Category Archives for "Accounting and Auditing"

How to Understand the New Lease Accounting Standard
Aug 11

How to Understand the New Lease Accounting Standard

By Charles Hall | Accounting

Do you need help in understanding the new lease accounting standard? This article provides you with a basic understanding of the new guidance.

The existing lease guidance (FAS 13; now ASC 840) came out in 1976. In that standard, FASB defines capital leases with criteria such as minimum lease payments of at least 90% of fair market value or lease periods of at least 75% of the economic life of the asset. Given the bright-line criteria, lessees have asked lessors to construct leases so that they are considered operating and not capital. Why?

Most lessees don’t desire to reflect capital lease liabilities on their balance sheets. So for forty years, lessees have controlled assets with a lease agreement and not recorded them on their balance sheets—sometimes called “off-balance-sheet financing.”

How to Understand the New Lease Accounting Standard

The Problem: Tailored Leases

As an example under present lease standards, a company leases a building with an economic life of 40 years and desires a lease term of 28 years. Why? Well, 75% of 40 years is 30. Since the lease is less than 30 years, it is an operating lease—one not capitalized, one not recorded on the balance sheet.

What happens if the lease term is 30 years? Then it is a capital lease, and the company records the building and the related debt on the balance sheet. The lessee is fine with the recording of the asset (the building) but wants to keep the debt off the books. However, if a capital lease criterion is triggered, the asset and the debt are recorded on the balance sheet.

The New Trigger: Is This a Contract?

Under existing lease accounting rules, bright-line criteria are used to make the capitalization decision, for example, lease terms of 75% or more of the economic life or lease payments of 90% or more of the fair market value.

But the bright-line criteria is being replaced with a question: Is it a contract? If the lease is a contract, it goes on the balance sheet. If it is not a contract, it does not go on the balance sheet.

Result: Most operating leases will now be recorded on the balance sheet at the inception of the lease.

Recording Leases Under the New Lease Accounting Standard

So what is the accounting entry to record leases under the new standard?

A right-of-use asset is recorded on the balance sheet at the amount of the lease liability. Also, a lease liability is concurrently recorded.

What’s the amount of the lease liability? It is the present value of the lease payments (including options). So, what is a right-of-use asset? It is an intangible that represents the lessee’s right to use the underlying asset. (The right-of-use asset will be amortized over the life of the lease.)

Is there any theory that supports this type of accounting? Yes, in FASB’s conceptual statements.

Congruence with FASB Conceptual Statement

FASB Concept Statement 6 says that assets are probable future economic benefits obtained or controlled by an entity as a result of past transactions or events. Liabilities are probable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Under the new lease standard, the right-of-use asset and the lease liability are congruent with the definitions in Concept Statement 6. So, if a company leases a truck for three years and the economic life of the vehicle is seven years, it has obtained “probable future economic benefits…as a result of past transactions.” And the company has “probable future sacrifices of economic benefits” arising from the lease obligation. Therefore, the lease should be booked on the balance sheet.

Effective Dates for New Lease Standard

ASC 842 (ASU 2016-02), Leases, replaces ASC 840, Leases.

The effective dates for 842 are as follows:

For public entities, the standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those years.

For all other entities, the standard is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Early implementation is permissible for all entities.

More Information

This post is the first in a series concerning the new lease standard. See my other posts here:

If you’re an auditor, check out my post Auditing Debt: The Why and How Guide.

Reviewing workpapers
Jul 12

Reviewing Workpapers, Keeping Friends

By Charles Hall | Accounting and Auditing

Do you review workpapers? If yes, you’ll relate to the following story. 

Bill calls Janet saying, “You can review the workpapers. We’re two days past the deadline, so we need to turn this one around today. Sorry for the late notice.”

Reviewing workpapers

Janet feels her blood pressure rise. She taps her fingers on the desk. Her response: “I have three other audits queued up for review. Which partners do you want me to disappoint?”

The conversation goes silent. Tension fills the air. Still more silence.

“I’ll see what I can do, but please give me more notice. This is the third time this has happened.”

Janet begins reviewing the workpapers.

She starts with the engagement letter, but it’s nowhere to be found. She makes a review note. The risk assessment documentation looks good. She thinks to herself, “The walkthroughs have improved, analytics are better, and the planning document has a nice summary of risks and responses.”

She reviews the financial statements, seeing only one deficiency. The fair value note needs improvement.

She calls Bill to advise him of the disclosure change. He hears her words, still laced with tension. A pang of guilt washes over him. He wishes he would have completed this job sooner.

As Janet completes Bill’s review, she receives two phone calls concerning the other queued jobs. The caller says, “When will you be done? What’s taking so long?” I am well acquainted with her frustration. I feel her pain.

What can Bill do to make Janet’s life better?

How Bill Can Win Friends and Influence People

Bill needs to provide Janet with adequate time to review workpapers. Granted, timeliness can’t always happen. But give as much advance notice as possible. Bill knows the job is running late. Calling Janet two days earlier would have been a big help.

Bill should also let Janet know that certain documents–such as the engagement letter–are not in the file and why.

Bill may need some assistance in project management. If this is the third time, maybe Bill needs to take some continuing education regarding efficiency and organization.

What can Janet do to make everyone’s life better?

How Janet Can Win Friends and Influence People

Let’s face it. The pressure in public accounting is unrelenting, so finding the better angels of our nature can be challenging. But this we know: Janet will foster greater cooperation with patience. Friction is not your friend.

Few people enjoy having their work reviewed, so critique kindly. We need to be clear regarding suggested corrections, but more than anything, we need to be respectful.

While I understand Janet’s “this is the third time” comment. But for now, these words need to be avoided. Should Janet address the problem with Bill? Yes, but save the conversation for another day when tensions are not so high.

Where possible, emphasize improvements. Janet noticed the risk assessment documentation was better. Including this positive review note goes a long way in winning friends and influencing people.

Workpaper Review Policy

The firm needs a policy that clearly defines the review process. Generally, work should be reviewed on a first-in, first-out basis. There will be exceptions; but if people–like Bill–repeatedly turn work in late, the managing partner may need to provide direction. If there are multiple “Bills,” Janet’s review role can become overwhelming.

Here are some suggested guidelines firms can use:

  • Engagements will be reviewed on a first-in, first-out basis
  • Review comments will be in writing
  • Feedback will be respectful
  • File reviews must be timely (if the reviewer waits a week to complete a review, the audit team may not be available for clearing the comments)
  • Reviewers will accumulate summaries of findings on a firm-wide basis (then the firm can develop continuing education classes to remediate issues noted)
  • Reviewers will have sufficient industry knowledge (for the engagements reviewed)

Action to be Taken

If your firm doesn’t already have written review guidelines, consider developing those. Much confusion can be avoided by having a protocol. That way, everyone knows the drill.

If you do have written review guidelines, consider reviewing them for improvement.

Feb 24

Group Audit Standards Applicability: One Firm

By Charles Hall | Auditing

Do the group audit standards apply when one firm audits all of the entities comprising a consolidated whole?

Yes.

You say, “confusing.” I say, “I agree.”

The confusion–at least for me–lies in the pre-clarity auditing standard, AU 543, Part of Audit Performed by Other Independent Auditors, which focused on who was performing the audit. The clarity standard, AU-C 600 Special Considerations — Audits of Group Financial Statements, focuses on what is being audited. The word group (as applied to the group audit standards) does not mean more than one auditor.

Regarding applicability (of the group audit standards), we look at the entities and business activities being audited rather than how many audit firms are involved. We used to focus on the interaction with other auditors; now we focus on the risks associated with the group financial statements.

Businessman holding a transparent screen with an inscription a auditing. Business, technology, internet and networking concept.

The picture is courtesy of DollarPhotoClub.com.

Group Audit Standards When There is Only One Audit Firm

The AICPA’s Technical Questions and Answers (8800.24) says the following about the applicability of AU-C Section 600 (Audits of Group Financial Statements) when only one engagement team is involved:

Inquiry—Company X consolidates the operations of Entity A. The same group engagement team that audits Company X also audits Entity A. Because only one engagement team is involved, does AU-C section 600 apply? If so, what does AU-C Section 600 require that is not already covered by other auditing standards?

ReplyAU-C section 600 applies to all audits of group financial statements, which are financial statements that contain more than one component. In the circumstances when the same engagement team audits all components of the group, the considerations addressed in AU-C Section 600 that relate to component auditors are not relevant. However, considerations addressed in AU-C section 600, such as understanding the components; identifying components that are significant due to individual financial significance and the significant risk of material misstatement; determining component materiality; understanding the consolidation process; and addressing the risks, including aggregation risk, of material misstatement in the group financial statements; are relevant in all group audits.

What does this mean?

If your firm audits consolidated financial statements, then the group audit standards apply, and you do need to comply with certain provisions (even though your firm audits all entities included in the consolidation). Consequently, you have some additional documentation requirements. Your audit file should contain the following documentation:

  • Your understanding of the components
  • Your identification of significant components (due to financial significance or risk)
  • Component materiality
  • Your understanding of the consolidation process
  • How you plan to address the identified risk of material misstatement (including aggregation risk)

Group Financial Statements

What are group financial statements? They are statements that include the financial information of more than one component.

Here are examples of components:

  • Subsidiaries
  • Geographical locations
  • Divisions
  • Investments (equity method)
  • Products or services
  • Component units of a state or local government

You can see from these examples of components, the concept of group financial statements is broader than that of consolidated or combined financial statements.

The idea behind the group audit standards is to highlight the risk of material misstatement whether at the group level or a lower level. If for example, a component is not financially significant but it has particularly risky assets (e.g., derivatives), then the group audit standards direct our attention here.

Examples of When Group Audit Standards are Applicable

Here are examples of when the group audit standards are in play:

  • Consolidated subsidiary
  • Combined financial statements due to common control
  • Investment accounted for using the equity method
  • Consolidated affiliate (due to variable-interest considerations)

Notice we made no mention of other auditors in these examples. It is possible that another firm may audit a subsidiary (for example), but this factor is not the determinant of when the group audit standards apply.

Single Audit under the Uniform Guidance
May 04

Single Audits under the Uniform Guidance

By Charles Hall | Accounting and Auditing , Local Governments

Recently I listened to the AICPA Governmental Audit Quality Center (GAQC) webcast titled: Uniform Guidance for Federal Awards: Auditor Planning Considerations for the New Single Audit Rules.

The presenters, Diane Edelstein, Mandy Nelson, and Mary Foelster, did a great job in providing helpful information. I made a few summary notes that are presented below; the notes are not intended to be comprehensive. The GAQC archived the presentation on their website.

Single Audit under the Uniform Guidance

Applicability of Uniform Guidance

Here’s a summary of when the new guidance is applicable.

Type of EntityEffective Date
Federal AgenciesMust implement policies and procedures by issuing regulations to be effective December 26, 2014 (accomplished with the issuance of the Joint Interim Final Rule)
Non-federal EntitiesImplement the new administrative requirements and cost principles for all new Federal awards made after December 26, 2014, and to additional funding related to existing awards ("increments") made after that date
AuditorsAudit requirements are effective for fiscal years beginning on or after December 26, 2014 (early implementation not permitted)

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deferred inflows and deferred outflows
Oct 24

GASB 63 and 65: Deferred Outflows, Inflows

By Charles Hall | Accounting , Local Governments

GASB 63 and 65 provide guidance regarding deferred outflows and inflows in governments. This article provides an overview of those standards.

  • Statement No. 63 – Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position
  • Statement No. 65 – Items Previously Reported as Assets and Liabilities

deferred inflows and deferred outflows

 

What are the effective dates for Statements 63 and 65?

  • GASBS 63 is effective for periods beginning after December 15, 2011; earlier application encouraged
  • GASBS 65 is effective for periods beginning after December 15, 2012; earlier application encouraged

It is best to implement GASBS 63 and 65 at the same time.

What is the purpose of these changes?

To put it succinctly, GASB is using one of its conceptual statements (specifically Concepts Statement 4) to make revisions to reporting requirements (to include deferred outflows and deferred inflows).

Prior to GASBS 63 and 65, debit balances were reported on the statement of net position (balance sheet) as assets; similarly, all non-equity credits were reported as liabilities. The new standards add deferred outflows and deferred inflows to the mix.

All debit balances in the statement of net position will be reported as:

  • Assets
  • Deferred Outflows

Assets represent present service capacity to the government; deferred outflows (e.g., prepaid bond insurance) represent the consumption of net position applicable to future reporting periods.

Liabilities represent amounts to be paid; however, some amounts previously reported as liabilities (e.g., deferred property taxes) involve no future payment. Consequently, with the implementation of GASB 63, all non-equity credits in the statement of net position will be reported as:

  • Liabilities
  • Deferred Inflows

The difference in liabilities and deferred inflows is primarily resources that are going out and resources that are coming in. Liabilities normally represent a future surrender of resources; deferred inflows do not.

What are the main points of GASB 63?

This statement distinguishes assets from deferred outflows of resources and liabilities from deferred inflows of resources.

Additionally, many of your financial statement titles (e.g., Statement of Net Position), categories (e.g., Assets and Deferred Outflows of Resources), and notes will change. Net Assets will now be labeled Net Position.

The five elements of the statement of net position are:

  1. Assets
  2. Deferred Outflows of Resources
  3. Liabilities
  4. Deferred Inflows of Resources
  5. Net Position

The three categories of net position are:

  1. Net Investment in Capital Assets
  2. Restricted
  3. Unrestricted

Note – The requirement to change to a statement of net position (rather than a statement of net assets) – a GASBS 63 change – occurs one year earlier than the requirements of GASBS 65; you are required to change the term net assets to net position even though you may not have any deferred outflows or inflows until GASBS 65 is implemented – possibly a year later. Again it is easier to simply implement both GASBS 63 and 65 at the same time (both can be early adopted).

What are the main points of GASB 65?

  • It identifies the specific items to be categorized as deferred inflows and deferred outflows.
  • It clarifies the effect of deferred inflows and deferred outflows on the major fund determination.
  • It limits the use of the term deferred in financial statements.

What are some examples of specific items to be categorized as deferred inflows and deferred outflows?

  • The gain or loss from current or advance refundings of debt (the gain or loss will no longer be netted with the related debt but will be shown separately as a deferred outflow or a deferred inflow)
  • Prepaid insurance related to the issuance of debt
  • Property taxes received or accrued prior to the period in which they will be used

How should debt issuance costs be treated?

Debt issuance costs should be expensed when incurred. GASB concluded that debt issuance costs do not relate to future periods, and, therefore, should be expensed.

If your government has debt issuance costs (recorded as assets), you will need to remove them as you implement these standards (using a prior period adjustment).

How should cash advances related to expenditure-driven grants be recorded?

Cash advances from expenditure-driven grants should be recorded as unearned revenue (a liability). The key eligibility requirement for an expenditure-driven grant is the use of funds (which does not occur until funds are spent). Any grant funds received prior to meeting eligibility requirements will be shown as a liability. It is improper to use the word deferred for this line item; for example, deferred revenue is not appropriate. The more appropriate title is unearned revenue.

How do these standards affect the determination of major funds?

Assets should be combined with deferred outflows of resources and liabilities should be combined with deferred inflows of resources for purposes of determining which elements meet the criteria for major fund determination.

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