Accounting Changes since 2001

Public Company Accounting Oversight Board (PCAOB)

It was company established under the Sarbanes Oxley Act of 2002 to oversee the audit of public companies subject to securities laws and related matters, to protect the interest of the investors and help the public by ensuring that the audit reports are informative, accurate and independent. It is a corporate with succession and shall only be dissolved by Congressional Act.

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Some functions of the PCAOB include registration of public accounting firms, adoption and development of auditing standards, inspect registered public accounting firms, conduct disciplinary proceedings improve quality of audit services, enforce compliance of Act and manager operations of the boards (PCAOBus.org:2008)

Changes in PCAOB since 2001

Adoption of Auditing standard No1-References in Auditor Reports to the Standards of the Public Accounting Oversight Board

The adoption of this standard has led to the changes on the way an auditor presents his report. PCAOB rule 3100, compliance with auditing and related professional practice standards, requires auditors to comply with all standards of PCAOB.

In the year prior to 2003, the auditor presented his report according to the generally accepted standards, SAS 95 in AICPA (PCAOBus.org:2008)

Since then, an auditor is required to present his audit report according to the standards of Public Company Accounting Oversight Board and also stating the city and state in which the report has been issued and therefore the reference to the generally accepted auditing standards in auditors report is no longer used.

Auditing standard No 5-An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements

This auditing standard supersedes Auditing standard no. 2-An Audit of Internal Control over Financial Reporting Performed in Conjunction with An Audit of Financial Statements which states the requirements and provides instructions that are used by the auditor performing an audit of the company’s financial statements and management’s assessment of the effectiveness of internal controls as required by the Securities Exchange Act of 1934.

Auditing standard no. 5 supersedes AS no. 2 in sense that it provides guidance that is used by an auditor engaged to perform an audit of management’s assessment of the effectiveness of the internal control over financial reporting. This audit is integrated with the audit of financial statements. The objective of the auditor is to express an opinion on the effectiveness of the internal controls and the presence of one or more material weaknesses renders the controls ineffective. AS no. 5 is applicable to financial statements audits on or after 15/11/07 (PCAOBus.org:2008)

Auditing standard no 3 audit documentation

This standard deals with the type of documentation that should be made by the auditor in relation to the audit engagement according to the PCAOB standards. This standard does not replace specific documentation requirements but some amendments have been done since the adoption of AS no.5 (PCAOBus.org:2008)

The amendments include AU sec 310 ‘Appointment of the Independent Auditor’ (SAS no.1- Codification of Auditing Standards and Procedures) the amendment states that the management is responsible for establishing and maintaining an effective internal control over financial reporting and if in the process of an integrated audit, the auditor cannot express an opinion on internal control because of limitation on scope of audit, then, the auditor should communicate in writing to management and audit committee about the internal control.

AU sec 230 ‘Due Professional Care in the Performance of Work’ in SAS no.1 paragraph 10 is changed to –professional care allows the auditor to obtain reasonable assurance on the financial statements, if they are free from material misstatements. Absolute assurance is not possible. It also recognizes that an audit conducted according to PCAOB standards may not detect material weakness in internal control and therefore reasonable assurance is only needed.

AU sec 311, ‘Planning and Supervision in SAS no. 22, reference to AS no. 2 paragraph 39 is replaced with reference of paragraph 9 of AS no. 5.

AU sec 312, “Audit Risk and Materiality in Conducting an Audit” in SAS no 4 is changed as follows. In notes to paragraphs 3, 7, 12, 18 and 30 in AS no.2 is replaced with references to AS no. 5. This is because AS no.5 supersedes AS no. 2

AU sec 313, “Substantive Tests Prior to Balance Sheet Date” in SAS no. 45 “Omnibus Statement on Auditing Standards-1983 is changed as follows. Note to paragraph

1 (paragraph 98-103) of AS no. 2 is replaced with paragraph 52-53 of AS no. 5

AU sec 315 “Communications Between Preceding and Successor Auditors” in SAS no. 84 paragraph 16 last sentence is changed to- the predecessor auditor is not a specialist (sec 336) and the predecessor’s work does not constitute work of others (sec 322), Paragraph 16-19 of AS no. 5)

AU sec 316 “Consideration of Fraud in a Financial Statement Audit” in SAS 99- the note to paragraph 1 (paragraph 26-26) of AS no. 2 is changed to paragraph 14-15 of AS no. 5 Auditing standard no. 4 –Reporting on Whether a Previously Reported Material Weaknesses Continues to Exist.

Adopted by the SEC on 6/2/2006 and effective on same date. This standard provides guidance on what the auditor engaged in an audit should report on whether a previously reported material weakness still exists as at the date stated by the management.

This standard has been amended since the adoption of Standard no. 5 the amendment is same as above.

Change in Financial Statements Accounting Standards

Summary of statement no. 123 (2004) supersedes SFAS no. 123 (1995), Accounting for Stock Based Compensation Plans, APB opinion no. 25. Accounting for Stock Issued to Employees, SFAS no. 148, ARB no. 43 chapter 13 B.

The major differences between the amended version and the 1995 one are as follows;

The liabilities to employees in share based transactions are measured at fair value for public corporations and at intrinsic value for non public.

The treatment in 1995 version is that fair value was recommended but not required for all entities.

The awards of equity instruments by private entities are based on fair value while in the original SFAS no. 123; the issue was based on either fair value or minimum value methods.

All entities are required to estimate the number of instruments needed for the service in the amended version but in the 1995 SFAS, forfeitures were allowed as they occurred.

The incremental compensation cost (for modification of terms and conditions) is measured by comparing the fair values before and after modifications while in original SFAS 123, effects of modification is the difference in fair value of modified at date of grant and awards value immediately before the modification based on the shorter of its initially remaining estimated life and the expected life of the modified award.

SFAS no. 154

This statement deals with Accounting Changes and Error Corrections. It was issued in May 2005. This statement supersedes APB no. 20(Accounting Changes), SFAS no. 3 (Reporting Changes in Interim Financial Statements) and SFAS no. 73 (Reporting a Change in Accounting for Rail road Track Structures) (cpaclass.com: 2008)

This standard result in a change of Accounting Principle no. 20 which deals with cumulative effects of (change to new principle) is reported in net income of the period of change. In the new SFAS no.154, prior period adjustment is also done.

The new standard allows a change in accounting only if it is allowed by GAAP or it is preferable to use the new principle.

The new principle adopted is applied to all prior periods with total changes resulting from adoption of new accounting principle being reflected in the opening assets and liabilities.

The adjustment to offset the difference is shown in the opening retained earnings.

The same case applies to correction of errors.

Any change in accounting estimate will be reflected in the period the change occurred and subsequent future periods only with amounts reported in prior periods not being restated respectively.

If there is any change in accounting entity, the principle is retrospectively applied to financial statements and changes in income being shown.

SFAS no. 53

Issued in December 2004 and deals with Exchanges of Non monetary Assets. This SFAS deleted the exception of similar productive assets from APB no.29 while at the same time adding general exception for exchanges that do not have commercial substance.

The modified APB no. 29 paragraph 20 allows for the recognition of loss if future value of asset surrendered is less than the book value. In this case the future value is used as the cost of the asset.

On the other hand if the future value is greater than the book value, the gain is not recognized with the book value being used as the cost.

SFAS no.151

This standard is an amendment to ARB no.43, chapter 4 which deals with inventory pricing. It clarifies the treatment of abnormal amounts of idle resources, freight, handling costs and wasted materials.

These items are recognized as current period expense whether they are so abnormal or not as opposed to previous paragraph 5 in which the treatment depended on whether the items were so abnormal, it would be treated as current charge (FASB: 2008)

The allocation of fixed overheads to costs of conversion is based on normal capacity of production. The issue of this statement improves comparability with IASB standards (IAS no. 2)

Change in FASB interpretations

FASB interpretation no. 39 amended “Offsetting of Amounts Related to Certain Contracts”

Conditional contracts have obligation and rights that depend on the happening of some specified future event that is uncertain and could affect the timing of the instruments received or exchange. Some examples of conditional and exchange contracts are forwards, swaps- interest rates, currency (Mc Gradley and Pullen: 2006)

FSP no. FIN 39-1 Amendment of FASB interpretation no. 39 replaced conditional contracts and exchange contracts with derivative instruments as in SFAS no. 133, Accounting for Derivative Instruments and Hedging Activities.

Paragraph 10 of FIN no. 39 allows a reporting entity to offset fair value amounts recognized for derivatives executed with same counter party under a master netting arrangement without applying the condition that the reporting entity intends to set off.

FSP no. FIN 39-1 allows a reporting entity to offset fair value amount recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with same counter party under the same master netting arrangement.

FSP effects should be treated as a change in accounting principle.

FASB Interpretation no. 46 (R) to Investment Companies

This FIN discusses the use of FASB interpretation no. 46 (Revised 2003) Consolidation of Variable Interest Entities, by an entity that accounts for its investments in accordance with specialized accounting directions in the AICPA audit Accounting Guide, Investment Companies.

Entities subject to SEC regulations S-X rule 6-03 (c) (1) cannot consolidate with another entity that is not subject to same rules (paragraph 4 (6)). These are companies in Investment Company Act of 1940 (Mc Gradley and Pullen: 2006)

FASB interpretation no. 48- Accounting for Uncertainty in Income Taxes- Interpretation of FASB statement no. 109

This interpretation provides more information in the accounting for uncertainty income taxes recognized under FASB statement no. 109

It further states the threshold and amount to be recognized in the financial statements when making a tax return or tax position. Derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition is also dealt with in this interpretation.

This interpretation indicates that the evaluation of a company’s tax position involves a two step process i.e. the recognition and the measurement (FASB: 2008)

This interpretation will improve the financial reporting by ensuring that the information presented in financial reporting is relevant and more comparable.

Changes Regulatory Bodies since 2001

In the quest to improve the financial reporting and reduce the complexity, make information more useful and understandable for the investors, the Securities Exchange Commission established the SEC Advisory Committee on Improvement to Financial Reporting.

The main task of this advisory committee is to offer better guidance to those who prepare the financial reports in order to provide more user friendly disclosures that are beneficial to investor (AICPA.org: 2008)

The advisory committee is mandated to look into the current practice of establishing financial accounting and reporting standards, regulation compliance process by financial professionals and registrants, the current trend of presenting information to investors and access to that information , environmental factors that complicate and reduce transparency of information to investors, the cost benefit analysis of current reporting standards and effects of international accounting use on cost and benefits of financial reporting.

The SEC intention of allowing the use of IFRS is another major change in the regulatory body. The recognition by the SEC that there is need to converge all accounting standards in the world has led to this process. The first process is the allowing of foreign registrants to use IFRS in their filings

The convergence of standards ensures the formulation of better standards, lead to expanded investment opportunities and consequently improves comparability of financial statements. All of the above benefits increase confidence in capital markets.

The Public Oversights Accounting Board issuance to the public for comment the guidance regarding the implementation of PCAOB Rule 4012 (Inspection of Foreign Registered Public Accounting Firms) is one of the changes adopted (PCAOBus.org:2008)

PCAOB realizes that there is need for more cooperation with non-US regulation bodies in order to meet the level of investor protection under the Sarbanes-Oxley Act of 2002.

Therefore, the international cooperation will ensure quality of audits globally.

The proposal by the FASB to develop standards based on principles is another important change in the FASB standard setting process. This is line with its objective of developing high quality standards that are useful to the public hence investors make decisions that are informed.

The information provide by the standards should be relevant and timely. This means that the standards should facilitate difference in decision making as well as being reliable.

This proposal of developing principle based standards is aimed at addressing the recent concerns of the complexity and quality of the US financial reporting.

Another recent development in the FASB is the Accounting Standards CodificationÔ. This is where constituents are encouraged to research accounting ideas and reply on whether the codification content reflects the U.S GAAP.

The FASB will then act on the feedback and formally approve the codification as the only source of authoritative U.S GAAP, other than guidance issued by SEC.

The codification includes all standards from level A-D of U.S GAAP hierarchy, including FASB, AICPA, EITF and related information.

Codification will reduce the duration of resolving research issues, improve usability, reduce non compliance, provide up to date news in standards, help the FASB on research and convergence and be the single trusted source of US GAAP.

Reference:

Mc Gradley and Pullen (2006), FASB Interpretation no.39. Amended, retrieved on 5/2/2008 from

www.mcgladrey.com/Resource_Center/Audit/Articles/FASBInterpretationNo39Amended051507.html

FASB.org (2008) Summary of Interpretation No. 48 Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (Issued 6/06) retrieved on 5/2/2008 from http://www.fasb.org/st/summary/finsum48.shtml

Mc Gradley and Pullen (2006), FSP no. 46(R)-7: Application of FASB Interpretation no.46(R) to Investment Companies. Retrieved on 5/2/2008 from

http://www.mcgladrey.com/Resource_Center/Audit/Insights/Insights05_30_07.pdf46r

AICPA.org (2008), SEC News and Items of Interest. Retrieved on 5/2/2008 from

http://thecaq.aicpa.org/Resources/SEC/SEC+News+and+items+of+Interest/

PCAOBus.org (2008), PCAOB Issues for Comment Proposed Guidance Regarding the Implementation of PCAOB Rule 4012(Inspections of Foreign Registered Public Accounting Firms) retrieved on 5/2/2008 from

http://www.pcaobus.org/News_and_Events/News/2007/12-05.aspx

cpaclass.com (2008), GAAP: Statements of Financial accounting standards. Retrieved on 5/2/2008 from http://cpaclass.com/gaap/sfas/gaap-sfas-153.htm

FASB.org (2008), Summary of Statement No. 151Inventory Costs—an amendment of ARB No. 43, Chapter 4 (Issued 11/04) retrieved on 5/2/2008 from http://72.3.243.42/st/summary/stsum151.shtml

PCAOBus.org (2008), Standards and Related Rules. Auditing Standard No. 5: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements. Retrieved on 5/2/2008 from http://www.pcaobus.org/Standards/Standards_and_Related_Rules/Auditing_Standard_No.5.aspx

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