Journal of Accountancy Large Logo
January 2013

  The Center for Audit Quality (CAQ) released two products with the interactions between external auditing firms and audit committees in mind, plus a Guide to PCAOB Inspections aimed at investors and capital market stakeholders.

A practice aid developed by the CAQ describes methods for enhancing the flow of information between audit firms and audit committees on audit inspections and quality-control matters. The CAQ, which is affiliated with the AICPA, also has released a tool to assist audit committees in annual evaluations of external auditors.

The practice aid, available at, says that “transparent, candid communication … supports the audit committee’s role in overseeing the external auditor.” The practice aid says the CAQ supports interaction that is consistent with the objectives of the PCAOB’s August 2012 Release No. 2012-003, Information for Audit Committees About the PCAOB Inspection Process.

“Proactive engagement by auditors with audit committees regarding inspections and firm quality-control improvement initiatives should provide audit committees valuable insights into the firm’s quality-control program,” Cindy Fornelli, the CAQ’s executive director, said in a news release.

According to the practice aid, a firm should consider the following elements in developing a communications plan:

  • Whether the issuer’s audit was selected for inspection by the PCAOB and, if so, the status of the progress of that inspection;
  • Information about the firm’s responses to the PCAOB findings with respect to the issuer’s audit;
  • Whether any items described in the public part of a PCAOB inspection report on the company, including matters not involving the issuer’s audit, involve issues and audit approaches similar to those from the audit of the issuer’s financial statements;
  • Steps the firm is taking to address issues identified with respect to its system of quality control; and
  • Whether issues described by the PCAOB in general reports summarizing inspection results across groups of firms (also known as “4010 Reports”) relate to the audit of the issuer’s financial statements and internal controls over financial reporting, and how the firm is addressing those issues.

The PCAOB’s August release, available at, describes how its inspections of audit firms work and how to gather information from audit firms about those inspections.

Seven organizations, including the CAQ, developed the tool for aiding audit committees in evaluations of external auditors. The tool is designed to help audit committees make an informed recommendation to boards of directors on whether to retain their auditor.

Public company audit committees are responsible for hiring and monitoring auditors, and the tool provides guidance on how to perform those duties. The guidance also could be used by audit committees at private companies, not-for-profits, and government entities, as well as others who monitor external audit services, including company boards, oversight bodies, and even management.

The tool will operate in a space that has received significant scrutiny over the past few years. The European Union has been debating mandatory audit firm rotation requirements proposed by the European Commission. The PCAOB has been exploring the idea of mandatory audit firm rotation for public companies in its project aimed at enhancing auditors’ independence, objectivity, and professional skepticism.

In addition, a PCAOB standard regulating audit committees’ communications with external auditors was forwarded in August to the SEC for ratification.

The new evaluation tool states that public focus on how audit committees perform, including how they oversee external auditors, has increased significantly. The tool says audit committees should evaluate auditors annually to make an informed recommendation to the company board on whether to retain his or her services. The tool, available at, says the evaluation should assess:

  • The auditor’s qualifications and performance.
  • The quality and candor of the auditor’s communications with the audit committee and the company.
  • The auditor’s independence, objectivity, and professional skepticism.

Sample questions in the tool highlight important areas for consideration. The guide also encourages audit committee members to evaluate the auditor’s performance throughout the audit process.

The CAQ’s Guide to PCAOB Inspections, available at, explains the objectives and process of inspections, the difference between a PCAOB inspection and an enforcement hearing, and the contents of inspection reports.

  Issued under the authority of the AICPA Auditing Standards Board, Statement of Position (SOP) 12-1, Reporting Pursuant to the Global Investment Performance Standards, supersedes SOP 06-1 of the same title and paragraphs 11.37–.42 of chapter 11, “Independent Auditor’s Reports and Client Representations,” of the AICPA Audit and Accounting Guide Investment Companies (as of May 1, 2012).

The SOP, available at, provides guidance to practitioners for engagements to examine and report on aspects of a firm’s claim of compliance with the GIPS standards. It also provides guidance on engagements to examine and report on any of the firm’s composites and their associated compliant presentations.

The GIPS standards are voluntary guidelines designed to promote full disclosure and greater apples-to-apples comparisons by investment managers reporting their performance to existing and prospective clients.

SOP 12-1 is effective upon issuance.

  Technical Question and Answer (TPA) 9170.02, developed by the AICPA Accounting and Auditing Technical Hotline, has been issued to provide nonauthoritative guidance regarding whether the auditor, when performing an interim review in accordance with AU section 722, Interim Financial Information (AICPA, Professional Standards), is required to report on supplementary information when a client presents supplementary information along with interim financial statements. The TPA, available at, also includes an example of a report based on the limited procedures applied in the review.

Financial reporting  
January 2013

FASB’s new model for impairment of financial instruments has cleared hurdles as the board pursues a different path than that of its international counterpart on expected credit loss.

The revised credit impairment model FASB is developing will be re-exposed separately from tentative proposals on the classification and measurement of financial instruments, according to a summary of tentative board decisions posted on FASB’s website and available at

FASB directed its staff to move forward with the drafting of a financial instruments impairment standard containing the “Current Expected Credit Loss” (CECL) model it has been developing separately from the International Accounting Standards Board (IASB) since July.

In a project that has been pursued jointly with the IASB, FASB in July decided to take a step back from the “three-bucket” impairment model the boards had been developing for financial instruments.

Addressing concerns from stakeholders, FASB has been working separately from the IASB to develop the CECL model for impairment. Stakeholders had been concerned about the understandability, operability, and auditability of the three-bucket model, as well as whether it would measure risk appropriately.

The CECL model retains the three-bucket model’s main concept of expected credit loss, and the current recognition of the effects of credit deterioration on collectibility expectations.

But the CECL model uses a single measurement objective—current estimate of expected credit losses—rather than the dual-measurement approach used in the three-bucket model. The dual-measurement approach requires a “transfer notion” to differentiate between financial assets that are required to use a credit impairment measurement objective of “12 months of expected credit losses” and those that are required to use a credit impairment measurement objective of “lifetime expected credit losses.”

The CECL model would require that at each reporting date, an entity would reflect a credit impairment allowance for its current estimate of the expected credit losses on financial assets held. The estimate of expected credit losses would reflect management’s estimate of the contractual cash flows that the entity does not expect to collect and is neither a best-case nor a worst-case scenario.

FASB tentatively decided to move forward with the CECL model without broadly considering the accounting for modifications. The CECL model would apply to all modified instruments where expected credit losses are based on the expected shortfall in contractual cash flows and discounted using the effective interest rate post-modification.

To accomplish this, the guidance in ASC Subtopic 310-40, Troubled Debt Restructurings by Creditors, would be amended. The amendment would require that when a troubled debt restructuring is executed, the cost basis of the asset should be adjusted so that the effective interest rate after modification is the same as the original effective interest rate, given the new series of contractual cash flows.

The basis adjustment would be calculated as the amortized cost basis before modification less the present value of the modified contractual cash flows, discounted at the original effective interest rate.

FASB tentatively decided that a cumulative-effect approach would be used as a transition method for the CECL model. A cumulative-effect adjustment would be recorded on an entity’s statement of financial position as of the beginning of the first reporting period in which the guidance is effective.

The IASB has been monitoring FASB’s credit loss model discussions but has not pulled back from its commitment to the three-bucket model. Both boards targeted the fourth quarter of 2012 for exposure drafts on impairment of financial instruments.

Management accounting  
January 2013

  The Committee of Sponsoring Organizations of the Treadway Commission (COSO) released Risk Assessment in Practice, a paper designed to help organizations find the optimal risk-taking zone, which the paper refers to as the “sweet spot.”

“Risk assessment is all about measuring and prioritizing risks so that risk levels are managed within defined tolerance thresholds without being over-controlled or forgoing desirable opportunities,” Deloitte & Touche LLP partner and paper co-author Patchin Curtis said in a news release.

The thought paper, available at, describes a risk assessment process that should be practical, sustainable, and understandable. The enterprise risk management process must be structured, disciplined, and correctly scaled to the organization’s size, complexity, and geographic reach, according to the paper.

Identifying risks requires casting a wide net at first to understand the possibilities that need to be included in the organization’s risk profile, according to the paper. Prioritization then takes place to focus senior management and board attention on key risks.

The risk assessment process outlined in the paper includes:

  • Developing assessment criteria.
  • Assigning values to each risk and opportunity.
  • Considering risk interactions because risks, when combined, can cause compounded damage.
  • Prioritizing risks.
  • Responding to risks.

The paper advises that the information learned from the risk management process must feed into the strategic planning process to facilitate the proper actions.

  The AICPA Health Care Expert Panel developed a series of technical practice aids related to implementing a 2010 FASB Accounting Standards Update (ASU) on insurance.

Technical Questions and Answers (TPA) 6400.49 to 6400.52 provide nonauthoritative guidance on the implementation of ASU No. 2010-24, Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries.

The TPAs, available at, discuss:

  • What is meant by “similar contingent liabilities” within the scope of the ASU.
  • The accrual of legal costs associated with contingencies other than medical malpractice liabilities.
  • The presentation of insurance recoveries when the insurer pays claims directly.
  • Insurance recoveries from certain retrospectively rated insurance policies.

Practice management  
January 2013

J.H. Cohn LLP and the Reznick Group have closed on their previously disclosed merger, a transaction that creates the 11th-largest U.S. accounting firm and represents the second marriage of top 20 firms consummated in 2012.

The Cohn-Reznick combination, first announced in May, creates a firm with 2,000 employees, 25 offices, and annual revenue in excess of $450 million. The new firm unveiled in a news release that it has chosen CohnReznick as its new name.

Thomas J. Marino, CPA, CEO of J.H. Cohn, and Reznick Group CEO Kenneth Baggett, CPA, will serve as co-CEOs of CohnReznick, which will maintain Cohn’s membership in the Nexia International global network.

The announcement in October came nine months after Clifton Gunderson and LarsonAllen closed a merger that created one of the 10 largest U.S. accounting firms, CliftonLarsonAllen, with annual revenue of more than $550 million, offices in 25 states and the District of Columbia, and a workforce of more than 3,600 professionals and 500 partners.

The Cohn-Reznick and Clifton Gunderson-LarsonAllen deals are the largest in a series of mergers involving top 50 accounting firms over the past three years. Other deals of note include Plante Moran and Blackman Kallick LLP closing July 1 on a merger creating a Southfield, Mich.-based firm with more than 2,000 employees, 22 offices, and $375 million in revenue, and Dixon Hughes merging with Virginia-based Goodman and Co. in 2011 to form Dixon Hughes Goodman, a Charlotte, N.C.-based firm with 1,700 employees.

Joel Sinkin, president of Transition Advisors LLC, a New York-based company that specializes in brokering accounting firm mergers, said the trend of accounting mega-deals will accelerate over the next couple of years. He predicts that the pace of accounting M&A activity will quicken, peak, and then plateau at a “reasonably high level” for several more years, at least until the transition of Baby Boomers into retirement slows down.

“I would be surprised if we don’t see several more mega-firms created through mergers,” said Sinkin, who was not involved in the Cohn-Reznick deal.

A couple of main factors will fuel a rush of accounting firm mergers over the next several years, Sinkin said:

- Top 100 firms will continue to look for deals that strengthen their competitive position and capture market share by growing their geographic footprint, expanding their service offerings into more niches, and bolstering their talent and client bases. These dynamics can be seen in the Cohn-Reznick deal, in which Bethesda, Md.-based Reznick’s strong presence in the mid-Atlantic and Southeast is combined with New Jersey-based Cohn’s foothold in the Garden State and in New York City, where the combined firm will be based. The merger also creates a larger mix of service offerings with Reznick’s strength in the affordable housing and commercial real estate niches added to Cohn’s portfolio of tax, auditing, and business-consulting services. The new firm also features a stronger California presence fortified by offices from both of the merging entities. “In the current economic environment, clients require a strong combination of geographic reach, diverse resources, and deep industry expertise,” co-CEO Baggett said in the news release.

- The mass movement of Baby Boomer partners toward and into retirement over the next several years will drive smaller firms to look for ways to finance partner retirements. With retirement prefunding still relatively rare, retiring partners in accounting firms will be looking for the sale of their ownership stakes—either to the firm in the form of a buyout or to an outside buyer—to provide the money to live on in their retirement. However, most firms have not yet implemented formal succession plans, and the financial strain of funding the retirement of multiple partners could prompt many firms to seek upstream mergers with larger firms that would provide the money needed to purchase the Baby Boomers’ ownership stakes.

View CommentsView Comments   |  
Add CommentsAdd Comment   |   ShareThis

AICPA Logo Copyright © 2013 American Institute of Certified Public Accountants. All rights reserved.
Reliable. Resourceful. Respected. (Tagline)