S. GLAZER, CPA, PhD , is professor of business
administration at Franklin & Marshall College, Lancaster,
Pennsylvania. He served as consultant to the American Institute
of CPAs best practices task force. |
SHERI L. FABIAN, CPA , is a technical manager in the SEC practice section of the AICPA division for CPA firms. She served as the staff liaison to the task force. Ms. Fabian is an employee of the American Institute of CPAs. Her views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.
Auditor independence has long been a hallmark of the CPA profession. The American Institute of CPAs report, Best Practices—Accounting Consultations, Communications with Boards of Directors/Audit Committees, and Communications with the SEC Staff is intended to help CPA firms improve their independence in two critical areas: determining the appropriateness of a companys accounting principles—particularly in the face of pressure from the client—and communicating with a companys board of directors and its audit committee. This article provides some highlights from the report by pointing out what best practices firms do in these areas to improve and maintain the necessary independence and professionalism as they strive to enhance overall client service. (The third area addressed in the AICPA report, communications among CPA firms, clients and the Securities and Exchange Commission staff, is not discussed in this article.)
How It Began
In 1994, the advisory panel on auditor independence of the Public Oversight Board (the body overseeing the American Institute of CPAs SEC practice section) issued Strengthening the Professionalism of the Independent Auditor , which discussed critical issues facing the CPA profession. In response, the AICPA recently completed projects—and a report—to identify "best practices" in two areas: CPA firms policies and procedures for accounting consultations and auditors communications with boards of directors and audit committees.
BEST PRACTICES FOR ACCOUNTING CONSULTATIONS
As technology, globalization and similar developments change their clients businesses, CPA firms must increasingly deal with complex transactions and events such as new financial instruments and cross-border business combinations. Research by audit engagement personnel into the appropriateness of the accounting principles a company is using often leads them to conclude, based on the substance of the transactions or events, that the principles are reasonable and consistent with professional standards. Sometimes, however, engagement personnel may have difficulty determining whether the accounting principles—and the companys application of them—are appropriate.
This problem typically occurs when authoritative pronouncements or firm policy are unclear or nonexistent or when applying complex guidance. The Financial Accounting Standards Board, for example, has issued numerous pronouncements on measuring and reporting on a variety of financial instruments and transactions, yet many issues remain unresolved. In such situations, a firm that has effective and efficient control policies and procedures—which the AICPA report calls best practices —encourages engagement personnel to seek advice from others, both inside and outside the firm. These best practices help ensure that all firm personnel are objective and independent of client pressures.
Although informal discussions among engagement personnel and other professionals in a CPA firm occur frequently, they do not take the place of formal consultations. When following best practices, firms encourage informal discussions and formal consultations on accounting issues, when appropriate, so more knowledgeable and experienced professionals are involved when engagement personnel believe it is necessary to seek advice from others.
Firm management designates all personnel who have consultation responsibilities. Consultants have knowledge and experience appropriate to the type and complexity of issues on which they work. Best practices firms provide on-the-job training and continuing education to ensure consultants are informed about new developments and emerging practice issues.
Engagement personnel determine the need for consultation as soon as possible after identifying and researching an accounting issue. Prompt decisions allow consultants to complete any additional research and discussions so engagement personnel can provide clients with a timely response. Because it is not always possible to identify the need for consultation early on, the consultation process is designed to be sufficiently flexible to handle emergencies.
Initiating the consultation . Initiating a formal accounting consultation and following the issue through the consultation process is the engagement partners responsibility; in some cases, engagement partners may delegate that responsibility to experienced engagement personnel. (The AICPA report uses the term partners to mean any owners of a CPA firm.) Personnel assigned to engagements as second (concurring) reviewers also provide significant consultations on accounting issues.
Firms that follow best practices have policies—updated when necessary—describing the circumstances requiring or encouraging consultations based on the nature of the firms accounting and auditing practice. The AICPA report includes examples of circumstances when a firm might require or encourage consultation.
- Transactions or events are unusual or sensitive in nature or complex, involve related parties or significant uncertainties over accounting estimates or are highly material.
- Recently issued authoritative guidance must be followed, the authoritative bodies are considering new accounting standards or there are emerging issues for which accounting practice is developing.
- Professional or firm guidance is nonexistent, is subject to differing interpretations or provides a choice among acceptable alternatives.
- Uses of accounting principles representing departures from authoritative pronouncements are necessary to make a clients financial statements not misleading.
- Material irregularities or illegal acts are discovered.
- Substantial doubt exists about a clients ability to continue as a going concern.
- Issues must be resolved with predecessor auditors before accepting an engagement.
- The firm is asked to express an opinion on the application of accounting principles to a completed, proposed or hypothetical transaction (a Statement on Auditing Standards no. 50, Reports on the Application of Accounting Principles , engagement).
In following best practices, a firm designs the consultation process to be sufficiently flexible to handle the wide variety of issues and circumstances requiring consultation. A formal consultation typically includes the following steps:
- Engagement personnel and consultants discuss the accounting issue.
- The consultant develops a conclusion and supporting rationale based on research and obtains approval—if appropriate—from supervisory personnel.
- The consultant communicates the conclusion to engagement personnel who—if appropriate—communicate the conclusion to the client.
- The engagement partner is responsible for ensuring that appropriate documentation of the conclusion is prepared and approved.
Discussions between engagement personnel and consultants . The extent of the discussion needed for a consultation can vary. If the issues are relatively straightforward, engagement personnel may simply stop by a consultants office for a brief conversation or contact a consultant by telephone, fax or electronic mail. A consultant often concludes these types of consultations quickly. (The AICPA report also describes a computerized consultation request system that facilitates the process.)
Other circumstances may call for more formal consultation. The engagement personnel in a best practices firm normally prepare and send a consultation request that includes the clients name and appropriate background information; a detailed description of the form and substance of the transaction or event; the research previously completed, including the accounting alternatives considered; the tentative conclusions on the issues with supporting rationale; the name of the engagement partner (or designee) initiating the request; and the date by which a conclusion is needed.
If the initial consultation request does not include enough information, the consultant asks engagement personnel for more information until the consultant fully understands the issues. At that point, the consultant either confirms the appropriateness of the engagement personnels tentative conclusion or recommends an alternative conclusion he or she believes is appropriate. Other times, consultants must develop their own conclusions based on careful analysis of the transactions and events and on additional research.
Consultation research materials . A best practices firm provides consultants with access to and training in the use of reference materials and—other resources inside and outside the firm—needed to analyze the accounting issues under consideration and to provide timely guidance to engagement personnel.
Appropriate supervisory personnel authorize the use of outside resources. Because client confidentiality may prevent a firm from disclosing certain information to outsiders, an external consultant may not be able to reach an appropriate conclusion. While external resources may help firm personnel reach conclusions on certain accounting issues, ultimately it is still the firms responsibility to come to an appropriate conclusion.
In keeping with best practices, consultants also develop their own informal information sources including other consultants, specialists, senior management and FASB or AICPA staff—as "reality checks" for their own tentative conclusions and as sources of information on emerging practice issues. For example, a consultant may contact the firms industry specialist, the AICPA technical hotline and an AICPA staff member concerning a new AICPA industry audit and accounting guide.
Completing the consultation . After completing their analysis, consultants develop their conclusions and the supporting rationale. Clients use of accounting principles should be supported by established sources, by analogy to similar transactions or by events for which established principles exist or by other sources (for example, by the firms position on accounting for new types of transactions or events). Firm policies ensure consultants provide consistent advice to engagement personnel throughout the firm.
Depending on the consultants experience and the importance of the issues, firms may require consultants conclusions to be approved at a higher level within the firm, for example, by the chief technical partner, before they are discussed with engagement personnel. This ensures the firms position on the issue—as expressed by the consultants—is appropriate in the clients circumstance and is approved by personnel with the right authority, knowledge and experience.
Disagreements within the firm . Because the resolution of accounting issues requires professional judgment, engagement personnel may disagree with a consultants conclusions. In those cases, best practices firms have policies and procedures to ensure a report is not issued (and the client not advised of the conclusions) until the firm resolves the disagreement and clarifies its final position so the client is not given conflicting advice.
In a best practices firm, any disagreements among engagement personnel, second (concurring) reviewers and consultants are discussed by appropriate personnel. These discussions take place at successively higher levels of authority. For example, the chief technical partner and other members of senior management may have to be involved until the firms position is established. Firm policies clearly state the lines of authority for settling such disagreements. Best practices firms establish and maintain a professional environment that encourages frank discussions of accounting issues and permits all personnel to feel comfortable expressing their disagreements.
Communicating conclusions to clients . In following best practices, engagement personnel keep clients appropriately informed of ongoing consultations. This is the engagement partners responsibility. A firm generally does not share its consultation documentation with clients because it is the firms own record of the work performed and conclusions reached. If a client wants a written explanation, engagement personnel can prepare a formal statement describing the firms position and supporting rationale; that statement is reviewed and approved by the consultant to ensure it properly summarizes the consultants conclusions.
Having a close working relationship with clients while maintaining professional objectivity and independence helps prevent the discussion of consultation conclusions from becoming contentious. Nevertheless, some clients may disagree with those conclusions when their positions on the issues are not the same as the CPA firms.
Engagement personnel are always prepared for such disagreements and seek further clarification from consultants, ask consultants to meet with clients to explain the basis for the firms conclusions or ask higher levels of authority within the firm to become involved. Additional information or changes in the substance of a proposed transaction may require additional consultation and lead to a different conclusion. Best practices firms ensure, however, that the pressures clients can bring to bear on accounting issues—particularly pressures on engagement personnel the client works with closely—do not result in firm personnel agreeing with a clients inappropriate use of accounting principles.
Documenting consultations . As noted earlier, engagement partners make sure the working papers include appropriate consultation documentation. Although oral approval of consultation conclusions sometimes may be necessary because of time pressures, written documentation and approval by consultants or engagement personnel with appropriate knowledge and experience follows formal consultations. When following best practices, firms develop policies that cover when written documentation of consultations must be prepared to ensure that all important accounting issues are recorded appropriately.
Documentation of consultations includes:
- A description of the transaction or event and the accounting issues involved.
- The conclusions reached and the rationale that form the basis for those conclusions, including references to professional literature and firm policies (whether applied directly or by analogy).
- The names of key individuals who were involved in the consultation.
- Other appropriate information or exhibits.
A copy of the documentation is filed in the engagement working papers to support the consultation conclusions; additional copies are sent to all those who provided substantive consultation.
Engagement personnel and consultants review drafts of the documentation, discuss those drafts to ascertain whether the information is clear, accurate and complete and approve the final version. Engagement partners and consultants sign the documentation when it is final. That process, if completed promptly, helps minimize any confusion or disagreement that might arise before the firm commits to the conclusions.
BEST PRACTICES FOR BOARD AND AUDIT COMMITTEE COMMUNICATIONS
Shareholders rely on the board of directors and its audit committee to monitor company performance and make decisions that serve the best interests of the company and its shareholders. A CPA firm following best practices helps boards of directors and audit committees fulfill their corporate governance responsibilities and serve the public interest. One way firms provide that assistance is by communicating qualitative assessments about a companys financial statements to its board.
Set the tone . A best practices firm designs policies and procedures on communicating with client boards by considering firm structure, size and client base. Such a firm then discusses those policies and procedures with its professional staff to enhance the staffs understanding of the issues and to reemphasize the firms commitment to client service. Periodic evaluation of these policies and procedures by the firm to incorporate changes in the firm environment ensures they remain appropriate and continue to stress development of a strong relationship between the firm and its clients.
Establish relationships . The relationship of best practices firms with clients boards stresses the importance of open and candid discussions among all parties. A firm may find it useful to discuss the POB panels report with board members and senior management. It also may be helpful to do the same with any firm literature on the role of boards. These discussions reemphasize to boards and to senior management the firms role in helping them fulfill boards responsibilities to shareholders.
Qualitative assessments of financial reporting . Discussions with boards cover the appropriateness and acceptability of the clients accounting principles and the clarity of financial statement disclosures. Those discussions also typically address the firms judgments on both the reasonableness of managements estimates included in the financial statements and how recently issued authoritative guidance is applied. A best practices firm holds discussions with senior management before meeting with the board to help ensure the firm understands managements rationale for using certain accounting principles and for making specific financial statement disclosures and estimates. Before discussing those issues with client personnel, the firm may involve second (concurring) review or consultation partners.
These discussions are best held before the clients yearend. Timely discussions allow the board to analyze managements estimates, choices of accounting principles and key financial disclosures; to discuss the firms assessment of the acceptability and appropriateness of those estimates, principles and disclosures; and to make appropriate changes before the financial statements are final. Such discussions could be incorporated into the agenda of the firms annual audit planning meetings with the board. A final discussion of the issues at the conclusion of the audit, in conjunction with communications required under generally accepted auditing standards, also may be appropriate.
Regular meetings with client boards and management to discuss financial reporting issues facilitate the communication process and an understanding of the mutual expectations of the CPA firm and the board. At least one annual face-to-face meeting is recommended. Quarterly communication also may be useful, especially for clients with quarterly reporting requirements.
ENHANCING POLICIES AND PROCEDURES
The best practices included in the AICPA report are not authoritative. They are, however, intended to help CPA firms evaluate and enhance their policies and procedures related to accounting consultations and communications with boards of directors and audit committees. Improving these areas should ensure that CPA firms provide quality client service while remaining objective and independent.
|The full research reports discussed in this
article are available on the AICPA Web site. |
Copies also can be obtained at no charge by contacting Sheri Fabian at 201-938-3455.