Peer Review: What’s New

1. Peer Review: What’s New Rachel K. Hall

2. Accounting and Financial Reporting • Compilation Services • Review Services • Audit and Attest

3. Accounting and Financial Reporting Income Taxes Fair Value Measurement Debt Statement of Cash Flows Risks and Uncertainties

4. Common Peer Review Matters Related to Accounting Since the issuance of FIN 48, there have been many matters identified that are associated with these new requirements. For example, some entities’ disclosures relative to uncertain tax positions did not include the open years as required by FIN 48. The FASB ASC 740 • Clarifies accounting for tax positions in an entity’s financial statement • Prescribes a more-likely-than-not recognition threshold • Measurement of a tax position taken or expected to be taken • Recognition, derecognition, and measurement • Classification and Disclosure • Undistributed earnings of a subsidiary included in consolidated income be accounted for as a temporary difference.

5. Fair Value Measurement Since the issuance of FAS No. 157, there have been many matters identified associated with these new requirements. Some companies have failed to disclose the fair value of investments by levels 1, 2, and 3 as required by FASB 820-10-50. FASB 820: • Defines fair value • Establishes a framework for measuring fair value • Requires certain disclosure about fair value measurements FASB 820-10-50-2 requires disclosure of the level within the hierarchy of fair value measurements using: • Quoted Prices (Level 1) • Significant other observable inputs (Level 2) • Significant unobservable inputs (Level 3)

6. Accounting for Uncertainty in Income Taxes A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: • Gross unrecognized tax benefits beginning of year • (Decrease) Increase in tax positions for prior years • Increase in tax positions for current year • Settlements with taxing authorities • Lapse in statute of limitations • Gross unrecognized tax benefits end of year Recognized interest and penalties for unrecognized tax benefits File income tax returns in the US and in various state, local and foreign jurisdictions.

7. Statement of Cash Flows Some companies fail to properly identify certain cash flow items as operating, investing, or financing activities. FASB 230-10-45 provides examples of these activities as follows: • Cash Inflows from Operating Activities • Cash Outflows from Operating Activites • Cash Inflows from Investing Activites • Cash Outflows from Investing Activities • Cash Inflows from Financing Activities • Cash Outflows from Financing Activities

8. Cash Inflows from Operating Activities • Sales of goods or services • Receipts from collection • Sale of accounts • Short and long-term notes receivable from customers (Includes certain loans and other debt and equity instruments or other entities that are acquired specifically for resale.) • Cash receipts from returns on loans, other debt instruments of other entities, and equity securities – interest and dividends. • All other cash receipts • Amounts received to settle lawsuits • Proceeds of insurance settlements (except for settlements related to investing or financing activities i.e. destruction of a building/refunds from suppliers

9. Cash Outflows from Operating Activities • Payments to acquire materials for manufacture or goods for resale, including principle payments on accounts and both short and long term notes payable to suppliers for those materials/goods. • Payments to other suppliers and employees for other goods or services • Payments to governments for taxes, duties, fines, and other fees or penalties • Payments to lenders and other creditors for interest • Payments to settle an asset retirement obligation • Payments to settle lawsuits, contributions to charities, and cash refunds to customers

10. Cash Inflows from Investing Activities • Collections or sales of loans made by the entity and of other entities’ debt instruments • Sales of equity instruments or other entities and from returns of investment in those instruments • Sales of property, plant, and equipment and other productive assets • Sales of loans that were not specifically acquired for resale

11. Cash Outflows from Investing Activities • Loans made by the entity and payments to acquire debt instruments of other entities • Payments to acquire equity instruments of other entities • Purchase to acquire property, plant, and equipment and other productive assets, including interest capitalized as part of the cost of those assets (advance payments, down payment, or other amounts paid at the time of purchase) However, incurring directly related debt to the seller is a financing transaction, and subsequent payments of principal on that debt thus are financing cash outflows.

12. Cash Inflows from Financing Activities • Issuing equity instruments • Issuing bonds, mortgages, notes, and from other short and long-term borrowing • Contributions and investment income that by donor stipulation are restricted for the purposes of acquiring, constructing, or improving property, plant, equipment, or other long-lived assets or establishing or increasing a permanent endowment • Proceeds received from derivative instruments that include financing elements at inception

13. Cash Outflows from Financing Activities • Payments of dividends or other distributions to owners, including outlays to reacquire the entity’s equity instruments • Repayments of amounts borrowed • Principal payments to creditors who have extended long-term credit • Seller financed debt directly related to a purchase of property, plant, and equipment or other productive assets are financing outflows • Payments for debt issue costs

14. Risks and Uncertainties A common peer review matter related to accounting is disclosures of Risks and Uncertainties. Some companies fail to properly disclose the use of estimates. FASB 275-10-50: • Nature of operations • Use of estimates in the preparation of financial statements • Certain significant estimates • Current vulnerability due to certain concentrations

15. Compilation Services Compilation Performance Requirements Income Tax Basis Financial Statements Reporting on the Financial Statements – Basic Report Elements Understanding the Entity Form of a Standard Compilation Report

16. Compilation Performance Requirements Peer review matters identified in compilation engagements is related to the basic performance requirements • Balance sheet including “current liabilities” without appropriate caption or description • Income statement notes the wrong periods These matters can be avoided by ensuring a thorough review of the financial statements and report therein prior to submission.

17. The accountant should read the financial statements and consider whether such financial statements are appropriate and free from obvious material errors that occur in preparation • Arithmetical or clerical mistakes • Mistakes of the application of accounting principles • Inadequate disclosure

18. Preparation of Financial Statements • Are headings appropriate? • Are major sections properly captioned? • Are accounts grouped in appropriate captions? • On the basis of transactions, are such transactions properly classified? • Are there arithmetical errors? • Are there clerical mistakes / typographical errors? • Are the appropriate periods under the arrangement compiled and presented? • Are there mistakes in the application of accounting principles? • Are required financial statement disclosures omitted?

19. Income Tax Basis Financial Statements Peer review matters identified in compilation engagements relate to the OCBOA financials. There have been several cases where a firm had GAAP basis financial statements titles on income tax basis financial statements.

20. Reporting on the Financial Statements- Basic Report Elements Address all periods presented in the compilation report Accountant may be engaged to compile or review: • Complete set of financial statements • Individual financial statement The financial statements may be annually, or for a shorter or longer period, depending on the management’s needs.

21. Understanding the Entity:Engagement Letters • Missing or lacking signatures • Required wording that the engagement could not be relied upon to disclose errors, fraud, or illegal acts • Required wording that the accountant would inform the appropriate level of management if any matters came to his or her attention unless clearly inconsequential The accountant should ensure the engagement letter includes: • Objectives of the engagement • Management’s responsibilities • Accountant’s responsibilities • Limitations of the engagement

22. Form of a Standard Compilation Report Peer review matter is related to firms issuing tax basis financial statements and the compilation report was not modified to reflect the GAAP departure. During the course of compiling the statements, an accountant may become aware of a departure from the applicable financial reporting framework that is material to the financial statements

23. The departure should be disclosed in a separate paragraph of the report including disclosure of the effects of the departure on the financial statements. The accountant is not required to determine the effects of the departure, provided that the accountant states in the report that such determination has not been made.

24. Review Services

25. Performing Analytical Procedures: Failure to Document Expectations and Compare Results • Compare with carefully prepared budgets and forecasts • Maintaining manufacturing or production budgets • Published industry data can provide a rich source of information for analytical procedures

26. Drawback to Use of Budgets • Management may be motivated to manipulate financial results to meet budgets or forecasts • Forecasts may be used more for motivational purposes than realistic expectations • The industry ratios may not be meaningful or may need to be adjusted

27. Generate Nonfinancial Data to Make Comparisons with Recorded Amounts • Production in Units • Direct Labor Hours • Number of Sales Calls • Size of Sales Staff • Square Feet of Selling Space Because they are generated and maintained outside the accounting department, comparisons involving such data can offer an independent check on the reasonableness of related financial information, sometimes referred to as Reasonable Tests

28. Management Representations:The Representation Letter • A management representation letter is required in a review engagement • Comparative financial statements were issued but the representation letter only covered the current year • The representation letter did not include the statement about management’s responsibility to detect and prevent fraud • Written representations are required from management for all financial statements and periods covered by the review report • The review should address all periods being reported even if the current management was not in place during the previous year(s) reported

29. Basic Elements of a Review Report The standard review report should • Identify the financial statements reviewed in the opening paragraph • Describe management’s responsibility for the financial statements in a second paragraph • Describe the accountant’s responsibility in a third paragraph • Describe the results of the engagement in the fourth (final) paragraph

30. Basic Elements of a Review ReportContinued • Title • Addressee • Introductory Paragraph • Management’s Responsibility • Accountant’s Responsibility • Results of Engagement • Signature of the Accountant • Date of the Accountant’s Report

31. Understanding the Entity:Engagement Letter • The required wording that the engagement could not be relied upon to disclose errors, fraud, or illegal acts was missing • The required wording that the accountant would inform the appropriate level of management if any matters came to his or her attention unless clearly inconsequential

32. Accountant should ensure the engagement letter includes • Objectives of the engagement • Management’s responsibilities • Accountant’s responsibilities • Limitations of the engagement

33. Engagement Letter should address the following: • Limited assurance • Management is responsible for • Preparation and fair presentation of the financial statements • Designing, implementing, and maintaining internal control • Prevention and detection of fraud • Identifying and ensuring the entity complies with laws and regulations

34. Engagement Letter should address the following: • Management will provide the accountant a letter that confirms certain representations made during the review • Statements on Standards for Accounting and Review Services (SSARSs) issued by the AICPA • Applying analytical procedures to management’s financial data and making inquiries of company management • Review is less in scope than an audit • Engagement cannot be relied upon to disclose errors, fraud, or illegal acts • Accountant will inform the appropriate level of management of any material errors and evidence or information that comes to their attention during the review of fraud or illegal act

35. The engagement letter should address the following if applicable: • Material departures from the financial reporting framework • Reference to supplementary information

36. Reporting on Comparative Financial Statements The peer review matters identified in review engagements relates to referencing all periods reviewed and to supplemental information provided in the accountant’s review report

37. Audit and Attest Communication with Those Charged with Governance Planning and Supervision Communicating Internal Control Audit Documentation Analytical Procedures

38. Communication with Those Charged with Governance

39. Planning and Supervision

40. Communicating Internal Control Matters Identified in an Audit

41. Audit Documentation

42. Analytical Procedures