think would have been ironed out by the accounting rule-makers years ago – it wasn’t.  I recall being introduced to leasing in my first accounting class as an example where accounting recognizes “substance over form”.

Under this new GAAP rule considerably more leased property will appear on balance sheets…and bring with it considerably more lease liabilities.  Consequently any company with restrictive covenants that are affected by these issues might find themselves with compliance issues.

man in yellow safety vest climbing on ladder
Photo by Pixabay on Pexels.com

But first…Lease Accounting – A History Lesson!

In fact, long before my first accounting class, accounting rule-makers have been grappling over the substance over form issue concerning with leases at least since the 1940s!

Perhaps it will only be accounting historians who will remember that Accounting Research Bulletin Number 39 issued in 1949 stated:

 “A lease arrangement is sometimes, in substance, no more than an installment purchase of the property.” – ARB 39 (1949)

“A lease arrangement is sometimes, in substance, no more than an installment purchase of the property.

This was further confirmed in 1953 when Accounting Research Bulletin 53 stated that “the committee (Committee on Accounting Procedure – an early predecessor to the FASB) is of the opinion that the facts relating to all such leases should be carefully considered and that, where it is clearly evident that the transaction involved is in substance a purchase, the “leased” property should be included among the assets of the lessee with suitable accounting for the corresponding liabilities and for the related charges in the income statement…”

The Committee on Accounting Procedure was replaced by the Accounting Principles Board (APB), a senior technical committee of the American Institute of Certified Public Accounting. The APB had the primary role of establishing GAAP prior to the formation of the FASB. In 1964 APB Opinion Number 5 reached a similar conclusion concerning leases:

On the other hand, some lease agreements are essentially equivalent to installment purchases of property. In such cases, the substance of the arrangement, rather than its legal form, should determine the accounting treatment.”     APB Opinion 5 (1964)

The attributes described in APB 5, which gave rise to the capitalization, were fairly narrow and were ultimately replaced by the FASB in its early days with FASB Statement 13 and its 4 specific tests covering various conditions which the FASB considered triggered accounting recognition of the leased asset as a capital assets.  Conceptually the four tests developed by the FASB were somewhat straightforward – but accounting firms, regulators and financial statement preparers found issues which spawned dozens of additional FASB statements, interpretation and other technical documents.

In 2016 the FASB issued ASC 2016-02 (ASC) which some say will simplify the lease capitalization issue considerably by requiring a lessee to recognize assets and liabilities for essentially all leases with lease terms of more than 12 months.

Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months    FASB 2016-02

So there you have it – essentially all leases of one year or greater will result in asset and liability recognition.

As you might have suspected there is more to than that.  The FASB described that consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP—which requires only capital leases to be recognized on the balance sheet—the new standard will require both types of leases to be recognized on the balance sheet.

So, the big difference?   The accounting standard setters old approach required that the lease arrangement transfer substantially all the economic risks and rewards of the leased property to the lessee should rule the day –  the new approach is that all leases of more than 12 months convey an asset to the lessee and that asset (and related liability) should be placed on the balance sheet. One of the more problematic issues with the old rule was determining if the underlying lease transferred enough risks and rewards:

no more

It now appears that the twelve month rule will simplify the balance sheet on/off switch aspect.  For example, should a lessee enter into a two-year lease of an asset with a useful life of say 40 years, the accounting standard setters have reasoned that it has an asset – albeit one with just a  two year life.  The preparer will still need to deal with the issues of qualification and financial statement classification.

The ASU on leases will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other organizations, the ASU on leases will take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.

Restrictive covenant compliance issues?

One of the consequences cited by respondents to this standard when it was in the proposal stage is that many companies have entered into debt agreements or other contracts with restrictive covenants…and that some of those covenants limit the amount of debt it can have…or even if it may have a capital lease on its balance sheet.  Consequently companies should evaluate their existing restrictive covenants and determine if implementing this new lease GAAP standard will affect them.

So is substance over form no longer a GAAP accounting concept?  Yes it is but the FASB prefers the term “faithful representation”. Faithful representation means that financial information represents the substance of an economic phenomenon rather than merely representing its legal form.

The new rule on accounting for leases has been known for a long time – what seemed like a far away implementation date is now less than two accounting quarters away.  But even with this long lead time…will all companies be ready?

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

 

 

 

 

Ethically speaking – International Code of Conduct – Global Principles for Professional Accountants

A new Code of Ethics has been released by the International Ethics Standards Board for Accountants.  It is reorganized to be easier to apply in practice.

Andrew Mintzer, CPA

The Code of Ethics(Code) is designed to present rich guidance about how accountants should deal with, and consider, ethics and independence issues.

Although the fundamental principles of ethics remain the same in the new code, the unifying conceptual framework has been revised. Accountants should use this framework to identify, evaluate, and address threats to compliance with the fundamental principles.

What does the new Code cover?

The Code has guidance for all professional accountants as well as specific additional guidance for both professional accountants in public practice, as well as professional accountants in business.

person taking photo of grey concrete building
Photo by Brett Sayles on Pexels.com

The new code contains:

  • Revised “safeguards” provisions designed to be better aligned to threats to compliance with the fundamental principles.
  • Independence provisions regarding long association of personnel with audit clients.
  • New and revised sections dedicated to professional accountants in business relating to preparing and presenting information, and relating to pressure to breach the fundamental principles.
  • Guidance for professional accountants in business.
  • Guidance to emphasizing the importance of understanding facts and circumstances when exercising professional judgment.
  • New guidance to explain how compliance with the fundamental principles supports the exercise of professional skepticism in an audit or other assurance engagements.

Professional Accountants in Business

The IESBA Code Part 2 has specific requirements for “professional accountants in business”.  As explained, this Part of the Code sets out requirements and application material for professional accountants in business when applying the conceptual framework. The conceptual framework does not describe every possible circumstance, including professional activities, interests and relationships, that could be encountered by professional accountants in business, which create or might create threats to compliance with the fundamental principles, the Code, thereforerequires professional accountants in business to be alert for such facts and circumstances.

Investors, creditors, employing organizations and other segments of business, as well as governments and the public, might rely on the work of professional accountants in business. Professional accountants in business might be solely or jointly responsible for the preparation and reporting of financial and other information, on which both others might rely. They might also be responsible for providing effective financial management and competent advice on a variety of business-related matters. The Code, therefore, sets out requirements for professional accountants in business in several key areas where they might encounter pressure to breach the fundamental principles.

One such pressure area faced by professional accountants in business is to breach the fundamental principles of ethical conduct.

Accountants in business should not let the pressures they face breach their compliance with the Code.

A professional accountant shall not:

  1. Allow pressure from others to result in a breach of compliance with the fundamental principles; or
  2. Place pressure on others that the accountant knows, or has reason to believe, would result in the other individuals breaching the fundamental principles.

Pressure might be explicit or implicit and might come from:

  • Within the employing organization, for example, from a colleague or superior.
  • An external individual or organization such as a vendor, customer or lender.
  • Internal or external targets and expectations.

Examples of pressure that might result in threats to compliance with the fundamental principles include:

  • Pressure related to conflicts of interest, such as pressure from a family member bidding to act as a vendor to the professional accountant’s employing organization to select the family member over another prospective vendor.
  • Pressure to influence preparation or presentation of information such aspressure to report misleading financial results to meet investor, analyst or lender expectations…or to please superiors.
  • Pressure to act without sufficient expertise or due care such aspressure from superiors to perform a task without sufficient skills or training or within unrealistic deadlines.

Boss to professional accountant – just do it!

  • Pressure related to inducements:

oPressure from others, either internal or external to the employing organization, to offer inducements to influence inappropriately the judgment or decision making process of an individual or organization.

oPressure from colleagues to accept a bribe or other inducement, for example to accept inappropriate gifts or entertainment from potential vendors in a bidding process.

  • Pressure related to non-compliance with laws and regulations, such as pressure to structure a transaction to evade or postpone tax.

I will cover other section of the Code of Ethicsin future articles.

 

 

Andrew M. Mintzer, CPAis a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

 

Shocking! New GAAP standard for revenue recognition is now effective. Tesla reports increased sales…by adopting new standard!

airport bolt bright danger
Photo by Pixabay on Pexels.com

Down the road: Look for more companies to report changes.

GAAP are the rules companies are supposed to use when preparing their financial reports. Although revenue is a fundamental concept that one might think would have been ironed out by the accounting rule-makers years ago – it wasn’t.  GAAP evolved with somewhat different revenue recognition concepts for different industries or situations. Accounting rule makers have been grappling with resolving these concepts.  In the USA, it is the Financial Accounting Standards Board (FASB) that develops these rules.  The FASB’s new accounting standard for revenue recognition is now effective for public companies. For many companies the new rules will not create major changes, but for some others, it will.  Among the more notable is Tesla…

and Tesla has reported increased car sales thanks to these rules.

Tesla’s reported automotive sales increased about $300 million – Instead of reporting “Automotive Sales” of $2.3 billion, as it would have under the old rules Tesla reported automotive sales of $2.6 billion, under the new rules, as announced its Form 10Q for its fiscal quarter ended March 31, 2018.  That’s an increase of $.3 billion…or about $300 million…from a rulechange.

Was that “increase” due to an increase its underlying activities?   NO

Did it “sell” more cars?  Well…

The $300 million increase was not caused by a change in the level customer of “transaction” but rather a change in that certain “leasing” activities heretofore reported as “Automotive Leasing” revenue are now – considered by the accounting rules – as automotivesales.  Indeed, under the new rules Tesla reported about $165 million lessAutomotive Leasing revenue…thus offsetting a bit more than half of the increase it reported in its Automotive Sales.

Tesla described the increase is its Automotive Sales was due to “vehicles leased through our leasing partners… with a resale value guarantee… now generally qualify to be accounted for as sales with a right of return”. While, on the other hand, “for certain vehicles sales with a resale value guarantee and vehicles leased through leasing partners prior to 2018, we have ceased recognizing lease revenue starting in 2018”. Thus, these transactions – vehicles leased with resale value guarantees – now qualify under GAAP as sales revenue transactions, not leasing revenue transactions; so that revenue stream has been diminished.

The new GAAP standard defines revenue as: Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (Source ASC 606-10-20).

What are the rules?

The level of complexity for implementing the new rules will vary. The new rule has five over-arching steps – but each of these steps has entity and circumstance specific implications.

    • Identify the contract
    • Identify performance obligation(s)
    • Determine price
    • Allocate the price, if appropriate
    • Recognize revenue

To people who follow the development of accounting rules the new FASB revenue recognition standard has been a hot topic for years – the process of issuing a new accounting standard like this one takes a lot of time – with exposure drafts, public roundtables, deliberation and re-deliberation of comments provided by interest parties along with an attempt to unify the standards with international accounting rules…the process has gone on for years.  And with concerns over whether companies will be able to re-tool their bookkeeping systems to keep up with the new rules the effective date was pushed back.

Some surveys had suggested that many companies were behind in their implementation efforts.  GAAP changes typically don’t attract headlines – the Tesla announce did shine a spotlight on the change. Not all companies will report a material change – and not all will report a change due to the same reasons reported by Tesla.  The financial reports of the companies should provide details and background as to the nature and scope of any changes.

Some changes might impact compliance with restrictive covenants or amounts due under existing agreements.

If you read financial statements you should be on the lookout for further announcements of the implementation of the new GAAP standard for companies that you are interested in.

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.

zz