Tag Archives: audit committees

Going Concern Reporting – The Gap in GAAP Versus GAAS – Part One

By: George M. Wilson & Carol A. Stacey

 

This is the first of three posts about an interesting conundrum in reporting that arose last year. The FASB, with ASU 2014-15, now requires disclosures by companies about going concern issues. However, there can be gaps between what companies are required to disclose and impact of going concern issues on the auditor’s report.

ASU 2014-15 added subtopic 205-40 “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” to the Accounting Standards Codification. This update became effective for periods ending after December 15, 2016. Previously there was no specific requirement for management to make these disclosures. (This is of course Generally Accepted Accounting Principles, or GAAP).

Auditors have had guidance in this area for many years courtesy of the PCAOB’s standard in AU section 341, which is now section AS 2415 in the PCAOB’s reorganized auditing standards. (This is Generally Accepted Auditing Standards, or GAAS).

 

To explore the gap between GAAP for companies and GAAS for auditors when reporting going concern issues we are going to present a series of three posts:

 

This first post will present an example of a going concern disclosure by a company and whether or not the auditor’s report was modified. (Spoiler – there was no mention in the auditor’s report!)

 

The second post will explore company disclosure requirements.

 

The third and last post will review auditor’s reporting requirements and detail the gaps between company and auditor reporting.

 

Sears Holdings, the retailer that owns Kmart and Sears, provided an example of this gap in their Form 10-K for the year ended January 28, 2017. In their financial statements Sears Holdings included this language:

We acknowledge that we continue to face a challenging competitive environment and while we continue to focus on our overall profitability, including managing expenses, we reported a loss in 2016 and were required to fund cash used in operating activities with cash from investing and financing activities. We expect that the actions taken in 2016 and early 2017 will enhance our liquidity and financial flexibility. In addition, as previously discussed, we expect to generate additional liquidity through the monetization of our real estate and additional debt financing actions. We expect that these actions will be executed in alignment with the anticipated timing of our liquidity needs. We also continue to explore ways to unlock value across a range of assets, including exploring ways to maximize the value of our Home Services and Sears Auto Centers businesses, as well as our Kenmore and DieHard brands through partnerships or other means of externalization that could expand distribution of our brands and service offerings to realize significant growth. We expect to continue to right-size, redeploy and highlight the value of our assets, including our real estate portfolio, in our transition from an asset intensive, historically “store-only” based retailer to a more asset light, integrated membership-focused company.

 

Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.

 

If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.

 

Sears Holdings used the term “substantial doubt”, but indicated that they believed their plans mitigated this “substantial doubt”.

 

This was the report of Sear’s Auditors:

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

No mention of a going concern issue at all in the auditor’s report! What is an investor to think? Historically, when the only concrete guidance was in GAAS, it was very rare to see this issue not discussed in both the financial statements and the auditor’s report.

 

This is, of course, part of the gap between GAAP and GAAS. In our next post we will begin to explore the space in this gap!

 

 

As always, your thoughts and comments are welcome!

Breaking News: Late last week, the PCAOB voted to make a significant change in auditing standards:

 

“The standard will create the first significant change to the standard form auditor’s report in 70 years, according to PCAOB Chairman James Doty.”

http://www.journalofaccountancy.com/news/2017/jun/pcaob-expands-auditor-reporting-duties-201716790.html

 

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PLI will highlight this significant event at our upcoming live program next Monday (June 12th)   in New York City  “Audit Committees and Financial Reporting 2017”

Representatives from the PCAOB and SEC will be on hand to discuss the new standard.

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Audit Committees and Financial Reporting 2017: Recent Developments and Current Issues

Co-Chairs: Catherine L. Bromilow – Partner, Governance Insights Center, PwC Linda L. Griggs – Consultant John F. Olson – Gibson, Dunn & Crutcher LLP

Join PLI on June 12 for a look at the rapidly changing responsibilities of the audit committee. Our expert faculty of government regulators, public company directors, audit committee members, lawyers and CPAs will give you the information and tools you need to successfully perform and meet the many challenges facing audit committees and boards today. You will benefit from their practical advice and real-world experience.

 

New York City and Live Webcast – June 12, 2017

Groupcast Locations: Atlanta, Boston, Cleveland, Philadelphia, Pittsburgh and Mechanicsburg – June 12, 2017

Key Topics Will Include:

  • The most important developments in the past year for audit committees, including SEC and PCAOB developments
  • Implications of the Trump administration on regulations implementing Dodd-Frank
  • Key accounting developments: important changes and GAAP/IFRS convergence update
  • How to build and maintain strong compliance programs
  • Ethical issues arising when advising audit committees

Special Feature:

  • Up to one hour of Ethics CLE credit

Credit Information: CLE, CPE, CPD and CFE Credit

Register Now!

 

Whither the Auditor’s Report?

By: George M. Wilson & Carol A. Stacey

 

Would you expect to find this language in an auditor’s report?

“We performed a full scope audit on seven components representing 99% of the Group’s revenue, 90% of the Group’s profit before tax and 90% of the Group’s net assets.

 

During our first year as auditor of the Group, we visited all significant locations. For our second year, we have implemented a rotational approach to these visits.”

Or how about a discussion of materiality such as this?

“We determined materiality for the Group to be £30 million.

We reported all audit differences in excess of £1 million.

 

We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable person would be changed or influenced.”

This language may sound like it is from the auditor’s internal conclusion memoranda, but in fact it is from the Deloitte report on the 2016 financial statements of an English company, Marks and Spencer.

Their annual report contains the expanded auditor’s report now required by UK Auditing Standards. The report is on pages 78 to 85 (Yes, it is that long!). It also enumerates several “Key Audit Matters”, describing how each such issue was dealt with in the audit.

While this might seem like an extreme example, there has been movement in international audit standard setting towards more tailored, descriptive audit reports. Here in the US the PCAOB began consideration of changes to the auditor’s report over 7 years ago.

In a May 24, 2017 news release the PCAOB announced that on June 1, 2017 they will consider adopting a new Standard on the auditor’s report. The proposal would eliminate the existing standardized form auditor’s report and replace it with a more tailored report which would include discussion of audit specific issues such as “Critical Audit Matters”. Also to be considered at the meeting are new standards about auditing estimates and using the work of specialists.

You can read about the auditor’s report project and review the most recent proposed version of the standard here.

 

As always, your thoughts and comments are welcome!

Audit Committees and Financial Reporting 2017: Recent Developments and Current Issues

The role of the audit committee is constantly changing. Recent regulations from the SEC and guidance from the PCAOB impact how audit committees, their advisors and those who prepare public company disclosures function. If you are a member of an audit committee, advise audit committees, or are responsible for corporate reporting on financial reporting and controls, you need to have the latest information and stay on top of current updates that occurred over the past year including SEC and PCAOB developments. Register today for PLI’s June 12th live program and webcast, Audit Committees and Financial Reporting being held in New York City.

http://www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z10o1a?fromsearch=false&ID=306520

CPE-Eligible On-Demand Programs Now Available from PLI

Practising Law Institute is pleased to announce that CPE credit is now available On-Demand to accountants, CPAs and other professionals. PLI’s CPE-Eligible On-Demand programs allow individuals to earn CPE credit online at their convenience and according to their schedule.

Samples of initial offerings include:

  • Evolving Expectations for Audit Committees, Including Audit Committee and Company Communications
  • Partnership Mergers and Divisions
  • SEC Reporting Foundations: A Primer to Key SEC Corporation Finance Concepts and Guidance
  • IRS and Treasury’s New Guidance Issued Under Sections 7874 and 385

For a complete and growing selection of PLI NASBA QAS approved CPE On-Demand programs, follow this link: http://www.pli.edu/products/by_promotion.aspx?t=RHQ4_CPEOD

 

 

 

 

 

Audit Committee Learning Opportunity

In a constantly changing world Audit Committee members know they need to be continuous learners to fulfill their responsibilities. To help them in this process PLI offers a variety of programs, and in June we will present:

Audit Committees and Financial Reporting 2016: Recent Developments and Current Issues.

The program is on June 21, 2016 and will be presented live in New York and via webcast.   You can find details here. The program features industry and SEC speakers, including Jim Schnurr the Chief Accountant.   The agenda includes:

SEC Developments You Need to Know About PCAOB Developments: What’s Happening in the Auditing Arena? Evolving Expectations for Audit Committees, including Audit Committee and Company Communications Financial Reporting Developments: What Audit Committees Need to Know Networking Break Risk Management & Compliance: What Audit Committees Need To Know Evolving Ethical and Liability Challenges for Audit Committee Advisors: 2016 Edition
As always, your thoughts and comments are appreciated!

Lots Happening at the PCAOB!

Since its inception with the Sarbanes-Oxley Act the PCAOB has faced many challenges in fulfilling its responsibilities to establish GAAS for public company audits, inspect audit firms and enforce when auditors do not fulfill their responsibilities. As the PCAOB has evolved one important lesson we have all learned is that their activities and agenda do not affect just auditors. All public company reporting participants have a stake in what they do. For example, the recent audit standard about related party issues was important not just for auditors, but companies needed to assure they would have the information the new standard required auditors to obtain. Some companies even modified their D and O questionnaires in this process.

To help us be aware of where the PCAOB’s activities could impact us all, here are a few items of note going on at the PCAOB right now.

  1. Auditor’s Involvement in non-GAAP Measures

If you use non-GAAP measures in an earnings release, MD&A or other communication vehicles you will want to follow the events of the May 18-19, 2016 meeting of the PCAOB’s Standing Advisory Group. A significant part of the first day’s agenda is a discussion of “Company Performance Measures and the Role of the Auditor”. The meeting will include breakout discussion sessions and a report of the breakout discussions on day two of the meeting. You can find the agenda and how to access a webcast at:

pcaobus.org/News/Releases/Pages/SAG-meeting-agenda-May-18-19.aspx\

  1. Anticipating and Avoiding Accounting and Auditing Problems

The PCAOB inspections staff has published a “Staff Inspections Brief” which provides a preview of their observations from 2015 inspections. Interestingly the number of audit deficiencies identified for annually inspected firms, those with over 100 public clients, has decreased. For firms with less than 100 public clients, who are inspected every three years, the inspection staff found “an overall high number of audit deficiencies”. Areas with frequent deficiencies were:

Auditing internal control over financial reporting

Assessing and responding to the risk of material misstatement

Auditing accounting estimates, including fair value

Audit areas affected by economic risks, including factors such as oil prices

 

The report also discussed several financial reporting issues including business combination accounting, the statement of cash flows, revenue recognition and income taxes.

 

Auditor independence continued to be a problem area, particularly for triennially inspected firms.

You can read the whole Staff Inspection Brief at:

pcaobus.org/News/Releases/Pages/staff-inspection-brief-2015-issuer-inspections.aspx

 

  1. A Board Member’s Perspective on Inspections, Enforcement and Standard Setting

This speech, delivered by Board Member Jeanette Franzel, is a wide ranging summary of “progress in audit oversite” and has some interesting perspectives on changes that could be in store for the inspection process. She comments that inspections of large firms are showing fewer audit deficiencies but that at smaller firms there are still some that “just don’t get it”. She also provides summaries of the enforcement program and standard setting at the PCAOB.

You can read the speech at:

pcaobus.org/News/Speech/Pages/Franzel-progress-in-audit-oversight-Baruch-5-5-16.aspx

 

  1. A “Darker” Staff Practice Alert

The PCAOB inspectors continue to see enough instances of auditors making changes after audit workpapers are supposed to be “locked down” that they have issued a Staff Practice Alert to remind, or perhaps warn, auditors not to make changes inappropriately in advance of an inspection. You can read the Alert at:

pcaobus.org/News/Releases/Pages/staff-audit-practice-alert-improper-alteration-of-documents-4-21-16.aspx

Interestingly, the last section of the new release has a link to the PCAOB’s tip line……

 

  1. Re-proposed Changes to the Auditor’s Report?

The Board met on May 11, 2016 to consider re-proposing changes to the standard auditor’s report. The current pass/fail model would be retained, but the original proposal and the potentially revised proposal hope to provide additional information to make the report more relevant and informative. Stay tuned for updates on the results of the meeting; in the meantime you can read about the meeting, the revised proposal and related original proposal at:

pcaobus.org/News/Releases/Pages/PCAOB-5-11-16-open-meeting-announcement.aspx

 

  1. Naming the Audit Partner is a Done Deal and the PCAOB’s Standard Setting Agenda

 

Last, as you may have heard, the SEC has approved the PCAOB’s new Auditing Standard requiring disclosure of the names of audit partners and information about other firms involved in an audit beyond the principal auditor. To learn about that change and to see what else is on the horizon, here is a link to the PCAOB’s current rulemaking agenda:

pcaobus.org/Standards/Pages/Current_Activities_Related_to_Standards.aspx

Clearly, the PCAOB is busy!

As always, your thoughts and comments are welcome!

Get the Message: SEC Enforcement Case Deals With Evaluating ICFR Weaknesses!

By sending a clear message through the enforcement process, the SEC has come full circle in their concerns about whether ICFR audits are finding material weaknesses. The staff has said on numerous occasions that they see too many situations where a company identifies a control deficiency but the company’s analysis fails when assessing whether the control deficiency is in fact a material weakness.

Over the last few years the SEC Staff have emphasized their concerns in numerous speeches and other public settings. As they sometimes do when they don’t see companies listening, they have also emphasized this issue through enforcement.

This enforcement is dramatic, involving:

The company

Two company officers

The audit partner

The ICFR consulting firm partner (a surprise here!)

 

This excerpt from a December 2015 speech by Deputy Chief Accountant Brian Croteau summarizes the SEC’s concerns:

Still, given the frequency with which certain ICFR issues are identified in our consultations with registrants, I’d be remiss not to remind management and auditors of the importance of properly identifying and describing the nature of a control deficiency and understanding the complete population of transactions that a control is intended to address in advance of assessing the severity of any identified deficiencies.  Then, once ready to assess the severity of a deficiency, it’s important to remember that there are two components to the definition of a material weakness – likelihood and magnitude.  The evaluation of whether it is reasonably possible that a material misstatement could occur and not be prevented or detected on a timely basis requires careful analysis that contemplates both known errors, if any, as well as potential misstatements for which it is reasonably possible that the misstatements would not be prevented or detected in light of the control deficiency.  This latter part of the evaluation, also referred to as analysis of the so called “could factor,” often requires management to evaluate information that is incremental to that which would be necessary, for example, for a materiality assessment of known errors pursuant to SAB 99. The final conclusions on severity of deficiencies frequently rest on this “could factor” portion of the deficiency evaluation; however, too often this part of the evaluation appears to be an afterthought in a company’s analysis.  Yet consideration of the “could factor” is very important. 

The issue is clear; too often companies are finding a control deficiency but not appropriately evaluating the severity of the issue to determine if it is a material weakness.

In a “classic” example this SEC enforcement involves a company that performed its annual ICFR evaluation and stated in its form 10-K that ICFR was effective at year-end. Then, shortly after that report in their Form 10-K, the company restated its financial statements and disclosed the existence of a material weakness. It is very unlikely that the material weakness arose between the year-end of the Form 10-K and the date of the restatement.

You can read about the enforcement in this press release, which also has links to the SEC Enforcement Orders for the company and the individuals involved:

www.sec.gov/news/pressrelease/2016-48.html

 

The fact that the company and auditor were named is not surprising. What is surprising is that the firm the company retained to provide SOX 404 services, which included assisting “management with the documentation, testing, and evaluation of the company’s ICFR” and no external report, was included in the enforcement.

This is a loud and clear message to all participants in the process! Be thorough and complete in your evaluation of control deficiencies!

If you would like to delve a bit deeper into this issue one of our follow-up posts to this year’s Form 10-K Tune-Up One Hour Briefing focused on ICFR issues, including the issue raised in this enforcement case.

You can read our post at:

seciblog.pli.edu/?p=530

 

As always, your thoughts and comments are welcome and appreciated!

 

An Audit Committee Update

We (that is Carol and George, your blog authors), frequently post about audit committee issues.  For audit committees that want to perform at the highest level possible, PLI has a great program in June.

 

PLI’s Audit Committees and Financial Reporting 2016: Recent Developments and Current Issues program will be presented June 21, 2016 in NYC.  It will be groupcast in several cities and also available via webcast.  Topics discussed will include current SEC reporting issues, audit committee oversight of the implementation of new accounting standards such as revenue recognition and leases, and PCAOB developments for the audit committee.

 

You can learn more about the detailed agenda and how to register at:

 

www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z11i36?fromsearch=false&ID=259781

 

As always, your thoughts and comments are welcome!