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Top Accounting and Auditing Issues for 201 9 | CPE COURSE

Top Accounting and Auditing Issues for 2019 CPE COURSE

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Top Accounting andAuditing Issuesfor 2019 ⏐ CPE Course

Patrick Patterson, CPAKelen Camehl, CPA Scott Taub, CPA

Contributors

Contributing Editor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Patrick Patterson, CPA

Kelen Camehl, CPA

Technical Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Kelen Camehl, CPA

Lorraine Zecca, CPA

Production Coordinator . . . . . . . . . . . . . . Mariela de la Torre; Jennifer Schencker;

Vijayalakshmi Suresh

Production . . . . . . . . . . . . . . . . . . . . . . . . . . Sharon Sofinski; Anbarasu Anbumani

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IntroductionTop Accounting and Auditing Issues for 2019 CPE Course helps CPAs stay abreast of the mostsignificant new accounting and auditing standards and important projects. It does so byidentifying the events of the past year that have developed into hot issues and reviewing theopportunities and pitfalls presented by these changes. The topics reviewed in this coursewere selected because of their impact on financial reporting and because of the role they playin understanding the accounting landscape in the year ahead.

Module 1 of this course reviews top accounting issues.

Chapter 1 explores the effects of the Tax Cuts and Jobs Act on financial reporting issues.

Chapter 2 discusses the latest developments from the Financial Accounting StandardsBoard (FASB) regarding lease accounting.

Chapter 3 provides an overview of the new revenue recognition standard, AccountingStandards Codification (ASC) Topic 606, Revenue from Contracts with Customers. It explainsthe principles that underlie the new model for revenue recognition and highlights thoseareas that represent the most significant changes between current guidance and the newrequirements.

Chapter 4 discusses the latest releases from the Financial Accounting Standards Board(FASB). Selected accounting standards are highlighted, and the FASB agenda and futurechallenges for the accounting and auditing profession are also discussed.

Chapter 5 discusses the current expected credit loss (CECL) model for losses and/orimpairments as presented in Financial Accounting Standards Board (FASB) AccountingStandards Update (ASU) 2016-13. It also gives an overview of ASU 2016-01, which includessignificant changes in authoritative professional standards concerning financial instruments(financial assets and financial liabilities) and their measurements, impairments, anddisclosures.

Module 2 of this course reviews top auditing issues.

Chapter 6 discusses key information related to Regulation S-K with a particular focus onthe more frequently used sections of the regulation.

Chapter 7 discusses significant changes in the authoritative professional standardsconcerning audit reporting in the area of forming an opinion and reporting on financialstatements. It also identifies future changes to auditor reporting.

Chapter 8 provides an overview of selected preparation, compilation, and review stan-dards and discusses new Statements on Standards for Accounting and Review Services(SSARS) 24, Omnibus Statement on Standards for Accounting and Review Services—2018.

Study Questions. Throughout the course you will find Study Questions to help you testyour knowledge, and comments that are vital to understanding a particular strategy or idea.Answers to the Study Questions with feedback on both correct and incorrect responses areprovided in a special section beginning at ¶10,100.

Final Exam. This course is divided into two Modules. Take your time and review all courseModules. When you feel confident that you thoroughly understand the material, turn to theFinal Exam. Complete one or both Final Exams for continuing professional education credit.

Go to cchcpelink.com/printcpe to complete your Final Exam online for immediate results.My Dashboard provides convenient storage for your CPE course Certificates. Furtherinformation is provided in the CPE Final Exam instructions at ¶10,200. Please note,

http://cchcpelink.com/printcpe

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manual grading is no longer available for Top Accounting and Auditing Issues. Allanswer sheets must be submitted online for grading and processing.

August 2018

PLEDGE TO QUALITY

Thank you for choosing this CCH® CPELink product. We will continue to produce highquality products that challenge your intellect and give you the best option for your Continu-ing Education requirements. Should you have a concern about this or any other WoltersKluwer product, please call our Customer Service Department at 1-800-344-3734.

COURSE OBJECTIVES

This course provides an overview of important accounting and auditing developments. At thecompletion of this course, the reader will be able to:

• Recognize how the Tax Cuts and Jobs Act affects financial reporting

• Identify the act’s changes to domestic income provisions

• Differentiate requirements for adjustments to deferred tax liabilities and assets for theeffect of a change in tax laws or rates

• Summarize how the act affects the taxation of foreign income

• Identify the FASB pronouncements that may impact entities with leases or that expectto have or enter into leases

• Recognize the major updates to the new Accounting Standards Codifications as pre-scribed by ASU 2016-02

• Understand best practices for starting a lease accounting project under the newstandards

• Understand the principles of ASC Topic 606, Revenue from Contracts with Customers

• Identify the five steps in the new revenue recognition model

• Address key issues in implementing the provisions of ASC Topic 606

• Describe required disclosures for private companies with respect to revenuerecognition

• Identify transition considerations as they relate to business practices

• Identify the latest issuances from the FASB

• Recognize the benefits of the FASB’s proactive outreach with stakeholders

• Summarize the latest implementation guidance for major accounting standards

• Recognize FASB guidance and challenges to expect in the near future

• Recognize the main objectives of ASU 2016-01 and ASU 2016-13

• Identify the steps for implementing the CECL model

• Identify ASU 2016-01 and ASU 2016-13 effective dates, reporting requirements, disclo-sure requirements, and related matters

• Identify key history as it relates to Regulation S-K

• Understand requirements of Regulation S-K that are applicable to common SEC forms

• Identify some of the key guidance throughout Regulation S-K

• Recognize current developments related to Regulation S-K

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• Understand selected new auditor reporting models

• Identify key audit matters in the independent auditor’s report

• Recognize the new form and content of modifications to the opinion in the independentauditor’s report

• Identify anticipated changes to auditor reporting

• Identify the requirements of revised SSARS 21, 22, and 23

• Recognize the revised compilation and review report requirements of SSARS 24

Additional copies of this course may be downloaded from cchcpelink.com/printcpe.Printed copies of the course are available for $2.99 by calling 1-800-344-3734 (ask for product10024493-0006).


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Contents

MODULE 1: TOP ACCOUNTING ISSUES1 Accounting for the Tax Cuts and Jobs Act

Welcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶101Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶102Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶103Overview of Changes: Domestic Income . . . . . . . . . . . . . . . . . . ¶104Overview of Changes: Foreign Earnings . . . . . . . . . . . . . . . . . . . ¶105

2 Leases and Impacts: Change to Changes 2018Welcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶201Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶202Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶203Five Major Changes to Leases . . . . . . . . . . . . . . . . . . . . . . . . . ¶204ASU 2016-02 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶205Starting A Lease Accounting Implementation Project . . . . . . . . . . ¶206

3 New Revenue Recognition StandardWelcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶301Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶302Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶303Five Steps to Revenue Recognition . . . . . . . . . . . . . . . . . . . . . . ¶304Other Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶305Contract Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶306Presentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶307Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶308Transition Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶309Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶310

4 FASB OutlookWelcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶401Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶402Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶403Implementing New Accounting Standards . . . . . . . . . . . . . . . . . ¶404Conducting Outreach with Stakeholders . . . . . . . . . . . . . . . . . . . ¶405Transition Resource Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶406Implementation Guidance for Major Standards . . . . . . . . . . . . . . ¶407Future Guidance and Challenges Ahead . . . . . . . . . . . . . . . . . . ¶408

5 CECL ModelWelcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶501Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶502Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶503ASU 2016-01 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶504ASU 2016-13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶505

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MODULE 2: TOP AUDITING ISSUES6 Regulation S-K

Welcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶601Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶602Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶603Form S-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶604Form 10-Q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶605Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶606Subpart 229.1: General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶607Subpart 229.100: Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶608Subpart 229.200: Securities of the Registrant . . . . . . . . . . . . . . . ¶609Subpart 229.300: Financial Information . . . . . . . . . . . . . . . . . . . ¶610Subpart 229.400: Management and Certain Security Holders . . . . ¶611Subpart 229.500: Registration Statement and ProspectusProvisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶612Subpart 229.600: Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶613Other Key Parts of Regulation S-K . . . . . . . . . . . . . . . . . . . . . . . ¶614Recent Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶615

7 Auditor Reporting ModelsWelcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶701Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶702Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶703Proposed Changes in Auditor Reporting . . . . . . . . . . . . . . . . . . . ¶704Other Projects Related to Auditor Reporting . . . . . . . . . . . . . . . . ¶705Significant Proposed Amendments to Existing Auditor ReportingStandards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶706Illustrations of Auditor’s Reports on Financial Statements . . . . . . . ¶707Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶708

8 SSARS 24Welcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶801Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶802SSARS 21, SSARS 22, and SSARS 23 . . . . . . . . . . . . . . . . . . . ¶803SSARS 24 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶804Illustrations of Accountant’s Compilation and Review Reports onFinancial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶805

Answers to Study Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,100Module 1—Chapter 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,101Module 1—Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,102Module 1—Chapter 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,103Module 1—Chapter 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,104Module 1—Chapter 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,105Module 2—Chapter 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,106Module 2—Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,107Module 2—Chapter 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,108

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Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page143

Final Exam Instructions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,200Final Exam Questions: Module 1 . . . . . . . . . . . . . . . . . . . . . . . . ¶10,301Final Exam Questions: Module 2 . . . . . . . . . . . . . . . . . . . . . . . . ¶10,302

Answer Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,400Module 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,401Module 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,402

Evaluation Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ¶10,500

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MODULE 1: TOP ACCOUNTING ISSUES—CHAPTER 1: Accounting for the Tax Cuts andJobs Act¶101 WELCOMEThis chapter explores the effects of the Tax Cuts and Jobs Act on financial reportingissues.

¶102 LEARNING OBJECTIVES

Upon completion of this chapter, you will be able to:

• Recognize how the Tax Cuts and Jobs Act affects financial reporting

• Identify the Act’s changes to domestic income provisions

• Differentiate requirements for adjustments to deferred tax liabilities and assetsfor the effect of a change in tax laws or rates

• Summarize how the Act affects the taxation of foreign income

¶103 INTRODUCTIONOn December 22, 2017, H.R. 1, An Act to Provide for Reconciliation Pursuant to Titles IIand V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (the Tax Cutsand Jobs Act), was signed into law. U.S. generally accepted accounting principles(GAAP) requires that the pervasive changes resulting from the Act must be accountedfor in the period that includes the enactment date. Financial statements will be signifi-cantly affected as companies adjust their deferred tax balances, valuation allowances,tax planning strategies, and income tax expense.

In addition to questions and answers (Q&As) on several aspects of the Act, theFinancial Accounting Standards Board (FASB) has issued a new standard on incometaxes recorded in accumulated other comprehensive income. The FASB’s guidanceapplies equally to public and private companies. The U.S. Securities and ExchangeCommission (SEC) staff and FASB staff have provided public and private companieswith some relief by allowing up to a year to finalize financial statement adjustmentsarising from the tax law changes.

This chapter addresses FASB staff guidance and other accounting questionsrelated to provisions of the Act. It presents very condensed summaries of changesbrought about by new tax law. In no case should these condensed summaries besubstituted for a full reading of the new law, nor should they be used to make tax oraccounting decisions. Given the complexity and timing of the new law, consultation withknowledgeable tax professionals should be considered when determining the effect ofthe tax law changes on a company’s tax situation.

¶104 OVERVIEW OF CHANGES: DOMESTIC INCOMEThe U.S. federal tax law changes resulting from the Act affect companies in allindustries, regardless of whether they are large or small, domestic or multinational,publicly traded or privately held. Changes to domestic income provisions may be lesscomplex for many companies, but the effects are still likely to be significant, both in

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2 TOP ACCOUNTING AND AUDITING ISSUES FOR 2019 CPE COURSE

terms of the amount of taxes paid as well as the measurement of deferred taxes on thebalance sheet.

Changes in corporate tax rules affecting the taxation of domestic income rangefrom the headliners that make front-page news, such as reducing corporate income taxrates and eliminating the alternative minimum tax, to the extras that are in the fineprint, such as limiting deductions for interest expense and disallowing all entertainmentexpenses. Although not every company is affected by every change, there is somethingfor everyone in this law.

Examples of changes in the domestic provisions of corporate tax law include thefollowing:

• Reducing the corporate income tax rate from 35 percent to 21 percent, effectiveJanuary 1, 2018. In the transition, blended rates apply to companies with fiscalyear-ends.

• Eliminating the corporate alternative minimum tax (AMT). Existing AMT cred-its can be used or refunded in the future.

• Eliminating the two-year carryback period and making indefinite the carryfor-ward period for a net operating loss (NOL). However, unlike prior law, NOLcarryforwards are now limited to 80 percent of taxable income for the year.

• Allowing the full expensing of the cost of qualified property in the year it isplaced in service. This provision phases out beginning in 2023.

• Modifying the tax deductibility of certain types of compensation to highly paidemployees. The new law expands the limitation to include more companies andpotentially more employees. In addition, commissions and performance-basedcompensation are no longer excluded from the computation of the employee’scompensation that is subject to the limitation.

• Limiting the deduction for net interest expense. While smaller companies areexempt from this provision, the net interest expense deduction for other compa-nies is limited to 30 percent of adjusted taxable income.

• Disallowing the deduction of 100 percent of entertainment expenses. Underprior law, the deduction of qualifying entertainment expenses was limited to 50percent. The new rule is effective for expenses incurred or paid after December31, 2017. Meals continue to be 50 percent deductible.

STUDY QUESTIONS

1. The domestic provisions of the Tax Cuts and Jobs Act:

a. Allow organizations to deduct 100 percent of entertainment expenses

b. Retain the two-year carryback period for net operating losses

c. Retain the corporate alternative minimum tax

d. Reduce the corporate income tax rate

2. Which of the following statements is true regarding tax law changes resulting fromthe Act?

a. The changes will impact all industries.

b. The changes specifically target certain financial services entities.

c. The changes will affect only companies that have more than 1,000 employees.

d. The changes will affect privately held companies only.

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3MODULE 1 - CHAPTER 1 - Accounting for the Tax Cuts and Jobs Act

Accounting for Income Taxes (ASC Topic 740)U.S. GAAP requires recording an income tax provision not only for taxes that are due asa result of the current year’s taxable income (“current tax expense or benefit�), but alsofor the future tax consequences of transactions that have been reported in the financialstatements or tax returns (“deferred tax expense or benefit.�)

The future tax consequences are recorded based on tax law enacted at the date ofthe financial statements. Therefore, deferred tax assets and liabilities are recorded onthe balance sheet at the corporate tax rate in effect at the balance sheet date (e.g., 35percent at November 30, 2017). Changes in tax law cannot be anticipated, regardless ofthe likelihood of the change being signed into law.

The most common examples of items that give rise to deferred tax liabilities aredepreciation of buildings, machinery, and equipment and the amortization of intangibleassets. The costs of those assets generally are expensed more rapidly for tax purposesthan for U.S. GAAP purposes, creating a basis difference in the asset.

Typical examples of items that lead to deferred tax assets include accrued ex-penses and allowances for bad debts. For these items, U.S. GAAP expense oftenexceeds the amount that is deductible in the current year’s tax return under the taxrules, also creating a basis difference in the asset or liability.

These differences between the amounts reported for tax purposes and U.S. GAAPpurposes, whether they create deferred tax assets or liabilities, are referred to in theaccounting literature as “temporary differences.� By contrast, a transaction reported inthe financial statements that is never deductible (or taxable) for income tax purposes iscommonly called a “permanent difference.� Permanent differences create an effectivetax rate that differs from the statutory rate.

U.S. GAAP requires that all companies, both public and private, recognize theeffects of tax law changes on the date of enactment. Such effects are charged to incomeas part of the income tax expense or benefit for the period. Companies will record theconsequences of the Act on their deferred tax balances (as well as any effect on currenttax expense) in the income statement for the reporting period that includes December22, 2017.

Recent FASB GuidanceThe FASB staff has issued five Q&A documents that address a number of implementa-tion issues raised by companies as a result of the new tax law. Those five Q&Asaddress:

• Whether private companies can follow SEC staff guidance on the measurementperiod for tax adjustments

• Whether to discount AMT credits that become refundable

• Whether to discount the one-time transition liability related to certain foreignearnings

• How to account for the base erosion anti-abuse tax (BEAT)

• How to account to the effects of the global intangible low-taxed income (GILTI)provisions of the Act

In addition, the FASB issued a standard to address stranded tax effects embeddedin accumulated other comprehensive income. While the topic is very narrow and has noeffect on reported income, this issue is particularly important to financial institutionsbecause of the effect on regulatory capital.

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The following Q&As address the accounting and financial reporting changesresulting from the Act and the relevant guidance provided by the FASB.

STUDY QUESTION

3. Under the new Act, deferred tax liabilities are recorded on the balance sheet atwhich rate?

a. 35 percent

b. 21 percent

c. The corporate tax rate in effect at the balance sheet date

d. The corporate tax rate in effect on December 22, 2017

Q&AsCorporate tax rate. Under the Act, the corporate tax rate is reduced from 35 percent toa flat rate of 21 percent. The new rate is effective January 1, 2018. For companies withfiscal year-ends, a blended rate applies to the fiscal year that includes the effective dateof the change in tax rates.

EXAMPLE: A company with a June 30 year-end would apply a blended rate of28 percent (six months at 35 percent and six months at 21 percent) to its taxableincome for the fiscal year ending June 30, 2018. Subsequent fiscal years’ incomewill be taxed at the 21 percent rate.

Remeasurement of deferred tax assets and liabilitiesQuestion: How does the change in tax rate affect existing deferred tax balances for acompany with a December 31, 2017 year-end?

Answer: Deferred tax assets and liabilities for temporary differences as of the enact-ment date that are expected to reverse after January 1, 2018 should be remeasured at 21percent. The debit or credit resulting from that remeasurement is reported in incomefor the fourth quarter of 2017. Any deferred taxes for temporary differences that areexpected to reverse in 2017 should continue to be measured at the old tax rate (i.e., therate in effect for the 2017 tax return). For example, a temporary difference for a bonusaccrual that resulted in a deferred tax asset at December 31, 2016 and is expected toreverse in 2017 would continue to be measured at 35 percent.

Question: How does the change in tax rate affect existing deferred tax balances for acompany with a fiscal year-end?

Answer: Deferred tax assets and liabilities for temporary differences as of the enact-ment date that are expected to reverse in the current fiscal year should be remeasuredat the blended rate that applies to that year’s tax return. If a temporary difference isexpected to reverse in subsequent years, the existing deferred tax should beremeasured at 21 percent. The remeasurement adjustments are reported in income forperiod that includes December 22, 2017 (enactment date).

EXAMPLE: Company A has a June 30 year-end. In its second quarter endedDecember 31, 2017, it remeasures the deferred taxes for temporary differences asof the enactment date that are expected to reverse in its June 30, 2018 tax return atthat fiscal year’s blended rate of 28 percent. The deferred taxes for temporarydifferences that will reverse after June 30, 2018 are remeasured at 21 percent.

¶104


If Company A has an existing deferred tax for a temporary difference that willreverse and be replaced by a new, similar temporary difference, the existingdeferred tax at the enactment date should be remeasured at the 28 percentblended rate. The deferred tax for the new (replacement) temporary difference ismeasured at 21 percent. An example would be Company A’s temporary differencefor a bonus accrual at June 30, 2017 that will reverse in fiscal 2018. The deferredtax asset for that temporary difference was initially recorded at 35 percent. In thesecond quarter of fiscal 2018, the deferred tax asset for that temporary difference isremeasured at 28 percent. When the new temporary difference for the fiscal 2018bonus accrual is recorded, it will be measured at 21 percent.

Question: Do carryforwards need to be remeasured at the new corporate tax rate?

Answer: Income tax credit carryforwards such as R&D and AMT do not represent taxdeductions. For that reason, they are not affected by the change in corporate tax rates.In contrast, NOL carryforwards are used to reduce taxable income in a future periodand thus should be measured at the new rate of 21 percent.

Setting aside tax rates, the Act makes important changes to AMT and NOLcarryforwards that must be considered in determining what adjustments are necessaryto the deferred tax assets generated by those items. Those considerations are discussedfurther later in this chapter.

Income statement classificationQuestion: Where is the adjustment to remeasure deferred tax assets and liabilitiesreported?

Answer: Under U.S. GAAP, the adjustment to remeasure deferred tax assets andliabilities as a result of a change in tax law is reported in income from continuingoperations as part of income tax expense in the period in which the new law is enacted.

Question: As mentioned earlier, adjustments to remeasure deferred tax assets andliabilities are included in income tax expense within income from continuing operations.But what if some of the deferred tax balances being adjusted to the new tax rate arerelated to discontinued operations, other comprehensive income, or items charged orcredited directly to equity?

Answer: The answer is still the same: adjustments arising from a change in tax law areincluded in income tax expense within income from continuing operations. It does notmatter where the item was initially recorded in the financial statements. U.S. GAAPdoes not require or permit “backwards tracing.� Irrespective of the initial classificationof the item that gave rise to the deferred tax asset or liability, the effects of changes intax law are recorded in income from continuing operations.

For example, a company may have recognized deferred tax benefits or deferred taxexpense through other comprehensive income (OCI). The effect of the tax rate changeon those deferred taxes is recognized in income tax expense from continuingoperations.

Question: Adjustments to remeasure deferred tax assets and liabilities are included inincome tax expense within income from continuing operations. But what about deferredtaxes recognized through goodwill due to an acquisition earlier in the year? Can theremeasurement of acquisition related deferred taxes based on the new corporate taxrate be made through an adjustment to goodwill?

Answer: No.

Question: U.S. GAAP requires all the effects of changes in tax laws or rates on deferredtax assets and liabilities to be recorded in income from continuing operations. No

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“backwards tracing� is allowed, even for the tax effects of items that were originallyrecognized in other comprehensive income.

However, the result is that the tax effects of items within accumulated othercomprehensive income (AOCI) do not reflect the appropriate tax rate. The differentialbetween the old and new tax rates is effectively stranded in accumulated other compre-hensive income and will almost never be reclassified into retained earnings. This couldbe confusing to investors. But more importantly, this accounting could significantlyaffect the regulatory capital of certain banks. Has the FASB addressed this issue?

Answer: Yes, but only as it applies to the tax effects of the Act. On February 14, 2018,the FASB issued Accounting Standards Update No. 2018-02—Income Statement—Re-porting Comprehensive Income (Topic 220)—Reclassification of Certain Tax Effects fromAccumulated Other Comprehensive Income (ASU 2018-02). ASU 2018-02 permits, butdoes not require, companies to reclassify stranded tax effects arising from the Act fromaccumulated other comprehensive income to retained earnings. This is a narrow-scopestandard and does not address the broader question of “backwards tracing.�

Under ASU 2018-02, the amount reclassified should include the effect of the changein the federal corporate income tax rate related to items remaining in accumulated othercomprehensive income. Because the standard does not specify what constitutes astranded tax effect, a company has the flexibility to determine what other stranded taxeffects resulted from the Act. Thus a company can reclassify other income tax effects(beyond the effect of the change in the federal corporate tax rate) of the Act on itemsremaining in accumulated other comprehensive income along with disclosure of thosereclassified effects.

The standard does not permit reclassification of the effect of the change in thefederal corporate income tax rate on gross valuation allowances that were originallycharged to income from continuing operations. It also does not permit reclassification ofthe stranded tax effects within accumulated other comprehensive income to retainedearnings for previous changes to other tax rates such as state and local tax rates and forall future tax rate changes.

Disclosure is required for:

• The company’s accounting policy for releasing income tax effects from AOCI(e.g., the portfolio approach or the security-by-security approach);

• Whether the company elected to reclassify to retained earnings from AOCI thestranded income tax effects from the Act; and

• Information about the income tax effects other than the change in the corporatetax rate that are reclassified.

ASU 2018-02 applies to public and private companies in all industries. It is effectivefor fiscal years beginning after December 15, 2018, and interim periods within thoseyears. Early adoption is permitted for financial statements that have not yet been issued.Companies can apply the new standard in the period of adoption or retrospectively toeach period (or periods) in which the effect of the change in corporate tax rates underthe Act is recognized.

The Exposure Draft issued by the FASB in January would have required allcompanies to reclassify stranded tax effects. However, the FASB received feedbackindicating that the cost and complexity of determining the amount to be reclassifiedwould exceed the benefit for some companies. For this reason, the final standardpermits, but does not require, reclassification.

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STUDY QUESTIONS

4. The five Q&A documents released by the FASB cover all of the following topicsexcept:

a. The measurement period for tax adjustments

b. Stranded tax effects

c. AMT credits

d. The base erosion anti-abuse tax

5. Which of the following statements about ASU 2018-02 is true?

a. It requires that companies reclassify stranded tax effects.

b. It applies to public companies only.

c. It is effective for fiscal years beginning after December 15, 2018.

d. Companies must apply ASU 2018-02 prospectively.

Interim accounting by fiscal year-end companiesQuestion: Under U.S. GAAP, interim tax expense is based on the company’s estimateof its annual effective tax rate for the year. For a fiscal year-end company, should theeffect of the tax rate change on deferred tax assets and liabilities be included as part ofthe annual effective tax rate estimate?

Answer: No. The effect of the tax rate change on deferred taxes represents a discreteitem. In other words, the adjustment to reflect the effect of the change in tax rates ondeferred tax assets and liabilities is recognized in the period of enactment and shouldnot be allocated to later quarters via the annual effective tax rate.

EXAMPLE: Company X, which has a June 30 fiscal year-end, has net deferredtax assets and determines that the net effect of the tax law change on its deferredtaxes is a charge (debit) to income of $200,000. The full amount of that charge isrecorded in income tax expense in the second quarter ended December 31, 2017(i.e., the period that includes the enactment date) and does not affect the computa-tion of Company X’s estimated annual effective tax rate.

Question: The previous question discussed the effect of the tax rate change ondeferred taxes for a company with a fiscal year-end. But the Act also changes the taxrate for the current year by creating blended tax rates for non–calendar year corporatetaxpayers. For a fiscal year-end company, should the reduction in corporate tax rateseffective January 1, 2018, be considered in estimating the annual effective tax rate?

Answer: Yes. U.S. GAAP includes an example of this fact pattern. As a refresher, tocompute income tax expense in an interim period, the company must first estimate theeffective tax rate that will be applicable for the full fiscal year. To make that estimate,each quarter the company considers the applicable statutory tax rate(s) and its bestestimate of tax credits, capital gains rates and usual transactions that have no taxconsequences (typically referred to as “permanent differences.�) The interim tax provi-sion is computed by multiplying the estimated annual effective tax rate against year-to-date pretax income and subtracting income tax expense previously reported. Taxexpense is trued up at the end of the year when the company computes its current anddeferred tax expense following the method described in Subtopic 740-10.

In other words, a company’s estimate of its annual effective tax rate necessarilyconsiders the statutory tax rate for the current year. Therefore, a company with a fiscal

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year-end will factor the company’s lower, blended tax rate into its estimate when makingits quarterly tax computation for the interim period that includes the enactment date.

EXAMPLE: Company Y has a fiscal year end of June 30. In its first quarterended September 30, 2017, Company Y recorded tax expense of $140,000 based onpretax income of $400,000 and an estimated annual effective tax rate of 35 percent.Pretax income for the six months ending December 31, 2017 is $800,000. Using itsestimated annual effective tax rate of 28 percent as of the end of its second quarter,Company Y will report income tax expense for the quarter is $84,000 ($800,000 x28 percent = $224,000 less $140,000). The $84,000 tax expense related to incomefor the quarter excludes the effect of tax law changes on Company Y’s deferredtaxes.

Effective tax rate reconciliationQuestion: Under U.S. GAAP, a public company is required to present a tax ratereconciliation in the footnotes. What rate should be used as the statutory tax rate for theannual period that includes the enactment date?

Answer: A public company should use 35 percent as its statutory tax rate for the yearended December 31, 2017. A public company with a fiscal year end should use itsblended tax rate, as discussed earlier. For example:

• March 31 year-end companies will reconcile to a 31.55 percent effective tax ratefor the fiscal year ending March 31, 2018.

• June 30 year-end companies will reconcile to a 28.06 percent effective tax rate forthe fiscal year-ending June 30, 2018.

• September 30 year-end companies will reconcile to a 24.53 percent effective taxrate for the fiscal year ending September 30, 2018.

Corporate alternative minimum tax. The Act eliminates the corporate AMT begin-ning with 2018 for calendar year taxpayers. For companies with AMT credits, the Actprovides two mechanisms by which those credits can be realized. Existing AMT creditscan be used against the taxpayer’s regular tax liability.

For taxable years beginning after 2017 and before 2022, existing AMT credits arerefundable. Specifically, the company can obtain a refund in an amount equal to 50percent (100 percent in the case of taxable years beginning in 2021) of the excess of theAMT credit for the taxable year over the amount of the credit allowable for the yearagainst the regular tax liability. In short, companies generally can expect the fullamount of the AMT credit to be used or refunded.

Question: Although prior law permitted a company to carry AMT credits forwardindefinitely, some companies recorded a valuation allowance against the deferred taxasset for AMT credits. Should the valuation allowance be released as a result of the newtax law?

Answer: Generally, yes. Companies that expect to either utilize or receive a refund fortheir AMT credits as a result of the Act should release any previously recordedvaluation allowance related to that deferred tax asset. The release (a credit to income)should be recognized as part of the effect of the change in tax law. In other words, thecredit arising from the reversal of the valuation allowance is recorded in income taxexpense in income from continuing operations in the period the new law is enacted.

Question: How should deferred tax assets for AMT credits be presented on thebalance sheet? In particular, how does a determination that the AMT credit will berefunded affect classification?

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Answer: U.S. GAAP does not provide a definitive answer. For this reason, it would beacceptable to classify the AMT credit as either a receivable or a deferred tax asset. Ifpresented as a receivable, companies should separate the current and noncurrentportion.

Bifurcation between deferred taxes and receivables is also acceptable. For exam-ple, assume a company expects to use a portion of its existing AMT credit to reduce itsregular tax liability and to receive a portion as a refund. In that case, the company couldpresent the portion that is likely to be reduce its regular tax liability as a deferred taxasset and the portion that is likely to be refunded as a receivable.

Question: To the extent that a company records a receivable for refunds of its AMTcredits, can the noncurrent portion of that receivable be discounted?

Answer: No. The FASB staff addressed this issue in a Q&A. Specifically: “The FASBstaff notes that paragraph 740-10-30-8 prohibits discounting deferred taxes. Accordinglyany AMT credit carryforwards presented as a deferred tax asset would not be dis-counted. Likewise, the FASB staff believes that any AMT credit carryforward presentedas a receivable should not be discounted because the staff does not believe thatSubtopic 835-30 on the imputation of interest applies.�

Net operating loss carryforwards. The Act changed the way in which a NOL can beutilized. While some aspects of the change are more generous than prior law, otheraspects are not.

Prior law permitted a company to carryback a loss generated in a taxable year toeach of the two preceding years, thereby generating a refund of prior taxes paid. Thenew law eliminates the ability to carryback an NOL, effective for taxable years begin-ning after December 31, 2017.

On the other hand, while prior law limited the carryforward period for NOLs to 20years, the Act permits an indefinite carryforward period. This good news is tempered bythe fact that NOL carryforwards are limited to 80 percent of taxable income for the year.Thus, a $100 NOL carryforward will not fully offset $100 of future taxable income. Acompany would need $125 of taxable income to realize $100 of NOLs.

Question: How do these two principal changes—the ability to carry forward an NOLindefinitely and the 80 percent limitation on the utilization of an NOL against taxableincome in any one year—affect the need for a valuation allowance?

Answer: Companies will need to reassess the need for valuation allowances on theirNOLs as a result of the new tax law.

A company that has deferred tax liabilities with indefinite reversal patterns (forexample, a taxable temporary difference related to an indefinite-lived intangible orgoodwill) may have future taxable income that it previously was unable to considerwhen assessing the need for a valuation allowance. Previously, the company may haveconcluded that a full valuation allowance was needed because the future taxable incomeassociated with these indefinite-lived temporary differences would not be available toutilize the NOL during the carryforward period. Therefore, in some circumstances, theability to indefinitely carry forward an NOL may result in the release of a valuationallowance against an NOL carryforward.

However, the 80 percent limitation on the use of NOLs against future taxableincome affects the amount of the NOL that may be realized. As noted above, taxableincome of $125 is needed to realize $100 of NOLs. This limitation not only affects theanalysis in the preceding paragraph, it also affects companies that had partial or novaluation allowances based on the reversal patterns of finite-lived temporary differences.

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EXAMPLE: Company Z has a $100,000 NOL carryforward that expires in 18years and $110,000 of taxable temporary differences related to depreciable machin-ery and equipment. Under prior law, Company Z concluded that the NOL would befully utilized based on the taxable income generated by the reversal of the taxabletemporary differences. Under the new law, $110,000 of taxable temporary differ-ences would not be sufficient to fully utilize the $100,000 NOL.

To the extent that a company reduces or increases its valuation allowance for itsNOLs as a result of changes in the law, the credit or debit to income is recognized aspart of the effect of the tax law change in the period of enactment.

Deductibility of compensation to highly paid employees. The Act modifies the taxdeductibility of certain types of compensation to highly paid employees in several ways.Prior law limited the tax deduction for compensation for the CEO and the four highestcompensated officers (so-called covered employees). The new law defines coveredemployees as the CEO, the CFO and the three highest paid employees. Further, oncean employee qualifies as a covered person, the limitation applies to that person forfederal tax purposes so long as the company pays compensation to that person or his orher beneficiaries.

Prior law applied to domestic publicly traded companies. Going forward, thelimitation also applies to all foreign companies publicly traded through AmericanDepository Receipts (ADRs) and certain corporations that are not publicly traded.

Exclusions from the computation of compensation for purposes of determining thelimitation have changed. Under prior law, commission-based compensation and quali-fied performance-based compensation were excluded when determining the amount ofcompensation that was not deductible. Said differently, salary in excess of $1 millionwas not deductible but commissions and qualified performance based compensationwere deductible. The Act removes the commission and performance-based compensa-tion exclusions. This change increases the amount of compensation that is notdeductible.

Question: How will these changes affect income tax accounting?

Answer: Compensation that is not deductible represents a permanent difference be-tween book income and taxable income. In all likelihood, these changes in tax law willincrease the amount of nondeductible compensation which, in turn, will result in ahigher effective tax rate.

Permanent differences between book income and taxable income affect a com-pany’s estimate of its annual effective tax rate for interim tax expense computations.Additionally, if material, nondeductible compensation would represent a reconcilingitem in a public company’s effective tax rate reconciliation.

The new law applies to compensation arrangements entered into after November 2,2017. Therefore, a company within the scope of this provision of the new law shoulddetermine whether the compensation arrangements it enters into after that date areaffected by the annual limitation. Deferred income taxes related to compensationarrangements should consider whether the deduction limitation will apply.

Deductibility of net interest expense. Prior tax law included limitations on thedeductibility of interest expense, but those limitations generally only applied to loansfrom foreign related persons when the corporate taxpayer’s debt-to-equity ratio andinterest expense as a percent of adjusted taxable income both exceeded defined limits.Under the Act, net interest expense is limited to 30 percent of the taxpayer’s adjustedtaxable income, a lower threshold than prior law. In addition, the limitation applies toboth related and unrelated-party debt arrangements that include domestic borrowings.Disallowed interest can be carried forward indefinitely.

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These changes make it more likely that a company with significant amounts ofinterest expense will be faced with a limitation on the deductibility of that expense.

Question: How does this change in tax law affect a company’s accounting for incometaxes?

Answer: Because any amounts that are disallowed in one tax year can be carriedforward indefinitely for use in a later tax year, a company that is subject to a limitationon the deductibility of its interest expense will generate a deductible temporary differ-ence (i.e., it will have a deferred tax asset). As with other deferred tax assets, a companyneeds sufficient positive evidence of book taxable income to demonstrate recoverability.

Deductibility of entertainment expense. The Act disallows 100 percent of entertain-ment expenses. Under prior law, the deduction of qualifying entertainment expenseswas limited to 50 percent. The new rule is effective for expenses incurred or paid afterDecember 31, 2017. Meals continue to be 50 percent deductible.

Question: What effect does the change in the rules regarding deductibility of entertain-ment expenses have on income tax accounting?

Answer: Entertainment expense that is not deductible represents a permanent differ-ence between book income and taxable income. Increasing the nondeductible portion ofentertainment expense from 50 percent to 100 percent will result in a higher effectivetax rate.

Permanent differences between book income and taxable income affect a com-pany’s estimate of its annual effective tax rate for interim tax expense computations. Inaddition, if material, nondeductible entertainment expense would represent a recon-ciling item in a public company’s effective tax rate reconciliation. (Private companies arerequired to provide a narrative discussion of reconciling items but are not required topresent a numerical reconciliation.)

Because the deductibility of meals is not affected, companies will need to insurethat their internal reporting properly separates “meals� from “entertainment.�

¶105 OVERVIEW OF CHANGES: FOREIGN EARNINGSOne area significantly affected by the Act is the taxation of foreign income. The Actreplaces the U.S. tax code’s long-standing worldwide system of taxing foreign earningswith what is being called a partial or quasi territorial system.

Under a worldwide system, earnings generally are subject to taxation based onwhere the taxpayer resides, regardless of where the income is earned. Prior to the Act,a U.S. company paid U.S. federal taxes at the U.S. corporate tax rate on a subsidiary’sforeign earnings when those earnings were repatriated (dividended) to the U.S. parententity. To reduce the effect of double taxation, the U.S. company received credit forforeign taxes paid by the foreign subsidiary. But it meant that the U.S. company waseffectively paying a 35 percent federal tax rate on its global earnings.

Under a territorial system, earnings are generally subject to taxation based onwhere the earnings are generated. The Act’s partial territorial system allows U.S.corporations to receive a 100 percent dividends-received deduction for foreign sourcedividends received from 10 percent or more owned foreign corporations. To implementthis shift to a partial territorial system, the Act mandates a one-time transition tax onpreviously unrepatriated foreign earnings.

The Act also creates certain incentives and disincentives that can affect a com-pany’s tax strategies. It encourages generating foreign earnings using U.S.-based assetsby creating a special deduction for foreign-derived intangible income (FDII). It discour-ages shifting certain assets and income to very low tax jurisdictions by creating a new

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tax on low-taxed foreign income deemed to have been generated by intangible assets(so-called global intangible low-taxed income, or GILTI).

A new alternative minimum tax (the Base Erosion and Anti-abuse Tax, or BEAT)addresses the tax base erosion created by the ability to deduct certain payments torelated foreign parties. While the goal of BEAT is to address potential base erosioncreated by certain tax strategies, it may have broader consequences, potentially func-tioning as a “backdoor� alternative minimum tax in some cases. These changes in theforeign earnings provisions of corporate tax law can be summarized as follows:

• Mandating a one-time tax payment on post-1986 undistributed earnings andprofits. The tax rate on these earnings ranges from 8 percent to 15.5 percent andis thus substantially lower than both the prior corporate tax rate of 35 percentand the new 21 percent tax rate.

• Creating a new tax on GILTI. Excluding any foreign tax considerations, theeffective tax rate on GILTI ranges from 10.5 percent (tax years 2018–2025) to13.125 percent (tax years after 2025).

• Creating a deduction for FDII. The mechanics of this provision result in aneffective tax rate ranging from 13.125 percent (tax years 2018–2025) to 16.406percent (tax years after 2025) on FDII, substantially less than the overallcorporate rate of 21 percent.

• Creating an alternative taxation model, called the Base Erosion and Anti-abuseTax (BEAT). The base erosion tax rate begins at 5 percent for 2018, increases to10 percent for tax years 2019–2025, and increases to 12.5 percent thereafter. Forcertain banks and registered securities dealers, as well as their affiliates, BEATis computed at a slightly higher rate.

Accounting for Income Taxes (ASC Topic 740)U.S. GAAP requires recording an income tax provision not only for taxes that are due asa result of the current year’s taxable income (“current tax expense or benefit�), but alsofor the future tax consequences of transactions that have been reported in the financialstatements or tax returns (“deferred tax expense or benefit.�)

The most common examples of items that give rise to deferred tax liabilities aredepreciation of buildings, machinery and equipment and the amortization of intangibleassets. The costs of those assets generally are expensed more rapidly for tax purposesthan for U.S. GAAP purposes, creating a basis difference in the asset. Typical examplesof items that lead to deferred tax assets include accrued expenses and allowances forbad debts. For these items, the U.S. GAAP expense often exceeds the amount that isdeductible in the current year’s tax return under the tax rules, also creating a basisdifference in the asset or liability.

These differences between the amounts reported for tax purposes and U.S. GAAPpurposes, whether they result in deferred tax assets or liabilities, are referred to assimply “temporary differences.�

However, U.S. GAAP exempts certain temporary differences from deferred taxaccounting. The most significant (and most common) is the exemption related toundistributed earnings of foreign subsidiaries and the related basis difference in theparent’s investment in its subsidiary. Although U.S. GAAP presumes that all undistrib-uted earnings will be transferred to the parent, if there is sufficient evidence that foreignearnings will be reinvested by the subsidiary, that is, evidence that remittance to theparent is postponed indefinitely, then no deferred taxes are provided.

This provision in U.S. GAAP, commonly referred to as the “APB 23 exception,�reflects the long-standing U.S. tax system under which foreign earnings were not

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subject to U.S. tax until the earnings were remitted. By changing the tax rules forforeign earnings, the Act requires companies to revisit their prior accounting conclu-sions regarding deferred taxes on this temporary difference.

Future tax consequences arising from temporary differences are recorded basedon tax law enacted at the date of the financial statements. U.S. GAAP requires that allcompanies, both public and private, recognize the effects of tax law changes on the dateof enactment. Such effects are charged to income as part of the income tax expense orbenefit for the period.

Companies will record the consequences of the Act on their deferred tax balances(as well as any effect on current tax expense) in the income statement for the reportingperiod that includes December 22, 2017.

Q&AsTransition tax: deemed repatriation of foreign earnings. One of the central featuresof the Act is the imposition of a one-time tax on the undistributed, previously untaxedforeign earnings and profits that have accrued since 1986. This transition tax applies to10 percent or more owned foreign corporations.

Under prior law, foreign earnings could be held outside the U.S. indefinitely, thusavoiding payment of U.S. tax at the then corporate tax rate of 35 percent. Under the Act,the one-time tax must be paid regardless of whether the company repatriates theearnings. However, the tax rate applied to those earnings is substantially reduced: 15.5percent tax rate for earnings and profits that have been retained in cash and other liquidassets and 8 percent for remaining earnings. Foreign tax credit and net operating losscarryforwards may be available to offset the transition tax liability.

Companies can elect to pay the one-time transition tax over eight years on aninterest free basis. Under this election, payments are due without regard to any futuretaxable income or losses and are made in the following amounts: 8 percent per year forthe first five years, 15 percent in the sixth year, 20 percent in the seventh year, and 25percent in the eighth year.

Question: To the extent that a company elects to pay the transition tax in installmentsover eight years, can the noncurrent portion of that tax obligation be discounted?

Answer: No. The FASB staff addressed this issue in a Q&A. Specifically: “The FASBstaff notes that paragraph 740-10-30-8 prohibits discounting deferred tax amounts. Dueto the unique nature of the tax on the deemed repatriation of foreign earnings, the staffbelieves that the guidance in paragraph 740-10-30-8 should be applied by analogy to thepayable recognized for this tax. Further, the FASB staff does not believe that Subtopic835-30 on the imputation of interest applies to the unique circumstances related to thisliability.�

In its guidance, the FASB staff also notes that the transition tax may be subject toestimation and the future resolution of uncertain tax positions. Examples of thoseuncertain tax positions include the amount of earnings and profits from foreign subsidi-aries, the availability and amount of foreign tax credits that can be used to reduce thetransition tax and determining the amount of earnings held in cash and other liquidassets. Because any uncertain tax positions related to the deemed repatriation of foreignearnings cannot be discounted, it would be inappropriate to discount the related taxliability.

Question: How should the transition tax be classified on the balance sheet?

Answer: In general, the obligation to pay the transition tax should not be classified as adeferred tax liability because it does not represent the tax effect of a temporary

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difference. It represents a tax determined based on a company’s accumulated earningsand profits for tax purposes and thus is unlikely to represent the outside basisdifference in the company’s investment in its subsidiary.

This conclusion is consistent with the manner in which the FASB staff answeredthe question on discounting. Note that the FASB staff refers to the obligation as a“payable� and references U.S. GAAP’s prohibition on the discounting of a deferred taxliability as being applicable by analogy. Companies with a classified balance sheet thatelect to remit the payment over eight years should distinguish between the current andnoncurrent portions of the tax obligation.

Question: Assuming sufficient evidence of indefinite reinvestment exists, U.S. GAAPallows a company to exempt the undistributed earnings of foreign subsidiaries and therelated basis difference in the parent’s investment in its subsidiary from deferred taxaccounting. Does the transition tax eliminate the need to consider whether foreignearnings are indefinitely reinvested?

Answer: No, for two reasons. First, the U.S. GAAP exception applies to the outsidebasis difference in the investment. Basis differences arise for many reasons and maycontinue to exist irrespective of this change in the tax law. Second, the one-timetransition tax does not require that the earnings be repatriated. The liability must bepaid regardless of where the accumulated earnings reside or are invested. Companieswill separately evaluate the repatriation decision because that can trigger other taxconsequences, such as state taxes and/or foreign withholding taxes. For these reasons,companies need to continue to assess how the outside basis difference in foreignsubsidiaries will reverse, including whether foreign earnings are indefinitely reinvested.

Some companies may continue to leave the earnings in the existing foreign taxjurisdiction and make no changes to their legal structures or tax strategies. Others maychange their tax strategies as a result of this change in tax law. For example, a U.S.parent may direct its foreign subsidiaries to remit dividends in order to provide theliquidity needed to pay the transition tax or to reduce debt so as to avoid the newinterest expense deduction limitation.

If a company can no longer assert the ability and intent to indefinitely reinvest, itshould record the resulting deferred tax consequences based on the manner in which itexpects to recover its investment. In some cases, management may conclude that theoutside basis difference will reverse through distributions (repatriation of earnings). Inother cases, it may conclude that it will recover its investment via liquidation or sale.

If management has sufficient evidence to support its conclusion that the earningsare indefinitely reinvested, the disclosure requirements of U.S. GAAP continue to apply.

Question: Where is the adjustment to record the one-time transition tax reported?

Answer: Under U.S. GAAP, the adjustment to remeasure deferred tax assets andliabilities and record any additional tax obligations as a result of a change in tax law isreported in income from continuing operations as part of income tax expense in theperiod in which the new law is enacted.

The transition tax is simply one of the many changes to previously recorded taxesbrought about by the Act. Companies that had previously recorded no taxes onunremitted earnings did so on the basis that tax law permitted them to postponetaxation indefinitely. Alternatively, companies that had provided taxes on some or all oftheir foreign subsidiaries’ unremitted earnings did so based on the tax rates that were ineffect. In both cases, adjustments are required as a result of the Act.

Question: Computing the transition tax requires extensive information gathering, anin-depth analysis of the tax law and, in some cases, judgments regarding the application

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of the new tax law to a company’s specific facts and circumstances. Must a companyfinalize its measurement of the one-time transition tax in the accounting period thatincludes the December 22, 2017 enactment date of the Act?

Answer: No. Based on the SEC staff guidance in SAB 118 and the FASB staff guidancein its Q&A, public and private companies are permitted up to a year to finalize themeasurement of the effects of the change in tax law. Companies that choose to use therelief provided by this guidance are required to make certain disclosures. Refer to thedisclosures addressed in the domestic earnings section above.

Global intangible low-taxed income. As part of the fundamental change to the U.S.regime for taxing foreign earnings, the Act introduces a new category of income,referred to as global intangible low-taxed income (GILTI). For tax years beginning afterDecember 31, 2017, a company will be subject to tax on GILTI to the extent that thatincome exceeds a safe harbor. While the provisions of GILTI are complex, this new taxwill most likely affect companies that (1) have foreign earnings generated without alarge aggregate foreign fixed asset base (i.e., income generated by intangible assets)and (2) are taxed on those earnings at a low tax rate.

GILTI is the excess of a U.S. shareholder’s total net foreign income over a deemedreturn on tangible assets. If the amount of GILTI for a tax year is a loss, the Act permitsno carryforward or carryback of that loss. If the amount of GILTI for a tax year isincome, the U.S. shareholder is allowed a deduction of 50 percent of that amount, up tothe amount of the U.S. shareholder’s taxable income.

The U.S. shareholder is also allowed a deemed paid foreign tax credit of up to 80percent of foreign taxes attributable to the underlying foreign corporation. However,foreign tax credits associated with global intangible low-taxed income can only be usedto reduce U.S. taxes owed on GILTI and cannot be carried forward. Because of the 50percent deduction, the effective tax rate on GILTI is 10.5 percent through 2025. In 2026,when the deduction is lowered to 37.5 percent, the effective tax rate on GILTI will be13.125 percent.

Question: How should the tax consequences associated with global intangible low-taxed income be accounted for? Specifically, is the tax on GILTI included in tax expensein the year it is incurred? Or should a company recognize deferred taxes for temporarybasis differences that are expected to reverse as global intangible low-taxed income infuture years?

Answer: According to the FASB staff, U.S. GAAP is not clear as to the treatment oftaxes on GILTI. As discussed in a FASB staff Q&A, pending further guidance from theFASB, a company should choose between one of the two following acceptable account-ing policies:

• Alternative Policy 1: The tax on GILTI should be accounted for as a period cost,similar to special deductions. This accounting policy views GILTI as a computa-tion that is not premised on the U.S. taxpayer’s basis in discrete investments orassets and liabilities and is dependent on future, contingent events. BecauseGILTI is based on the aggregate income from all foreign corporations in a year,the unit of account for deferred tax purposes is neither the investment in anindividual foreign corporation or that corporation’s assets and liabilities. U.S.GAAP’s accounting model for income taxes does not address taxes on aggre-gated income across multiple jurisdictions in which basis differences offset suchthat any particular basis difference might never be taxed. Further, GILTI isdependent on contingent or future events, such as the amount of foreignqualified business asset investment in a given year, future foreign tax creditsand future foreign income versus loss. This suggests that taxes on GILTI areperiod costs.

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• Alternative Policy 2: Deferred tax assets and liabilities should be recognized whenbasis differences exist that are expected to affect the amount of GILTI inclusion uponreversal. This accounting policy views the tax on GILTI as similar to the taximposed on existing Subpart F income. Currently, deferred taxes generally areprovided for basis differences that are expected to result in Subpart F incomeupon reversal. Because GILTI is included in taxable income when earned by aforeign corporation, similar to Subpart F income, it is appropriate to account forit similarly. Companies that elect this second accounting policy are likely to haveadditional implementation questions. More guidance may be forthcoming as theFASB staff receives additional questions and monitors what companies aredoing in practice.

A company should disclose its accounting policy related to GILTI inclusions, as re-quired by U.S. GAAP.

Question: Must a company select its accounting policy for GILTI in the accountingperiod that includes the December 22, 2017, enactment date of the Act?

Answer: The SEC staff guidance in SAB 118 that provides public companies with somerelief regarding the measurement of the effects of the change in tax law does notspecifically address accounting policy issues arising from the new tax law. (Privatecompanies are permitted to follow the guidance in SAB 118.)

While U.S. GAAP does not permit a “temporary� accounting policy election, itwould not be unreasonable for a company to defer its election of an accounting policy tothe period in which it completes its measurement of the effects of the GILTI tax lawprovisions. In other words, so long as the company has not recorded a provisional orfinal amount for the effects of GILTI, it has not adopted an accounting policy. Thus, itwould disclose that its accounting for the effects of GILTI tax law provisions isincomplete and an accounting policy has not been elected.

Once the company records an amount that reflects GILTI provisions of the tax law,however, it has implicitly adopted an accounting policy. Any change to that policy wouldneed to be based on the requirements of U.S. GAAP.

Deduction for foreign-derived intangible income. To encourage certain tax strate-gies, the Act creates a deduction for income earned by a U.S. corporation in connectionwith sales of goods or services to a non-U.S. person for foreign use only (i.e., U.S. exportsales). For taxable years beginning after December 31, 2017, and before January 1,2026, the deduction is equal to the sum of 37.5 percent of FDII plus 50 percent of GILTItax (if any). After that date, the deduction for FDII and the GILTI tax are reduced to21.875 percent and 37.5 percent, respectively. The effect of this specific deduction is tolower the tax rate on this category of income to 13.125 percent for and taxes 2018through 2025 and 16.406 percent thereafter.

The computation of the tax benefit is based on a measure of export sale intangible-derived income that can vary based on any number of factors. It is similar to previoustax benefits such as foreign sales corporations and the extra territorial income exclu-sion, both of which have been repealed.

Question: How should a company account for an FDII deduction?

Answer: U.S. GAAP states that the tax benefits associated with special deductionsshould not be anticipated for purposes of offsetting a deferred tax liability and thusgenerally should be recognized no earlier in the year in which the special deduction isdeductible on the tax return. U.S. GAAP does not define “special deductions.� However,the FDII deduction is similar to prior export-related benefits that were accounted for asspecial deductions.

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Base Erosion and Anti-abuse Tax. The Act created a new alternative minimum tax(Base Erosion and Anti-abuse Tax, or BEAT) to address the tax base erosion created byother aspects of the tax law. Specifically, the computation of BEAT differs from thecomputation of the regular tax liability in two broad respects: (1) BEAT disallows taxdeductions for certain payments made to related foreign parties, and (2) BEAT imposesa lower tax rate. Specifically, amounts that are not deductible for BEAT (referred to asbase erosion payments) include payments to foreign related parties for items such asroyalty payments or payments to acquire depreciable or amortizable property. The taxrate used to compute the BEAT is 5 percent in 2018 but increases to 10 percent in 2019through 2025 and 12.5 percent thereafter.

Under the Act, if the BEAT is greater than the company’s regular tax liability, thelarger amount must be paid. The payment of BEAT does not result in a tax credit. Whilethe goal of BEAT is to address potential base erosion created by certain tax strategies, itmay have broader consequences, potentially functioning as a “backdoor� alternativeminimum tax in some cases.

BEAT applies to companies that have average annual gross receipts of at least $500million and that have made related party deductible payments totaling 3 percent (2percent for banks and securities dealers) or more of total deductions for the year. BEATis effective for base erosion payments paid or accrued in taxable years beginning afterDecember 31, 2017.

Conceptually, BEAT is similar to the corporate AMT that Congress eliminated viathe Act. Both are alternative tax computations that impose a minimum level of taxationby excluding certain tax deductions to arrive at an alternative amount of taxable incomethat is taxed at an alternative, lower tax rate. However, there is an important distinction:while the payment of AMT resulted in a tax credit that could be carried forward, thepayment of BEAT does not.

Question: If a company reasonably expects to be subject to BEAT, should the companymeasure its deferred tax assets and liabilities at the BEAT tax rate?

Answer: No. The FASB staff addressed this issue in a Q&A. Based on an analogy toU.S. GAAP related to the accounting for AMT, the FASB staff concluded: “[A]n entitythat is subject to BEAT should measure deferred tax assets and liabilities using thestatutory tax rate under the regular tax system. The FASB staff believes that measuringa deferred tax liability at the lower BEAT rate would not reflect the amount an entitywould ultimately pay because the BEAT would exceed the tax under the regular taxsystem using the 21 percent statutory tax rate.�

Question: How should a company that is subject to BEAT account for the incrementaltax incurred?

Answer: The incremental effect of BEAT should be recognized in income tax expensein the year that the BEAT is incurred. This conclusion is consistent with the manner inwhich the FASB staff answered the question on the measurement of deferred taxes for acompany that is subject to BEAT.

Question: Given the interaction between BEAT and certain deferred tax assets such asNOL and AMT credit carryforwards, should a company that is subject to BEAT considerthe effect of BEAT in evaluating the need for a valuation allowance?

Answer: Possibly. In its Q&A addressing BEAT, the FASB staff specifically states that acompany “would not need to evaluate the effect of potentially paying the BEAT in futureyears on the realization of deferred tax assets under the regular tax system.�

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The FASB staff explains its view by noting that “the realization of the deferred taxasset [such as an NOL carryforward or AMT credit carryforward] would reduce itsregular tax liability, even when an incremental BEAT liability would be owed in thatperiod.� Said differently, because deferred taxes are measured based on the regular taxsystem, as long as the deferred tax asset results in a reduction of the regular taxliability, there is no need for a valuation allowance.

That conclusion is logical. However, it nonetheless seems inconsistent with the factthat a company subject to BEAT may receive no economic benefit from that deferredtax asset. Consider a fact pattern in which a company’s regular tax liability is reduced bya $1,000 AMT credit carryforward. If the company is not subject to BEAT, the $1,000deferred tax asset is economically realized. However, if the company is subject toBEAT, the $1,000 AMT credit carryforward produces no economic benefit. The com-pany’s tax return shows the offset of the AMT credit carryforward against the regulartax liability. However, the company does not pay the regular tax liability because theBEAT is higher. The deferred tax asset is indeed used, but the company does notreceive an equivalent economic benefit.

Although the FASB staff Q&A states that there is no requirement for a company toconsider BEAT when evaluating the need for a valuation allowance against certaindeferred tax assets, it remains to be seen how this area will evolve. Companies that havesignificant NOL and/or AMT credit carryforwards and believe that they are reasonablylikely to be subject to BEAT for the foreseeable future should carefully consider theirspecific facts and circumstances in determining whether a valuation allowance isappropriate.

STUDY QUESTION

6. Which of the following identifies the new alternative minimum tax introduced by theTax Cuts and Jobs Act.

a. BEAT

b. FDII

c. GILTI

d. Corporate AMT

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19

MODULE 1: TOP ACCOUNTING ISSUES—CHAPTER 2: Leases and Impacts: Change toChanges 2018¶201 WELCOMEThis chapter discusses the latest developments from the Financial Accounting Stan-dards Board (FASB) regarding lease accounting.



• Identify the FASB pronouncements that may impact entities with leases or thatexpect to have or enter into leases

• Recognize the major updates to the new Accounting Standards Codifications asprescribed by ASU 2016-02

• Understand best practices for starting a lease accounting project under the newstandards

¶203 INTRODUCTIONFASB Accounting Standards Codification 842, Leases, added by Accounting StandardsUpdate (ASU) 2016-02 (Topic 842), provides significant changes to the financial report-ing of leases. Experts agree that companies will see huge impacts on their balancesheets as a result of implementing the new standard, with some estimating more than85 percent of lease liabilities not currently reflected on the balance sheet needing to beincluded.

¶204 FIVE MAJOR CHANGES TO LEASESCompanies will face a number of challenges when implementing the new lease account-ing standard (ASC 842). The following sections highlight the five biggest changes.

Major Change 1: Reporting Operating LeasesOne major change resulting from ASC 842 is in the reporting of operating leases.Capital (now called finance) leases have been on the balance sheet. ASC 842 requiresoperating leases to recognize a right-of-use (ROU) asset and a lease liability. A ROUasset means there is no clear title to the asset; one just has the right to use it.

Operating leases will be calculated based on the present value of lease payments tobe made over the lease term discounted at the rate implicit in the lease, if known. TheROU asset is the same amount as the lease liability calculation with some adjustmentsfor certain items.

Major Change 2: Determining Whether an Arrangement Is a LeaseAnother change companies will face in implementing the new standard is whether ornot an arrangement meets the definition of a lease under ASC 842. Under ASC 842, allcontracts meeting the definition of a lease must be on the balance sheet, even if thelease is classified as an operating lease. The only exception relates to short-term leases,which are those with original terms of fewer than 12 months (with some exceptions).

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While the criteria for determining whether an arrangement is a lease under ASC842 are similar to those under current U.S. generally accepted accounting principles(GAAP), there are several differences. Companies must look at the actual terms in ASC842 to determine what qualifies as a lease. Under current U.S. GAAP, determiningwhether a lease is on or off the balance sheet is more manageable. If a companystructures its leases so they are not capital leases (now finance leases), the leases arenot on the balance sheet.

Major Change 3: What Is the Lease Payment?Lease origination costs capitalized under ASC 842 will most likely differ from currentU.S. GAAP. Specifically, there is a new definition of indirect costs, which will probablyresult in fewer indirect costs that are capitalized under the new leasing standard.

In addition, under current U.S. GAAP, all executory costs, such as those forproperty taxes or insurance, are excluded from minimum lease payments. However,under ASC 842, these types of costs are part of lease payments used to calculate thelease liability and ROU asset.

Major Change 4: Difference in Sale-LeasebacksUnder ASC 842, sale-leaseback accounting is substantially different than in current U.S.GAAP (Topic 840). Under the new standard, for a sale to occur, the transfer of the assetmust meet the revenue recognition requirements in ASC Topic 606, Revenue fromContracts with Customers. If there is not a sale of the asset from the seller-lesseeperspective, the buyer-lessor does not account for a purchase of the asset. As a result,both the seller-lessee and the buyer-lessor account for any consideration paid for theasset as a financing transaction.

Further, ASC 842 provides new guidance on determining when a lessee controls anunderlying asset before lease commencement, resulting in fewer built-to-suit arrange-ments subject to sales-leaseback accounting requirements.

Major Change 5: More Financial Statement DisclosuresDisclosure requirements under current U.S. GAAP for leases (Topic 840) are notterribly insightful, especially for lessees who primarily enter into operating leases,which are not recorded on the balance sheet. This has changed under ASC 842. ASC842 adds significant disclosure requirements for both lessees and lessors.

Analysts estimate that entities have approximately $3 trillion in off-balance sheetlease commitments. Currently, the only disclosures companies are likely to see are thedisclosure for off-balance sheet arrangements and contractual obligations within Man-agement’s Discussion and Analysis, which is unaudited, or within the footnotes wherethe future minimum rental payments are disclosed. This lack of clarity and insight intoan entity’s lease commitments is one of the main reasons the FASB decided to revisethe accounting and reporting for leases.

STUDY QUESTIONS

1. Under ASC 842, which types of leases are generally not required to be on thebalance sheet?

a. Operating leases

b. Capital leases

c. Short-term leases

d. Finance leases

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21MODULE 1 - CHAPTER 2 - Leases and Impacts: Change to Changes 2018

2. Which of the following is one of the five major changes brought about by the newlease standards?

a. Financial statement disclosures

b. Reporting of capital leases

c. Lessor accounting rules

d. Definition of a component

¶205 ASU 2016-02The FASB issued ASU 2016-02 (Topic 842) in February 2016 to make things clearer andmore comparable among organizations for recognizing leased assets and liabilities onthe balance sheet, and in disclosing that in their leasing arrangements disclosures. ASU2016-02 was issued along with International Financial Reporting Standards (IFRS) 16,Leases, to meet that objective and improve financial reporting.

Based on criticisms of previous leases guidance, the IASB and FASB decided to notfundamentally change lessor accounting. However, they did make some changes tolessor accounting to conform and align that guidance with the lessee guidance andother areas within GAAP. The primary difference between previous Topic 840 and Topic842 is the recognition of lease assets and lease liabilities by lessees for leases that wereclassified as operating leases under previous GAAP. The criteria for distinguishingbetween finance and operating leases are about the same in the new standard as theywere for capital and operating leases. There is not much difference, other than changingthe name “capital� to “finance� along with an additional criteria around the uniquenature of an asset.

Assets that are included are property (real estate), plant, and equipment. Excludedassets include intangible assets, exploring or use of nonregenerative resources, inven-tory, and assets under construction.

Lessee AccountingThe basis of Topic 842 is that the lessee should recognize the assets and liabilities thatcome from leases. In the financial statement, the lessee should recognize the leaseliability and a ROU asset representing its right to use the underlying asset for the leaseterm.

When measuring assets and liabilities arising from a lease, the lessee shouldinclude payments to be made in optional periods only if the lessee is reasonably certainto exercise an option to extend the lease or not to exercise an option to terminate thelease. Another issue under the new guidance is that payments to purchase the assetsshould be included in the measurement of leases and liabilities only if the lessee isreasonably certain to exercise that purchase option. The reasonably certain threshold isconsistent with, and intended to be applied in the same way as, the reasonably assuredthreshold in the previous guidance.

Another issue addressed by the new standard is so-called variable lease paymentsand whether they should be included in lease arrangements. The standard allows anaccounting policy election not to recognize lease assets and lease liabilities for leasesthat have a term of 12 months or less.

With regard to leasehold improvements, if they are made before the lease is there,so that the lease includes the leasehold improvements, they generally would beincluded in that lease and that payment. If the improvements are included after the fact,

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there is a modification to the lease. Generally, improvements to real estate belong to theowner of the property, so they become a separate line item.

In ASU 2016-02, the recognition, measurement, and presentation of expenses andcash flows from a lease by a lessee are similar to that in previous GAAP. Finance leasesand operating leases continue to be differentiated. According to the new standard, forfinance leases, a lessee must:

• Recognize a ROU asset and a lease liability, initially measured at the presentvalue of the lease payments, in the statement of financial position.

• Recognize interest on the lease liability separately from amortization of the ROUasset in the statement of comprehensive income.

• Classify repayments of the principal portion of the lease liability within financingactivities and payments of interest on the lease liability and variable leasepayments within operating activities in the statement of cash flows.

For operating leases, a lessee must:

• Recognize a ROU asset and a lease liability, initially measured at the presentvalue of the lease payments, in the statement of financial position.

• Recognize a single lease cost, calculated so that the cost of the lease is allocatedover the lease term on a generally straight-line basis.

• Classify all cash payments within operating activities in the statement of cashflows.

Lessor AccountingLessor accounting has not changed significantly from the previous guidance. Mostoperating leases should still be classified as operating leases, and the lease income isrecognized straight-line over the lease term. Some changes were made to the lessoraccounting guidance to conform it with the changes made to lessee accounting. Forexample, some glossary terms that will affect a lessee applying the lessor guidance as asublessor were updated so that both lessee and lessor use the same terminology.

Topic 842 aligns the lessor accounting guidance and the revenue recognitionguidance in Topic 606. Whether a lease is similar to a sale of the underlying assetdepends on whether the lessee has control of the underlying asset. This is consistentwith the Topic 606 transfer of control principle.

Leveraged LeasesThe Topic 840 accounting model for leveraged leases continues to apply only if theleveraged lease commenced before ASU 2016-02’s effective date. The previous guidancedoes not apply to leases commenced after that effective date.

Definition of a LeaseTopic 842 defines a lease as “a contract, or part of a contract, that conveys the right tocontrol the use of identified property, plant, or equipment (an identified asset) for aperiod of time in exchange for consideration.� Control means the lessee has all of theeconomic benefits coming from the use of the asset, including the right to keep or toobtain that asset and to direct its use.

EXAMPLE: Company T needs to obtain railroad cars for its business. Itarranges with a leasing company to get 10 railcars on a three-year lease. Therailcars are each specifically identified by a serial number, and according to thelease arrangement, Company T has the right to get substantially all the economic

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benefits from them. In other words, nobody else can get any economic benefit fromthe railcars. In this case, Company T has control over the assets (railcars).

In Topic 840, the critical determination was whether a lease was a capital lease oran operating lease; lease assets and liabilities were recognized only for capital leases.However, under the new standard, that determination is whether the contract is orcontains a lease. Lessees must recognize lease assets and lease liabilities for all financeand operating leases (other than short-term leases). Further details and examples areincluded in Topic 842 to help organizations make this determination.

ComponentsA component is something that is usually separate from the lease. For example,components may deal with repair and maintenance or some types of overall improve-ments. Although Topic 840 required entities to separate lease components fromnonlease ones, Topic 842 provides additional guidance on how to identify, separate, andaccount for such components.

Sale and Leaseback TransactionsGenerally, for a sale to occur in the context of a sale and leaseback, it must meet therequirements for a sale under Topic 606. If there is no sale for the seller-lessee, then thebuyer-lessor does not account for a purchase.

In some cases, a transaction would have qualified for a sale under the previousguidance but will not qualify for a sale under Topic 606. Many real estate transactionswill qualify for sale and leaseback accounting under the new guidance that might nothave qualified under Topic 840. On the other hand, transactions that involve assetsother than real estate that would have qualified for sale and leaseback under previousguidance will not qualify for sale and leaseback accounting under the new guidance.

Topic 842 also includes guidance for repurchase options. If a seller-lessee repur-chases the assets from the buyer-lessor, it precludes sale accounting unless the asset isnonspecialized and the exercise price of the option is the fair value of the asset on thedate the option is exercised.

DisclosuresThe new guidance requires both qualitative disclosures and specific quantitative leasedisclosures. The FASB wants to “require enough information to supplement theamounts recorded in the financial statements so that users can understand more aboutthe nature of an entity’s leasing activities.�

TransitionAccording to the transition guidance in Topic 842, lessees and lessors must recognizeand measure leases at the beginning of the earliest period presented using a modifiedretrospective approach, which includes several optional expedients that focus on theidentification and classification of leases that occurred before the topic’s effective date.

If a company elects to apply these expedients, it must continue to account for leasesthat started before the effective date. Companies will treat the leases the same way theydid in previous GAAP, unless the lease is modified. The only difference is that theleases’ lessees must still recognize ROU and liabilities for all operating leases at eachreporting date based on the present value of the remaining minimum rental paymentsthat were tracked and disclosed.

Topic 842 also provides some transition guidance for sales-leaseback, build to suit,and other types of leases.

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Effective DateThe amendments are effective for fiscal years beginning after December 15, 2018,including interim periods, for:

• Public businesses

• Nonprofit entities that have issued or are conduit bond obligors or are involvedwith any securities that are traded over-the-counter or on the Exchange

• Employee benefit plans that file financial statements with the U.S. Securities andExchange Commission (SEC)

For all other entities, the update is effective for fiscal years beginning after December15, 2019. Public companies have all of 2018 to implement the changes, while nonpublicentities have two years (2018 and 2019).

STUDY QUESTIONS

3. Under ASC 2016-02, for which type of lease must a lessee classify all cash paymentswithin operating activities in the statement of cash flows?

a. Leveraged lease

b. Finance lease

c. Operating lease

d. All leases

4. What is the primary difference between Topic 840 and Topic 842?

a. Recognition of operating leases

b. Updated glossary terms

c. Criteria for distinguishing between finance and operating leases

d. Recognition of expenses and cash flows from a lease by a lessee

¶206 STARTING A LEASE ACCOUNTINGIMPLEMENTATION PROJECTStarting a lease implementation project is a huge endeavor for many companies. Forexample, a company that handles air freight might have several hundred airplanes ofdifferent sizes, natures, and leases, all with different built-in functions that have to becovered in the leases. The following steps are designed to help companies plan and starta lease project under the new rules.

Step 1: Understand the New RulesA company’s first step is to understand the new lease accounting standard and the risksto its business. The end goal of the new standard is to provide a company’s investorswith more transparency around its leasing contracts.

Operating leases, which have historically been off balance sheet, will now betreated as assets and liabilities on the balance sheet under both U.S. GAAP and IFRS.Operating leases represent the majority of leases for 93 percent of companies. There-fore, the challenges with these new standards should not be underestimated. In fact,some have called the new leasing standards the “biggest accounting change ever.� TheIASB estimates that more than $2 trillion in liabilities will move onto corporate balancesheets during this transition. While most of the dollar value of these leases is associated

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with real estate, many companies will have a larger number of leases for non-real estateassets such as vehicles, information technology (IT), and equipment.

Operating leases moving onto the balance sheet could impact various financialmetrics, debt covenants, and even executive compensation plans at some firms. Remem-ber that the implementation deadlines start in December 2019 for public companies.However, three years of comparative reporting will be required for income statements.The biggest changes are the need to track leases at an asset level and the need toaccount for embedded leases.

Impact on financial reporting. Because several hundred million dollars’ worth ofleases could transition onto their balance sheets as a result of the new lease accountingrules, Fortune 500 companies must consider the following:

• What will be the impact to our market capitalization and share price?

• How will we communicate these changes to investors?

• Will the changes to our balance sheet impact existing debt covenants andborrowing ability?

• How will ratings agencies respond?

• How will financial metrics such as earnings before interest, taxes, depreciation,and amortization (EBITDA) and return on assets be impacted?

• Are changes needed to executive compensation and performance plans?

PLANNING POINTER: Learn more about the technical standards by review-ing one of the guides available from the standards boards or Big Four firms:

• FASB Standards Documentation

• IFRS Standards Documentation

• EY Lease Accounting Guide

• PWC Lease Accounting Guide

• Deloitte Lease Accounting Guide

• KPMG Lease Accounting Guide

Administrative reporting burden. To determine this burden, companies shouldconsider how much effort will be required to comply with the new accounting rules.Will it be another Sarbanes-Oxley-like burden that will create massive administrativeburdens for the accounting department? Or, will it just be a few months’ worth of workfor the accountants and the IT department?

Implementation time frame. The SEC has defined implementation deadlines for thenew lease accounting standard that vary based upon a company’s fiscal year and theprivate/public nature of its ownership. The earliest implementation deadlines for De-cember 31 filers are for public companies with a fiscal year of 2019. Deadlines forprivate companies are one year later. However, the official deadlines are a bit mislead-ing. The SEC is also requiring comparative reporting: three years of income statementsand two years for balance sheets.

As a result, companies likely need to start tracking more data about operatingleases well in advance of the official deadline. To implement the new standard, they willneed to:

• Take an inventory of all leases.

• Gather key data about each lease.

• Apply the new accounting standards.

• Upload the data into a lease accounting subledger.

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• Generate the new journal entries.

• Produce updated balance sheet and income statements.

On balance sheet. As mentioned earlier, operating leases will now move onto thebalance sheet. Both U.S. GAAP and IFRS will require new lines on the balance sheet toreport on ROU assets and liabilities. With the additional visibility provided to leases, thelevel of scrutiny from auditors will increase. Companies can expect to spend more timewith auditors testing the completeness and the accuracy of the leasing figures.

Because leases will be reported on the balance sheet as assets, they will need totrack all lease data at an asset level. While most real estate leases have one asset perschedule, this is not the case for equipment leases. Most companies track lease dataonly at a schedule-level under the current lease accounting standards. Gathering asset-level data will be one of the biggest challenges.

The new lease accounting standards consider some outsourcing and service con-tracts to have embedded leases as well. In other words, contracts that a lawyer or abanker might not call a lease could be deemed leases by accountants if they meetcertain criteria. And even if 80 percent of these service contracts prove not to meet thedefinition of a lease, a company will still have to collect the contracts and perform theanalysis.

Step 2: Situational AssessmentMany executives will make the mistake of jumping into a lease accounting implementa-tion project without really understanding the key challenges. It is tempting to rush outto purchase an expensive new lease accounting package and then start to upload thedata. However, there is more than meets the eye with this new standard.

A better way to start is by asking tough questions up front. Understand the hiddencomplexities of the new accounting standards, and understand what are expected to bethe top implementation challenges with collecting the data. Performing diligence upfront will mitigate your risk of project delays and compliance issues. Take the followingitems into account:

• Financial metrics: Credit ratings, existing debt covenants, and future borrowingabilities

• Credit impact: Financial ratios impacted by move of leases onto the balancesheet as assets and liabilities

• Asset-level tracking

— Current lease administration systems do not track at asset-level.

— Data is needed for accounting not captured in any system.

• IT, fleet, and equipment

— No one owns equipment leases.

— Look for weak processes, controls, and systems.

— A significant effort is required to collect data.

• Embedded service contracts: Outsourcing agreements and other services con-tracts may now be considered leases for accounting purposes.

• Talent scarcity

— There are relatively few experts on leasing in the market.

— As the deadline approaches, it will be challenging to find talent.

• Comparative reporting: Three years for income statement; two years for balancesheet.

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The most common mistakes companies make include:

• Ignoring non-real estate

— Although the dollar value of equipment leases might be lower than realestate, the number of lease contracts is typically higher. The data for theseleases will be much harder to collect.

— At most companies there is no centralized group that owns these leases, noris there is an enterprise application to track them.

— Companies that put off data collection efforts for equipment until the elev-enth hour of the project will find themselves behind the proverbial “eightball� scrambling to gather data at the last minute.

• Sarbanes-Oxley (SOX) and post-implementation

— Although the priority for most companies will be complying with the initialdeadline, a far greater challenge exists with the ongoing reporting.

— Success requires that you not only collect all the data necessary to performaccounting on day one, but that you also develop a repeatable process toconsistently maintain accurate, complete records in perpetuity.

— You will need to automate processes for tracking midterm and end-of-termchanges to leases.

— You must have systems, policies, and controls in place that will stand up tothe scrutiny of a SOX audit.

Also consider how mature your program is. Ask key stakeholders the following ques-tions, and then ask them what their confidence level in the answers is. Would they signtheir name to the numbers provided? The responses you get will provide you with asense of the maturity of your leasing program and the scope of the challenge ahead.

• How many leases do we have?

• Who owns the leasing program?

• Where is leasing data stored?

• When was the last time lease accounting was audited?

• Do we track leases at an asset-level?

Companies might also consider getting an executive briefing on the new leaseaccounting standards from a trusted advisor. Various accounting and software firmshave developed significant expertise in the new standards during the developmentprocess. Another suggestion is to find out if a financial audit or SOX audit has beenperformed on your lease accounting recently. If so, what were the issues?

Step 3: Team StaffingPerhaps the most critical role in the project team will be that of the executive sponsor. Atmost companies, the controller or chief accounting officer is the likely candidate.However, the chief financial officer adds even more weight to the project if his or hertime can be secured. The executive sponsor’s role is not to manage the day-to-dayaspects of the project, but to act as the advocate for the project, championing andcommunicating the rationale for a lease accounting initiative to the various stakeholdersin the business. Initially, the sponsor will help to secure budget and resources.Throughout the project, the sponsor will help to clear obstacles that put milestones orproject goals at risk.

The project manager will work in concert with the executive sponsor, but at a moretactical level. The project manager will host recurring meetings, issue weekly statusreports, and monitor project risks. She or he also will develop the initial implementation

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plan, on-board new project members, and prepare for quarterly executive meetings. Fora lease accounting implementation project, the project manager should be someonewho has prior experience with a global, cross-functional initiative as well as priorknowledge of finance and accounting.

Because many groups in the company will touch a lease during its life cycle, across-functional team should be assembled to participate in the project. Plan to includerepresentatives from the following areas:

• Technical accounting. Will play a critical role in lease accounting softwareselection, policy strategy, and identification and assessment of controls for thenew standards.

• Corporate real estate. The definitive source for property lease terms, pay-ments, and future plans. Understands complex sublease or sale-leaseback ar-rangements that exist.

• Procurement. Responsible for negotiating the pricing and business terms forall new leases, extensions, and end-of-term buyouts/purchases.

• Treasury. Typically owns the financial strategy and policies for leasing toensure the company is making optimal use of its cash.

• IT. Needed to scope upgrades of existing systems and define requirements forpurchases of new lease accounting software.

• Financial reporting. The most impacted by the new standard, as this group isaccountable for meeting the SEC deadlines for implementation.

• Corporate tax. Will need to evaluate the impacts of new accounting standardsto sales, property, and income taxes.

In addition, depending on the types of assets the company leases, it may want to includelogistics, fleet, and operations teams.

Another item to consider with regard to staffing is to identify external businesspartners that will be critical to the project’s success. These might include real estatebrokers and equipment lessors who are closely involved in the day-to-day operations ofyour leasing program. Some companies choose to outsource the project managementaspect of the initiative to a consulting organization with specialized leasing expertise.

Step 4: The Current Leasing ProgramA critical step in a company’s journey toward compliance with the new lease standard isto understand the maturity of its existing leasing program. Some items to considerinclude:

• How does your current accounting process for capital leases work?

• Who provides the data that goes into the notes disclosure for your 10-K today?

• Which of the internal systems store data about leases?

• How is the data kept current and accurate throughout the life cycle of a lease?

• What are the weakest links in the reporting?

• What policies and controls are in place?

• Are they enforced?

• How would leasing perform in a SOX compliance audit?

• What external entities are involved in the leasing process?

• Do you use real estate brokers in some regions?

• Do you use full-service equipment leasing companies?

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Unfortunately, there are no public benchmark studies for a company to compare thematurity of its leasing program to those that are “best in class.� At most organizations,leasing programs have been neglected, with insufficient funding, resources, and over-sight. As a result, it should become obvious what the issues are. Possible assessmentissues include the following:

• Accounting

— What controls, processes, and systems are in place for current notes disclo-sure process?

• Systems

— Do you have a real estate lease administration system?

— Are leases tracked in asset management systems?

• Data quality

— Is data in digital format? Or stored in file cabinets? Spreadsheets? Lessorsystems?

• Controls

— Who can initiate a lease?

— What approvals are required?

— When is a lease-versus-buy analysis conducted?

• Ownership

— Do you have a centralized real estate group?

— Who owns the success of your IT, fleet, and other equipment leasingprograms?

• Processes

— How do business processes vary by geographic region? By the type of assetbeing leased?

— How are non-real estate assets tracked?

A key aspect of assessing a company’s current leasing program is to identify what isbeing leased. The company should consult the following groups to gather a master listof all of its leases:

• Procurement. Every lease has a contract that is negotiated by procurement,legal counsel, and the relevant subject matter experts. These groups shouldhave records on what is being leased.

• Lessors. There is a leasing company or landlord on the other end of everycontract. These lessors definitely know what you are leasing, because they billyou for it on a regular basis.

• Asset owners. Various groups in the organization are accountable for manag-ing your leased assets. This might be IT for laptops and data center gear,corporate real estate for buildings and warehouses, or logistics teams forforklifts and trucks. These asset owners should have a handle on what is beingleased.

• Financial reporting. Financial reporting ensures that leased assets are prop-erly accounted for under the current accounting rules. As a result, they shouldhave records on both capital and operating leases to support the currentdisclosures.

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• Accounts payable. A/P is responsible for ensuring that the invoices for leasesare paid monthly. As a result, the A/P department should know what recurringpayments are being made that could be leases.

Step 5: Defining Project Scope and StrategyNext, a company should define the project scope and strategy. The cross-functionalteam should review the results of the business process assessment with the executivesponsor to recommend how to approach the lease accounting project. Most companieswill choose from the following three options:

• Plan A: Comply. Our leasing program is relatively mature. We need to imple-ment the additional systems, processes, and controls needed for compliance.

• Plan B: Control. Our leasing program is poorly executed. The way we managesystems, processes, and controls would not survive a SOX compliance audit. Weneed to enhance our program while complying with the new standards.

• Plan C: Transform. We want to do more than just comply. A significant savingsopportunity could be realized by overhauling the program at the same time weredesign systems, processes, and controls for the new standards.

It may turn out that the answer is different by asset type. For example, a company’sreal estate leasing program may be quite mature, while the IT, fleet, and equipmentleasing programs are in dire need of attention. In that case, the company might want tosplit the project into multiple subprojects, each focused on different asset types.

Some companies are using the new accounting rules as a reason to reevaluate theirreal estate leasing program. They can ask their team the following questions to assessthe potential impacts of a more effectively managed real estate leasing program:

• Capacity. How quickly are you able to identify and act on excess capacity? Arethere underutilized facilities that could be subleased, consolidated, or disposedof?

• Overbilling. Are you able to identify overcharges on monthly invoices and thenseek reimbursement from the landlord? What percentage of your invoices areincorrect? Are you paying late fees?

• Start dates. Are you overpaying rent by using the wrong start date? Are youusing the contract signature date or the commencement date?

• Notifications. Are you missing out on cost savings opportunities to expand byfailing to notify lessors of your plans?

• Funds recovery. Are you recovering security deposits owed to you at the endof a lease term? Are you consistently collecting rent from sublease tenants?

There may be an opportunity for the company to save millions of dollars per year,not only by solving its lease accounting problem, but by also enabling better real estatelease administration.

Other companies are using the new lease accounting standards as a catalyst forfixing their equipment leasing programs. At many companies, IT, fleet, and equipmentleasing programs have lacked proper ownership, processes, and systems. Ask thefollowing questions to assess the potential financial impacts from a new strategy:

• Lease versus buy. Are you conducting lease versus buy analysis for thesetypes of leases? Are decision makers using the latest market rates and financialvariables? Are the appropriate controls in place to ensure the company ismaking the best economic decisions?

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• End of term. Are you realizing the savings expected from your leasing pro-gram? Are you returning equipment for leases at end of term? How much moneyis being lost to evergreen fees?

• Competitive sourcing. Are you getting the most competitive financing andcontract terms from your leases? How much could you save by leveraging acompetitive bidding process when sourcing new leases?

By solving its lease accounting problem and enabling better equipment leaseadministration, the company might be able to save a considerable amount of money peryear.

With a strong understanding of its current program and a project strategy in place,the company’s next step is to design its business processes and information systems forthe future. Questions to consider include:

• Who owns your leasing program for non-real estate assets? Should IT, fleet, andother equipment leases be unified with a common owner? Should there becommon business processes?

• How are midterm changes being tracked (e.g., sublease, early termination,equipment lost/stolen)? What is the notification process? How will the datanecessary to perform the proper remeasurement be captured?

• How will you track leases at an asset level? Can your systems track if two out offive assets on a lease are terminated at the end of a lease and the other threepieces are renewed under different terms?

• Is leasing data being manually captured and keyed in for each contract? Is therean automated way to abstract lease data from contracts or receive it digitallyfrom lessors?

Companies should document their future state and then identify gaps with thecurrent processes. The gaps should form the basis for new policies, controls, andbusiness processes that need to be implemented. The future state should also providethe key requirements for a lease accounting software application. Best practices includethe following:

• Lease-versus-buy analysis should be conducted using up-to-date financial vari-ables. Leases exceeding a dollar threshold require C-level approval.

• Ensure proper classification of leases based upon the new rules for terms,payments, classifications, etc.

• Eliminate the daisy chain of spreadsheets. Software should be able to produceall your debits and credits in minutes.

• Changes may trigger remeasurement events. All location changes, contractadditions, early terminations, and buyouts should be tracked.

• Lessors and accounting should be notified by contractual deadline of intent torenew or terminate lease (or purchase the asset).

• Invoices should be compared to expected charges based upon contractualterms. Overcharges should be identified followed by request for reimbursement.

There are several additional actions a company might consider. For example, itmight want to conduct a return on investment (ROI) assessment to understand theamount of savings that could be realized by better managing its real estate and/orequipment leasing programs. Also, it might speak to an outsourcing firm about assum-ing responsibility for the day-to-day activities associated with its real estate and/orequipment leasing program. This might lead to a faster ROI.

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Step 6: Budget, Timing, and StaffingAfter steps 1 through 5 have been addressed, the next step is to look at the budgeting.The length of time it will take to complete the lease accounting project depends onseveral factors. Perhaps the most important factor influencing the time line is thecomplexity of the leasing program. To determine how complex it is, ask the followingquestions:

• How many leases do you have? More than 1,000?

• What is your estimate of the volume of “unknown leases�?

• How big is your lease portfolio? More than $100M?

• How long have you been leasing? More than three years?

• How many lessors do you work with? More than 20?

• How many countries do you lease in? More than 10?

The maturity of the current lease accounting is also a key factor impacting the timeline. And, as with any project, the schedule will be heavily influenced by how busy thekey stakeholders are. Shorter projects with less complex leasing portfolios and moremature accounting processes will take 6 to 12 months on average. Longer projects withmore complex leasing portfolios and less mature accounting processes will have a 12- to18-month implementation time frame. Four main budget elements should beconsidered:

1. Financial impact analysis. Invest time to understand the overall financialimpact of the new accounting standards. Budget time to assess the impact toyour credit and debt covenants. Your investor relations team will also need toeducate shareholders on the impact. And you may need to reevaluate yourlease versus buy strategy.

2. Accounting and tax transition. Budget time to analyze each lease to classifyit, identify key terms, and then perform the initial recognition and measure-ment as well as the subsequent accounting. You will also need to identify andassess impacts to sales, property and income taxes across states and countries.Perhaps most importantly, budget time to assess potential embedded leases incurrent service arrangements. Additionally, you should also consider whetheryou will need to hire consultants to assist in the project or manage theimplementation project fully with internal resources.

3. Lease accounting software. Budget for software licenses (or subscriptions)and maintenance fees, as well as costs for the associated server hardware,storage, and database licenses.

4. Data collection and implementation. After you select the software, you willneed to install and customize it, aggregate and upload the data, integrate andtest with other systems, and communicate and train users on the application.Running the new software in parallel with existing systems is also a criticalelement of data testing.

There are a few options for budget estimation. The “top-down� strategy is toestimate the cost of the project as a percentage of the value of the company’s leasingportfolio. If its overall leasing portfolio is $500M or less, then it should plan to spend 1percent on its lease accounting project. If the portfolio is between $500M and $1B, itshould plan to spend 0.75 percent. If the portfolio is greater than $1B, plan to spend 0.5percent.

Another strategy is to use a similar project as a benchmark for what leaseaccounting might cost. For example, the new revenue recognition rules might be a good

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comparison. A third, “bottom-up,� strategy is to budget the individual components of thelease accounting project separately. While more effort will be required, this will likelyresult in a more accurate estimate.

For most companies, there will be no incremental costs associated with thefinancial impact analysis. The activities can be conducted with the existing treasury,finance, and investor relations staff. A simple method to estimate the cost is to assume acertain number of hours per lease. A company can arrive at an estimate by reviewing asample set of leases to discover the average time. Alternatively, it can use industrybenchmarks. For example, a recent study found that two-thirds of companies expect tospend one to three hours per lease on accounting.

With budget secured, the company will be ready to start the implementation phaseof the project. Some of the key tasks in the remainder of the project include selecting asoftware vendor, if needed; selecting an implementation partner; data capture andupload; software testing; updating policies and controls; accounting transition; andtraining and communications. With the program in place, the company can apply thenew lease accounting rules to its portfolio.

STUDY QUESTIONS

5. Generally, who has the most important role on a lease project team?

a. Project manager

b. Executive sponsor

c. Treasurer

d. IT manager

6. Entity XYZ has a poorly executed leasing program that probably would not survive aSOX audit. To define its lease project scope and strategy, which option should it use?

a. Plan A: Comply

b. Plan B: Control

c. Plan C: Transform

d. Plan D: Situational assessment

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35

MODULE 1: TOP ACCOUNTING ISSUES—CHAPTER 3: New Revenue RecognitionStandard¶301 WELCOMEThis chapter provides an overview of the new revenue recognition standard, AccountingStandards Codification (ASC) Topic 606, Revenue from Contracts with Customers. Itexplains the principles that underlie the new model for revenue recognition andhighlights those areas that represent the most significant changes between currentguidance and the new requirements.



• Understand the principles of ASC Topic 606, Revenue from Contracts withCustomers

• Identify the five steps in the new revenue recognition model

• Address key issues in implementing the provisions of ASC Topic 606

• Describe required disclosures for private companies with respect to revenuerecognition

• Identify transition considerations as they relate to business practices

¶303 OVERVIEWIn 2014, the Financial Accounting Standards Board (FASB) issued its new revenuerecognition guidance in Accounting Standards Update (ASU) No. 2014-09, Revenue fromContracts with Customers (Topic 606). In addition, the International Accounting Stan-dards Board (IASB) issued new revenue recognition guidance in IFRS 15, Revenue fromContracts with Customers. The guidance from both boards is very similar.

ASC 606 started by coming up with a principle for revenue recognition. This is incontrast to a prior GAAP, which had about 50 principles, depending on the industry andtransaction. In fact, this is one of the benefits of ASC 606: it is a single model with asingle principle that is intended to apply to all types of revenue recognition, rather thanindustry-based or transaction-based guidance as in the past.

¶304 FIVE STEPS TO REVENUE RECOGNITIONThe core revenue recognition principle (ASC 606-10-05-3) is to recognize revenue todepict the transfer of promised goods or services via contracts with customers in anamount that reflects the consideration to which the entity expects to be entitled inexchange for those goods or services. The ASC 606 model is built around a five-stepprocess:

1. Identify the contract with the customer.

2. Identify the separate performance obligations.

3. Determine the transaction price.

4. Allocate the transaction price to the separate performance obligations.

5. Recognize revenue when (or as) each separate performance obligation issatisfied.

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ASC 606 provides a single framework for all industries and all transactions. If anentity remembers which of the five steps it is dealing with as it addresses an issue,resolving that issue becomes much clearer. The framework is a good starting point anda way to structure all the judgments that need to be made to decide how to recognizerevenue.

Step 1: Identify the Contract with the CustomerThe first step in the process is to define the contract (ASC 606-10-25-1). To haverevenue, the agreement must meet the following criteria:

• It must be an approved agreement between two or more parties that createsenforceable rights and obligations.

— Enforceable is a legal (not accounting) determination.

— The parties must intend to perform obligations.

• It must be written, oral, or implied by customary business practice.

• It must have commercial substance.

• It must identify performance obligations and payment terms.

• Collectability must be “probable.�

There has to be an obligation to provide goods or services on the part of the seller,and an obligation to pay for goods and services on behalf of the buyer. A contract that istruly optional, a contract that can be canceled by both parties without penalty, is not yeta contract for revenue recognition purposes.

Steps 2 through 5 in the revenue recognition process are applied only to the itemsthat are in the contract initially. That means true commitments must be determined.Consider a five-year service contract that is can be terminated after two years. An entitywill account for it as a two-year contract with an option to extend. It will not beaccounted for as a five-year contract until the parties are actually committed to it being afive-year contract. Sometimes the termination is accompanied by a termination fee; if so,the termination fee should be taken into account in evaluating the contract. A two-yearcontract might include the termination fee as part of the fee for the two years of service,or the termination fee might be so high that the customer really would not cancel thecontract. In that case, it might be a five-year contract. That judgment has to be made inorder to decide what will be accounted for while completing step 1 of the analysis.

The new standard also includes guidance on combining contracts. Combiningcontracts is required if the contracts are with the same (or related) customer, and

• The contracts are negotiated as a package with one objective,

• The goods or services are interrelated, or

• The fee in one contract is affected by price or performance on the other.

If the contracts are combined, the combined contract is evaluated as one.

With regard to accounting for modifications of contracts, ASC 606 provides that acontract modification should be accounted for as a separate contract if both of thefollowing conditions exist:

(1) the scope increases because of the addition of distinct promised goods orservices, and

(2) the price of the contract increases in an amount that reflects the entity’s stand-alone selling price of the additional promised goods or services.

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37MODULE 1 - CHAPTER 3 - New Revenue Recognition Standard

The promised goods or services not yet transferred at the date of the contractmodification are accounted for in one of the following ways when a contract modifica-tion is not accounted for as a separate contract:

• A termination of the existing contract and the creation of a new contract, if theremaining goods or services are distinct from the goods or services transferredon or before the date of the contract modification.

• As a part of the existing contract if the remaining goods or services are notdistinct and, therefore, form part of a single performance obligation that ispartially satisfied at the date of the contract modification.

• In a manner that is consistent with the objectives of this paragraph, if theremaining goods or services are a combination of the above.

Step 2: Identify the Separate Performance ObligationsStep 2 of the model is to identify the performance obligations, which are the units ofaccount for recognizing revenue. This process begins by first listing the promises in thecontract (ASC 606-10-25-16 through 25-18). A promise is anything in the contract thatrequires the seller to transfer a good or service to the customer. Activities that do nottransfer goods or services (setup, administration, etc.) are not promises (ASC606-10-25-17). Therefore, performing those activities cannot result in the recognition ofrevenue.

Once the list of items that are promised to be transferred to the customer iscomplete, the next step is to determine whether to account for each of those promisesindividually or in a bundle with other goods and services. The term that ASC 606 uses isdistinct. A good or service is accounted for on its own if it is distinct from otherpromised goods or services. If not, that good or service should be combined with othergoods and services until there is a bundle that is distinct. Two criteria must be met for agood or service, or a group of goods or services, to be considered distinct. The first isthat it is capable of being distinct, that is, it is possible for the customer to benefit fromthe good or service on its own. The second is that it is distinct within the context of thecontract.

The indicators in the standard help identify items that are not distinct in thecontext of the contract. If there are two goods and services that could be used on theirown, but in the contract the customer wants something that the seller is going to makefrom those goods or services, then those goods and services should not be accountedfor separately.

EXAMPLE: Pete contracts to buy a house from Monica. The house’s wood,nails, paint, carpeting, and appliances are capable of being distinct; after all, theyare sold on their own in many transactions. But in this particular transaction, Petedoes not want to buy those things. He wants to buy the house in which thosethings are put together. Therefore, those items will not be accounted for as distinctbecause in the context of the contract, Pete wants the thing (the house) that ismade up of those items.

If one good or service significantly modifies another, it also is not considereddistinct for accounting purposes. The classic example is customized software. To workfor a customer, off-the-shelf software often needs significant modification and customiza-tion, and the seller agrees to do that. The sale of the off-the-shelf software is notaccounted for separately from the customization services. In this case, only the custom-ized software is useful for the customer. Therefore, the software license and thecustomization services are considered together as a single unit of account even thoughother companies might well be able to use the off-the-shelf software.

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Finally, goods and services are not distinct if they are highly interrelated. Thissituation perhaps requires more judgment. Consider the following example.

EXAMPLE: Julie, the owner of Julie’s Hotel, pays Hotel Chain A to managethe hotel. Hotel Chain A staffs the front desk, provides housekeeping services,runs the restaurant, handles security, takes reservations, and processes payments.It performs all the tasks needed to run Julie’s Hotel. While these services arepurchased separately in many transactions, Julie is not interested in buying eachservice separately. She wants Hotel Chain A to perform the services for her.Consequently, the services in the hotel management contract are not accounted forseparately. Instead, Julie will account for a single performance obligation to man-age the hotel.

Step 3: Determine the Transaction PriceStep 3 looks at the other side of the rights and obligations in the contract: the amountthe customer has promised to pay the vendor in exchange for goods and services (ASC606-10-32-2). The transaction price is defined as the amount of consideration that thevendor expects to be entitled to in exchange for transferring the promised goods orservices to the customer. Expects connotes that sometimes items are booked based onhow an entity thinks the transaction price will turn out rather than on what is certain. Inother words, the entity would estimate the outcome based on whatever method bestpredicts the actual fee—and then include amounts, in its estimate of the transactionprice, to the extent that it is probable that doing so will not result in a significantrevenue reversal.

The guidance on variable consideration applies to any contractual provision thatcould change the amount due under the contract, such as volume discounts, rebates,performance penalties and bonuses, and usage base fees.

When it comes to determining the fee or estimating the transaction price, ASC 606provides specific guidance on financing components. To the extent that payment is duesignificantly before or significantly after the transfer of goods and services, the entityshould consider whether there is an implicit loan in the deal. Prepayment would be aloan from the customer to the vendor. Payment significantly in arrears would be a loanfrom the vendor to the customer. If there is a significant financing component, then theentity has to account for it separately by recognizing interest income or expense basedon whether the vendor has borrowed or lent, and that will adjust the amount of revenuethat gets recognized. Therefore, the amount of revenue that gets recognized will notequal the cash payment because the entity has interest income or expense that adjustsit.

Step 4: Allocate the Transaction PriceIn step 4, an entity allocates the transaction price determined in step 3 to the perform-ance obligations identified in step 2 (ASC 606-10-32-31 through 34). The allocation isbased on the relative stand-alone selling price, which is defined as the price at which anentity would sell a promised good or service separately to a customer. To determinerelative stand-alone selling price, the entity should use observable transactions if theyexist. If it sells each performance obligation separately, that will tell it what the stand-alone selling price is. Otherwise, the entity should make its best estimate. The standardoutlines different ways to develop the best estimate of the stand-alone selling pricebased on the circumstances.

ASC 606 differs from ASC 605, Revenue Recognition, in regard to software compa-nies. Under the previous guidance, software companies that did not sell elementsseparately did not allocate them. They just accounted for the elements together, even if

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they were distinct or had stand-alone value. However, under ASC 606, even softwarecompanies will be directed to do their best to come up with a stand-alone selling priceand then allocate items based on that stand-alone selling price.

ASC 606 offers special allocation guidance for variable consideration (ASC606-10-32-39 through 41). Generally, it is allocated proportionally to all performanceobligations. However, if the variable consideration relates only to one performanceobligation, or only to some but not all performance obligations in the contract, then thevariable consideration will be allocated to the performance obligation that it is reallybased on.

Some performance obligations are actually a series of distinct items. Consider thehotel management contract example presented earlier in this chapter. The hotel man-agement contract might have the vendor managing the hotel for five years. Butrealistically, the vendor is doing the same kinds of things every year, every quarter,every month. The contract could have been written for two years instead of five, or forone year, or for six months. Those services could be purchased for any proportion oftime. The services performed today—for example, the cleaning and the processing ofpayments—are distinct from the cleaning and payment processing that will be donetomorrow. The customer benefits from the services as they are performed and does notneed the rest in order to benefit from what has already been done. Nonetheless, thathotel management contract would be accounted for as a single performance obligationbecause it is much easier than accounting for, for example, each day in the five-yearcontract as a distinct performance obligation.

When a performance obligation is a series of distinct goods or services, there mayalso be a consideration that is variable based on the performance of a portion of theseries. The hotel management contract may specify that the payment due is a fixedpayment plus 2 percent of revenues generated each month. It would be complicated totake that 2 percent of revenues generated each month and allocate it across the entirefive-year contract. ASC 606 states that is not necessary. Where there is a variableconsideration that is calculated based on a portion of a series, it can be allocated solelyto the portion of the series on which it is calculated. In other words, the monthlyconsideration is recognized in the month that it is earned.

Note that this is done only if the result of applying it is reasonable. For a five-yearservice contract with a bonus paid each quarter, each quarter’s bonus would beallocated to that quarter; there is no need to allocate it across the five years. However, ifthe five-year contract had only a bonus based on first-quarter results, it would beunreasonable to allocate that entire bonus all to the first quarter. It should be spreadacross a longer portion of the contract.

Step 5: Recognize Revenue as Each Separate PerformanceObligation Is SatisfiedIn step five, we finally get to recognize revenue when each performance obligation issatisfied. An obligation is satisfied when control over the good or service is transferredto the customer. Control is the ability to direct use of the asset and obtain substantiallyall benefits from it. ASC 606 says that revenue is recognized as performance obligationsare satisfied either at a point in time or over time. Generally, if a performance obligationis satisfied over time, revenue is recognized earlier, as delivery or completion are notnecessary. However, if the performance obligation is satisfied at a point in time,generally that point in time is when the work is done.

ASC 606 provides three factors to consider in deciding whether a performanceobligation should be deemed to be satisfied at a point in time or over time. If any ofthese factors exist, then the performance obligation is considered to be settled and

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satisfied over time rather than at a point in time. Transfer of control occurs over time if(ASC 606-10-25-17):

• The customer benefits as performance occurs.

• The customer controls asset the vendor is creating or enhancing.

• The seller’s work does not create an asset with alternative use, and the vendorhas the right to payment for work to date if the customer cancels.

The last factor is new and is producing some interesting situations, particularly withentities that create custom goods for their customers. Take the following as an example.

EXAMPLE: Company G makes car seats for one make and model of car; itscar seats fit that make and model and no other. In this case, the goods that theCompany G is making do not have an alternative future use.

Similarly, a good would not have an alternative future use if the seller was contractuallyprohibited from selling it to anyone else.

When an obligation is satisfied over time, revenue is recognized based on a singlemeasure of progress, such as cost, hours of work, or number of actions that haveoccurred (ASC 606-10-25-31 through 37; 606-10-55-16 through 21).

COMMENT: Note that this does not always generate a constant growthmargin. It is not equivalent to applying percentage of completion under ASC 605.Under ASC 605, a constant gross margin is generated from applying percentage ofcompletion. Under 606, a constant gross margin might be generated, but only ifcost is the best measure of progress.

Again, the measure of progress chosen must be one that most faithfully depicts thetransfer of goods and services to the customer. A single measure of progress must bechosen for each performance obligation; different measures of progress cannot be usedfor different payment streams.

If an obligation is not satisfied over time, then it will be satisfied at a point in time(ASC 606-10-25-30). That point in time is when control of the item passes to thecustomer. Note that this is based on control, not on risks and rewards. Indicators thatcontrol has transferred include the following:

• The customer has legal title.

• The vendor has a right to nonrefundable payment.

• The customer has physical possession.

• The customer has significant risks/rewards of ownership.

Control transfers ahead of acceptance only if the vendor can objectively determine thatthe terms are met (ASC 606-10-55-85 through 87).

Sometimes there are arrangements with distributors regarding the way they will becompensated if certain things happen. Such arrangements often result in the “sell-through method� of revenue recognition, where revenue is not recognized when themanufacturer ships goods to the distributor, but rather when the distributor ships thegoods on to its customer. Under ASC 606, if the distributor has control, revenue isrecognized.

As a result, ASC 606 causes revenue to be recognized faster than under ASC 605.The FASB and the IASB decided that some of the existing revenue recognition rulesinappropriately delayed revenue recognition. Consequently, they sought to make thesituation more balanced.

The FASB and the IASB essentially decided that for some licenses for intellectualproperty (IP), the revenue should be recognized up front. For others, it should be

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recognized over time (606-10-55-54 through 64; as amended by ASU 2016-10). “Sym-bolic� IP is valuable largely because of its association with the licensor (e.g., brand,logo, copyrighted character). Symbolic IP’s value can be affected by licensor activity.Revenue is therefore recognized over term. “Functional� IP is valuable primarily be-cause of something it does (e.g., software, film, music). The licensor typically does notaffect the IP’s usefulness, and therefore revenue is usually recognized up front. How-ever, if it is clear that ongoing activities will affect the licensed IP, revenue is recognizedover term. Sales- or usage-based royalties from contracts where the value is largely IPlicenses are recognized only when the sale or use occurs.

STUDY QUESTIONS

1. Which of the following identifies the first step in the new revenue recognitionmodel?

a. Identify the contract with the customer.

b. Identify the performance obligations in the contract.

c. Determine the transaction price.

d. Allocate the transaction price to the performance obligations in the contract.

2. Each of the following statements with respect to step 5 (i.e., recognizing revenue) iscorrect, except:

a. Entities can use multiple measures for multiple payments streams.

b. The method must faithfully depict the transfers of goods and services.

c. Entities should focus on control instead of risk and rewards.

d. Entities should ignore activities that do not relate to performance.

¶305 OTHER ITEMSThe ASC 606 guidance on warranties (ASC 606-10-55-30 through 35) is generally thesame as in current U.S. GAAP. There is guidance in the new standard on contract costs.It provides a framework to evaluate the costs of complying with contracts that are nototherwise addressed. It does provide for deferral of costs in some situations, but onlysituations that are specifically laid out and only direct costs.

Guidance on rights of return is generally the same as it has been in the past. UnderASC 606-10-55-22 through 29, a right of return is treated like a variable consideration.An entity should:

• Record revenue for amounts that are probable of not being returned.

• Record refund liability (and asset for goods to be returned) for amounts that arenot probable of not being returned.

There is new guidance on “breakage� (ASC 606-10-55-46 through 49). What if thecustomer does not take advantage of all of the goods and services it is entitled to? Withregard to gift cards, for example, usually a percentage is not going to be redeemed.How does an entity recognize revenue when it expects breakage? If it is probable thatall the goods and services the customer has a right to are not going to be provided,revenue can be recognized based on the entity’s estimates. If it believes that 10 percentof gift cards will go unredeemed, it would recognize a $1.10 of revenue when somebodycashes in a dollar of gift card money.

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ASC 606’s guidance on customer options basically states that if a customer has anoption to buy more goods and services than it is committed to, and that option is at adiscount to what the customer might otherwise be able to buy at, then the option mayrepresent a material right and the entity must allocate value to that material right (ASC606-10-55-41 through 45). Entities should estimate the price of the option based on theterms of the offer, the likelihood of exercise, and the discount available to others. If theoption is for an additional quantity or time period for same goods or services, the entitymay just estimate total goods or services to be provided and allocate accordingly.

For consignment sales (ASC 606-10-55-79 and 80), the focus in Topic 606 is onwhether the customer has “control� and “unconditional obligation to pay�; the result isvery similar to existing U.S. GAAP. For bill and hold sales (ASC 606-10-55-81 through84), the guidance is similar to current U.S. GAAP but less explicit. It may require theseparation of the promise to hold goods (custodial service).

There are likely to be questions around gross versus net presentation and perform-ance obligations (ASC 606-10-55-36 through 55-40). Entities should carefully considerthese areas along with other implementation issues specific to their facts and circum-stances. As clarified in ASU 2016-08, the principle is to recognize gross presentation ifthe reseller controls the good or service before transfer to the customer. Indicators ofcontrol include whether the entity is the primary obligor, has inventory risk, orestablishes the price. While the new ASC 606 guidance is somewhat similar to currentGAAP, the focus on “control of the good or service� may change some answers.

¶306 CONTRACT COSTSThe FASB has provided general guidance (Topic 340, Other Assets and Deferred Charges,Subtopic 340-40, Contracts with Customers) on accounting for contract costs, which willresolve some of the existing uncertainty and diversity. Costs incurred in fulfilling acustomer contract might involve the creation of an asset as defined in other parts of U.S.GAAP (e.g., inventory; property, plant, and equipment; or software) that should beaccounted for according to that guidance. Costs that cannot be recognized as an assetunder other parts of U.S. GAAP (e.g., preproduction costs under a long-term supplyarrangement) cannot be recognized as a cost of the customer contract.

Costs incurred in fulfilling a contract that are not addressed in other parts of thestandards should be recognized as an asset if they meet all of the following criteria:

• They relate directly to a contract or to an anticipated contract.

• They generate or enhance resources that will be used in satisfying or incontinuing satisfying performance obligations in the future.

• They are expected to be recovered.

Costs that relate directly to a contract include direct labor; direct materials; allocationsof costs directly related to the contract or to contract activities; costs that are explicitlychargeable to the customer under the contract; and other costs that are incurred onlybecause the entity entered into the contract (e.g., payments to subcontractors).

¶307 PRESENTATIONThe most significant part of the balance sheet presentation guidance (ASC 606-10-45)surrounds the treatment of a contract asset or liability. Any contract under which eitherof the parties has performed results in the recognition of either a contract asset, acontract liability, or a receivable, depending on the relationship between the entity’sperformance and the customer’s payment.

A contract asset should be recorded if a vendor satisfies a performance obligation(and therefore recognizes revenue) ahead of payment. When the entity becomes

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entitled to payment (i.e., has an unconditional right to consideration), the contract assetis classified as a receivable, whether invoiced or not. A contract asset should beassessed for impairment in accordance with Topic 310, Receivables. A contract liabilityshould be recorded if the customer pays all or a portion of the transaction price ahead ofperformance. A contract liability would also be created to represent the portion of goodsthat is estimated to not meet customer acceptance or warranty criteria. The contractliability would be settled, and revenue recognized, when the entity satisfies its perform-ance obligation. The contract asset or liability would encompass the amounts that mightbe reflected as deferred revenue or unbilled receivables under current GAAP.

A receivable should be recognized whenever an unconditional right to paymentpursuant to the terms of the contract exists. Recording a receivable would adjust thecontract asset or liability if the entity’s right to payment becomes unconditional forreasons other than because of the satisfaction of a performance obligation. Becausethere is no guidance in current GAAP, practice varies. The new guidance will likelyimprove consistency.

¶308 DISCLOSURESTopic 606 has a large number of disclosure requirements (ASC 606-10-50). The newguidance replaces most of the revenue recognition disclosures currently required with asingle set of detailed disclosure requirements. ASC 606 also establishes an overallobjective for disclosure requirements: to enable users of financial statements to under-stand the nature, amount, timing, and uncertainty of revenues and cash flows fromcustomer contracts.

Disclosures under ASC 606 fit into two broad categories: qualitative and quantita-tive. Disclosures include qualitative and quantitative information about all of thefollowing:

• Revenue from contracts with customers (as distinct from any other revenue)

• Receivables, contract assets, and contract liabilities:

— Opening and closing balances

— Losses from impairments of receivables or contract assets

• Assets from costs to obtain or fulfill contracts

— Closing balances

— How amounts to capitalized were determined

— Amortization and impairment

• Interim disclosures

When preparing disclosures, entities must consider the level of detail needed andthe amount of emphasis to place on each of the disclosure requirements. Disclosuresshould be aggregated or disaggregated so that useful information is not obscured byinsignificant details or the aggregation of items that have substantially different charac-teristics. The disclosure requirements are broad because the requirements apply tomany industries, and disclosures may be applicable to some entities and not to otherentities. Specific disclosures are required for interim periods.

Disaggregated information disclosures include:

• Revenue disaggregated into categories (by segment) that reflect different re-sponses to economic factors

— Customer type, contract duration, timing of transfer of goods/services, typeof fee, etc.

— Multiple breakdowns may be necessary.

— Private companies may just use over time versus point in time.

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Transaction price disclosures include:

• Methods, inputs, and assumptions used to determine the transaction price instep 3, including:

— Whether there is a financing component, and how determined

— How variable consideration is estimated, and how the company determinedwhat amounts are probable of becoming due

— How non-cash consideration was measured

— How refund and return obligations were measured

• Private companies need only discuss how probable the amount of variableconsideration was determined to be.

Information to be disclosed about the allocation of the transaction price includes:

• How stand-alone selling prices were estimated

• Whether the allocation is based on relative stand-alone selling prices or adjustedin some way

• How discounts and variable consideration were allocated

For performance obligations satisfied over time, an entity must disclose the meth-ods used as well as explain why those methods are appropriate (although privatecompanies may omit this.) For performance obligations satisfied at a point in time, thejudgments made in determining the right point in time must be disclosed (althoughprivate companies may omit this.) For bill-and-hold arrangements, entities must providea specific discussion of when the performance obligations are satisfied.

Quantitative disclosures required on interim basis include:

• Disaggregated revenue

• Opening and closing balances of contract assets and liabilities

• Amount of revenue recognized in current period that was included in thecontract liability balance

• Amounts related to remaining performance obligations

• Adjustments to revenue in current period related to performance that wassatisfied in a prior period

STUDY QUESTION

3. Entities are required to disclose information about the methods, inputs, and assump-tions used for which of the following?

a. Assessing whether fixed consideration is constrained

b. Determining the transaction price

c. Determining discount rates used in significant financing components of acontract

d. Assessing the value of promised goods or services in material contracts

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¶309 TRANSITION CONSIDERATIONSThe FASB has provided two methods for applying the new guidance:

• Retrospectively to each prior reporting period presented in accordance with theguidance on accounting changes in paragraphs 250-10-45-5 through 45-10; or

• Retrospectively with the cumulative effect of initially applying ASU 2014-09recognized at the date of initial application.

For reporting periods that include the date of initial application, an entity shoulddisclose the nature of and reason for the change in accounting principle and provideboth of the following disclosures if the new guidance is applied retrospectively with acumulative effect adjustment:

1. The amount by which each financial statement line item is affected in thecurrent reporting period by the application of ASU 2014-09 as compared withthe guidance that was in effect before the change; and

2. An explanation of the reasons for significant changes identified in item 1directly above.

For purposes of the transition guidance above:

1. The date of initial application is the beginning of the reporting period in whichthe entity first applies ASU 2014-09; and

2. A completed contract is a contract for which all (or substantially all) of therevenue was recognized in accordance with revenue guidance that is in effectbefore the date of initial application.

An entity may elect to apply the new guidance using the same transition method orapply a different one to contracts with customers than to contracts with noncustomers.For example, an entity could elect to apply the new guidance retrospectively to eachreporting period to contracts with customers (i.e., contracts within the scopes of thistopic and Subtopic 340-40 on other assets and deferred costs—contracts with custom-ers) and retrospectively with a cumulative effect adjustment to contracts with noncus-tomers (such as contracts within the scope of Subtopic 610-20 on gains and losses fromthe derecognition of nonfinancial assets).

If an entity elects to apply a different transition method to contracts with customersthan to contracts with noncustomers, it should disclose that election and provide theappropriate disclosures associated with each transition method. An entity also may electto apply different practical expedients to contracts with customers than to contracts withnoncustomers.

¶310 CONCLUSIONASC Topic 606, Revenue from Contracts with Customers, introduces a new model forrevenue recognition from contracts with customers. The new principles-based modelreplaces most of the existing U.S. GAAP revenue recognition guidance and applies to allentities and industries (with some specific exceptions). To successfully implement thenew guidance, entities should form a cross-functional team that includes representativesfrom accounting and finance, tax, legal, sales, human resources, and informationtechnology.

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47

MODULE 1: TOP ACCOUNTING ISSUES—CHAPTER 4: FASB Outlook¶401 WELCOMEThis chapter discusses the latest releases from the Financial Accounting StandardsBoard (FASB). Selected accounting standards are highlighted, and the FASB agendaand future challenges for the accounting and auditing profession are also discussed.



• Identify the latest issuances from the FASB

• Recognize the benefits of the FASB’s proactive outreach with stakeholders

• Summarize the latest implementation guidance for major accounting standards

• Recognize FASB guidance and challenges to expect in the near future

¶403 INTRODUCTIONIn the last several years, almost every professional standard for the accounting profes-sion has changed. In 2009, the FASB began the major process change to the AccountingStandards Codification and began promptly issuing Accounting Standards Updates(ASUs). The FASB has certain basic concepts that apply to all financial applications.This is true whether the engagements are audits, reviews, or compilations. The con-cepts are as follows:

• Materiality

• Misstatement

• Measurement

• Disclosure

• Form and content

• Basis of accounting

The U.S. Securities and Exchange Commission (SEC) Staff Accounting Bulletin,SAB-99, on materiality stated that the problem with materiality is that there is noauthoritative formulation for determining what is material in a financial statementengagement. There are several different definitions of materiality, and all focus on theidea that materiality is the point in time when the outcome of a transaction wouldchange someone’s opinion about that transaction, or change someone’s view of whatthat transaction really is.

Preventing material misstatement, some have said, is the main reason the account-ing profession exists. If there is a difference in an amount determined in accordancewith generally accepted accounting principles (GAAP) and an entity’s financial state-ments, then that is considered a misstatement. The measurement concept includesseveral different varieties of measurement, including historical cost, accrual versuscash, tax versus GAAP, international, liquidation basis of accounting, estimated valuebasis of accounting, and several others. Even the tax law can be looked at in twodifferent measures: cash basis and accrual basis. Measurement can change what ismaterial and what is a misstatement as well, depending on the reporting and how it isdone.

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Further, disclosures come into play with all of these concepts. Disclosures are,primarily, management’s responsibility. The accountant’s or auditor’s responsibility is tolook at the disclosure and determine if it is reasonable and appropriate given thesituation as well as in accordance with the disclosure guidance prescribed within thevarious ASC topics.

The form and content of financial statements has continued to change, slightly. Thenot-for-profit industry is a prime example of an industry where form and content haschanged dramatically over the last 15 to 20 years. It changed from a funds format to anet asset format, with three types of net assets: restrictive, unrestrictive, and tempora-rily restrictive. Recently, there has been a change to two types of net assets: un-restricted and restricted.

Most accounting professionals think of two bases of accounting, cash and accrual.There are, really, many different bases of accounting. However, there is no authoritativebasis other than the accrual basis; GAAP focuses primarily on the accrual basis ofaccounting. Again, the interesting point about these concepts is that they apply to allfinancial statements.

In May 2008, the AICPA Council approved International Financial Reporting Stan-dards (IFRS) as issued by the International Accounting Standards Board (IASB) asacceptable GAAP in the United States. The IASB is an independent, privately funded,accounting standard-setter based in London, England. It was founded on April 1, 2001,as the successor to the International Accounting Standards Committee (IASC). It isresponsible for developing IFRS (the new name for International Accounting Standardsissued after 2001) and promoting the use and application of these standards.

Russell G. Golden, FASB Chairman, noted the following in August 2015: “In thepast six months, it has become increasingly clear that the United States is unlikely toadopt International Financial Reporting Standards, or offer U.S. public companies theoption to use IFRS when they file their financial statements with the Securities andExchange Commission.� In May 2015, SEC Chief Accountant James Schnurr told anaudience at an accounting conference at Baruch College that “There is virtually nosupport to have the SEC mandate IFRS for all registrants.� He added, “There is littlesupport for the SEC to provide an option allowing domestic companies to prepare theirfinancial statements under IFRS. Based on what I hear from stakeholders, I agree withthat assessment.�

Many jurisdictions around the world have adopted the international standardsdeveloped by the IASB. However, some countries that are home to major capitalmarkets—Japan, for example—continues to permit businesses to choose among avariety of approaches to accounting, including distinct national versions of GAAP. InJapan, companies may file financial reports using IFRS, U.S. GAAP, Japanese GAAP, orJapanese Modified International Standards. While a mandate that the United Statesadopt IFRS is increasingly unlikely, there is still a strong connection to the internationalside as both U.S. standards and international standards continue to be developed withconvergence (or some version thereof) in mind.

¶404 IMPLEMENTING NEW ACCOUNTINGSTANDARDSAn important part of the FASB’s mission of developing high-quality standards ismonitoring the implementation process. The FASB accomplishes this by assistingpreparers and other practitioners in their understanding and ability to consistently apply

¶404

49MODULE 1 - CHAPTER 4 - FASB Outlook

new standards. As part of positioning organizations for a successful and smoothtransition to new standards, the FASB undertakes a variety of initiatives focused on:

• Educating its stakeholders

• Helping preparers and practitioners interpret the standards

• Making any necessary clarifications to the standards to address unintendedconsequences, if any.

One example of the FASB monitoring implementation was in the going concern area.The FASB looked at going concerns and realized there was a problem: What if a goingconcern issue, or liquidation, in an entity is immediate, meaning that it has happened, ishappening, or will happen very soon? As a result, the FASB issued a standard in 2013that provided if the liquidation is imminent, the liquidation basis of accounting must beused and certain disclosures are required.

¶405 CONDUCTING OUTREACH WITHSTAKEHOLDERSStakeholder outreach is a key component of the standard-setting process, especiallyafter a standard is issued. Proactive outreach helps the FASB educate stakeholdersabout the standard. It also helps the FASB better understand what implementation-related questions professionals have—especially recurring questions. This type ofoutreach also helps the FASB learn about implementation concerns firsthand, so it canaddress them efficiently. FASB stakeholder outreach initiatives include:

• Meeting individually with preparers, auditors, and regulators

• Addressing preparer organizations through small group meetings

• Issuing “plain English� educational materials, such as videos and fact sheets

• Discussing implementation progress with FASB’s advisory groups

• Presenting at conferences to explain new standards

• Participating in continuing professional education (CPE) provider training ses-sions to train providers on how to educate their stakeholders about the standard(“train the trainer�)

• Conducting its own CPE webcasts for preparers and auditors

¶406 TRANSITION RESOURCE GROUPForming a Transition Resource Group (TRG) early in the standard-setting process helpsthe FASB do the following:

• Avoid having to make revisions to a standard after it is issued.

• Reduce diversity in practice.

• Proactively address preliminary cost-benefit concerns.

TRGs give stakeholders a forum to learn about a new standard from others who areimplementing it. Through a TRG, stakeholders can submit implementation issues forpublic discussion—and the TRG can address issues that many other practitioners mightface. TRGs are not established for all standards; they are most useful for comprehensivestandards that have significant and broad changes. For example, a TRG was establishedfor the new revenue recognition standard as well as the standard related to credit losseson financial instruments.

The FASB also offers a technical inquiry service for implementation questions.Technical inquiries, usually in the form of comment letters and other communications,are critical to the FASB’s ability to develop the best standard-setting solutions. These

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inquiries also help the FASB to determine which implementation issues might be raisedand to identify recurring themes and questions. In addition, technical inquiries givestakeholders input on applying the standards to their specific circumstances.

STUDY QUESTIONS

1. Which of the following statements about the International Financial ReportingStandards (IFRS) is correct?

a. Few jurisdictions around the world have adopted IFRS.

b. IFRS is mandatory in Japan.

c. The United States has been mandated to adopt IFRS.

d. U.S. accounting standards have been converging with IFRS.

2. Transition Resource Groups (TRGs):

a. Are established for all accounting standards

b. Are established by the AICPA

c. Give stakeholders a forum to learn about new accounting standards

d. Submit technical inquiries about accounting standards

¶407 IMPLEMENTATION GUIDANCE FOR MAJORSTANDARDSThe FASB has released implementation guidance on a number of standards, includingthose for revenue recognition, leases, credit losses, not-for-profit financial reporting,hedge accounting, the Tax Cuts and Jobs Act, and other standards.

Revenue RecognitionRevenue is one of the most important measures used around the globe to asses anentity’s performance. However, GAAP and IFRS revenue recognition guidance differed,and many believed both standards were in need of improvement. GAAP had complex,detailed, and disparate revenue recognition requirements for specific industries, such assoftware and real estate. As a result, different industries were using different accountingfor economically similar transactions. On May 28, 2014, the FASB and the IASB issuedconverged guidance on recognizing revenue in contracts with customers. The FASBissued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts withCustomers (Topic 606), a major achievement in the boards’ efforts to improve this areaof financial reporting.

The objective of ASU 2014-09 is to establish principles to report useful informationabout the nature, amount, timing, and uncertainty of revenue from contracts withcustomers. The new guidance:

• Removes inconsistencies and weaknesses in existing revenue requirements

• Provides a more robust framework for addressing revenue issues

• Improves comparability of revenue recognition practices across entities, indus-tries, jurisdictions, and capital markets

• Provides more useful information to users of financial statements throughimproved disclosure requirements, and

• Simplifies the preparation of financial statements by reducing the number ofrequirements to which an organization must refer.

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Effective dates. For public organizations, the new revenue recognition guidance iseffective for annual reporting periods beginning after December 15, 2017, includinginterim reporting periods within that reporting period. ASU 2015-14, Revenue fromContracts with Customers (Topic 606), Deferral of the Effective Date, deferred the originaleffective date of December 15, 2016, by one year. Early application is permitted as of theoriginal effective date.

A public organization is any of the following:

• A public business organization

• A not-for-profit organization that has issued, or is a conduit bond obligor for,securities that are traded, listed, or quoted on an exchange or an over-the-counter market

• An employee benefit plan that files or furnishes financial statements to the SEC

For nonpublic companies and organizations (including not-for-profits), the newguidance will be required for annual reporting periods beginning one year later, afterDecember 15, 2018, and for interim and annual reporting periods after those reportingperiods. Nonpublic companies and organizations may early-elect, but no earlier than theeffective date for public entities.

LeasesASU 2016-02, Leases (Topic 842), issued on February 25, 2016, requires that organiza-tions that lease assets (lessees) recognize on the balance sheet the assets and liabilitiesfor the rights and obligations created by those leases. Under the new guidance, a lesseewill be required to recognize assets and liabilities for leases with lease terms of morethan 12 months.

Consistent with current GAAP, the recognition, measurement, and presentation ofexpenses and cash flows arising from a lease primarily depend on whether the lease isclassified as a finance or operating lease. However, unlike current GAAP—whichrequires only capital leases to be recognized on the balance sheet—the new ASUrequires both types of leases to be recognized on the balance sheet. (Note that in thenew standard, capital leases are known as finance leases; operating leases are still knownas operating leases.) ASU 2016-02 also requires disclosures to help investors and otherfinancial statement users better understand the amount, timing, and uncertainty of cashflows arising from leases. These disclosures include qualitative and quantitative require-ments, providing additional information about the amounts recorded in the financialstatements.

Lessor accounting is largely unchanged from current GAAP. However, the ASUcontains some improvements to align lessor accounting with lessee accounting and withthe updated revenue recognition guidance issued in 2014.

The new guidance establishes the principles to report transparent, economicallyneutral information about the assets and liabilities arising from leases. The newguidance:

• Results in a more faithful representation of the rights and obligations arisingfrom leases by requiring lessees to recognize the lease assets and lease liabili-ties that arise from leases in the statement of financial position and to disclosequalitative and quantitative information about lease transactions, such as infor-mation about variable lease payments and options to renew and terminate leases

• Results in fewer opportunities for organizations to structure leasing transactionsto achieve a particular accounting outcome on the statement of financial position

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• Improves understanding and comparability of lessees’ financial commitmentsregardless of the manner in which they choose to finance the assets used intheir businesses

• Aligns lessor accounting and sale and leaseback transactions guidance moreclosely with comparable guidance in Topic 606, Revenue from Contracts withCustomers, and Topic 610, Other Income

• Provides users of financial statements with additional information about lessors’leasing activities and lessors’ exposure to credit and asset risk as a result ofleasing

• Clarifies the definition of a lease to address practice issues that were raisedabout the previous definition of a lease and to align the concept of control, as it isused in the definition of a lease, more closely with the control principle in bothTopic 606 and Topic 810, Consolidation.

ASU 2016-02 affects any organization that enters into a lease or sublease, with a fewexemptions. Because a lease is defined as a contract, or part of a contract, that conveysthe right to control the use of identified property, plant, or equipment (an identifiedasset) for a period of time in exchange for consideration, this guidance does not apply tothe following types of leases:

• Leases to explore for or use minerals, oil, natural gas, and similar nonregenera-tive resources (see Topic 930, Extractive Activities—Mining, and Topic 932,Extractive Activities—Oil and Gas)

• Leases of biological assets, including timber (see Topic 905, Agriculture)

• Leases of inventory (see Topic 330, Inventory)

• Leases of assets under construction (see Topic 360, Property, Plant, andEquipment)

Effective dates. The new guidance is effective for fiscal years beginning after Decem-ber 15, 2018, including interim periods within those fiscal years, for any of the following:

• A public business entity, as defined in GAAP

• A not-for-profit entity that has issued, or is a conduit bond obligor for, securitiesthat are traded, listed, or quoted on an exchange or an over-the-counter market

• An employee benefit plan that files financial statements with the SEC

For all other organizations, the new guidance is effective one year later, for fiscalyears beginning after December 15, 2019, and interim periods within fiscal yearsbeginning after December 15, 2020. All organizations can elect early application.

Credit LossesOn June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses(Topic 326). This update was issued to improve financial reporting by requiring timelierrecording of credit losses on loans and other financial instruments held by financialinstitutions and other organizations.

Current GAAP requires an incurred loss methodology for recognizing creditlosses, but it delays recognition on other losses until it is probable that a loss has beenincurred. This model has been criticized for restricting an organization’s ability torecord credit losses that are expected but do not yet meet the “probable� threshold. Theglobal financial crisis in 2008 through 2011 highlighted this. Financial statement userswere estimating expected credit losses using forward-looking information and devaluingfinancial institutions before accounting losses were recognized. This brought to lightthe fact that the information needs of users differed from what GAAP actually required.

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Preparers were frustrated during this period because they could not record creditlosses that they were expecting because the “probable� threshold had not been met.

In 2008, the FASB and the IASB formed a Financial Crisis Advisory Group (FCAG)to give suggestions on how to improve financial reporting in response to the financialcrisis. The FCAG’s project focused on better aligning the financial reporting for creditlosses with financial statement users’ information needs. Throughout the project, theFASB solicited feedback on several approaches to meeting this objective. It emphasizedthe scalability of the standard and considered feedback from organizations of all sizes,including community banks and credit unions.

Under ASU 2016-13, organizations must measure all expected credit losses forfinancial instruments held at the reporting date based on historical experience, currentconditions, and reasonable and supportable forecasts. The new guidance does thefollowing:

• Eliminates the probable initial recognition threshold in current GAAP and,instead, reflects an organization’s current estimate of all expected credit lossesover the contractual term of its financial assets

• Broadens the information an entity can consider when measuring credit lossesto include forward-looking information

• Increases usefulness of the financial statements by requiring timely inclusion offorecasted information in forming expectations of credit losses

• Increases comparability of purchased financial assets with credit deterioration(PCD assets) with other purchased assets that do not have credit deteriorationas well as originated assets because credit losses that are expected will berecorded through an allowance for credit losses for all assets

• Increases users’ understanding of underwriting standards and credit qualitytrends by requiring additional information about credit quality indicators by yearof origination (vintage)

• For available-for-sale debt securities, aligns the income statement recognition ofcredit losses with the reporting period in which changes occur by recordingcredit losses (and subsequent changes in credit losses) through an allowancerather than a write-down

ASU 2016-13 affects organizations that hold financial assets and net investments inleases that are not accounted for at fair value with changes in fair value reported in netincome. It affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assetsnot excluded from the scope that have the contractual right to receive cash.

Effective dates. For public business entities that are SEC filers, the new guidance iseffective for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2019. For public business entities that are not SEC filers, it is effective forfiscal years, and interim periods within those fiscal years, beginning after December 15,2020. For all other organizations, ASU 2016-13 is effective for fiscal years beginningafter December 15, 2020, and for interim periods within fiscal years beginning afterDecember 15, 2021. Early application is allowed for all organizations for fiscal years, andinterim periods within those fiscal years, beginning after December 15, 2018.

Not-for-Profit Financial ReportingASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements ofNot-for-Profit Entities, issued on August 18, 2016, is intended to simplify how a not-for-profit organization classifies its net assets, as well as the information it presents infinancial statements and notes about its liquidity, financial performance, and cash flows.

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The new guidance was issued in response to stakeholder concerns about problemsassociated with the not-for-profit financial reporting model, such as:

• Complexities associated with the required three classes of net assets

• Deficiencies in the transparency and utility of information in assessing anorganization’s liquidity

• Inconsistencies in the information provided about expenses

• Misunderstandings about (and limited usefulness of) the statement of cashflows

ASU 2016-14 improves how not-for-profits communicate their financial performanceand condition to stakeholders; reduces the costs and complexities in preparing financialstatements; provides more relevant information about resources and changes in re-sources of not-for-profits by simplifying the face of financial statements and enhancingdisclosures in the notes; and improves users’ assessments of liquidity, financial perform-ance, availability of resources to meet cash needs for general expenditures, serviceefforts and ability to continue to provide services, and execution of stewardship respon-sibilities and other aspects of management performance.

Specifically, the new guidance:

• Revises the net asset classification scheme to two classes (net assets with donorrestrictions and net assets without donor restrictions) instead of the previous three

• Enhances disclosures for self-imposed limits on the use of resources withoutdonor-imposed restrictions and the composition of net assets with donorrestrictions

• Updates the accounting and disclosure requirements for underwater endow-ment funds

• Requires net presentation of investment expenses against investment return onthe statement of activities and eliminates the requirement to disclose investmentexpenses that have been netted

• Requires the presentation of expenses by nature as well as function, includingan analysis of expenses showing the relationship between functional and naturalclassification for all expenses

• Requires qualitative disclosures on how a not-for-profit manages its availableliquid resources

• Requires quantitative disclosures that communicate the availability of financialassets to meet cash needs for general expenditures within one year of thebalance sheet date

• Allows for a choice between the direct and indirect method of reporting operat-ing cash flows; presentation of the indirect reconciliation is no longer required ifusing the direct method.

ASU 2016-14 affects not-for-profit organizations (e.g., charities, foundations, col-leges and universities, healthcare providers, religious organizations) and the users oftheir general purpose financial statements.

Effective dates. ASU 2016-14 is effective for annual financial statements issued forfiscal years beginning after December 15, 2017, and for interim periods within fiscalyears beginning after December 15, 2018. Application to interim financial statements ispermitted but not required in the initial year of application. Early application is allowed.

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Hedge AccountingOn August 28, 2017, the FASB completed its Accounting for Financial Instruments:Hedging project by issuing ASU 2017-12, Derivatives and Hedging (Topic 815): TargetedImprovements to Accounting for Hedging Activities. The new standard addresses con-cerns about applying hedge accounting and its limitations for hedging both nonfinancialand financial risks. Financial statement users’ concerns about the way hedging activitiesare reported in financial statements are also addressed by the new standard.

The FASB wanted to better align the accounting rules with a company’s riskmanagement activities and to simplify the application of the hedge accounting standard.The new guidance improves the financial reporting of hedging relationships to betterportray the economic results of an entity’s risk management activities in its financialstatements. It also simplifies the application of the hedge accounting guidance incurrent GAAP. The new guidance:

• Eliminates the separate measurement and reporting of hedge ineffectiveness

• Allows more risk components to qualify for hedge accounting, such as thevariability in cash flows attributable to change in a contractually specifiedcomponent of a forecasted purchase or sale of a nonfinancial asset or thecontractually specified interest rate of a variable-rate financial instrument

• Adds the SIFMA swap rate to the list of permissible benchmark interest rates inthe United States

• Amends measurement methods for calculating the change in fair value of thehedged item in fair value hedges of interest rate risk

• Introduces the “last-of-layer� method for hedges of portfolios of prepayablefinancial assets

• Permits an entity to exclude from the assessment of effectiveness the portion ofthe change in fair value of a currency swap that is attributable to a cross-currency basis spread

• Permits an entity to recognize in earnings the initial value of amounts excludedfrom the assessment of effectiveness using a systematic and rational methodover the life of the hedging instrument

• Aligns the recognition and presentation of the effects of the hedging instrumentand the hedged item in the financial statements to increase the understandabil-ity of the results of an entity’s risk management activities. An entity is nowrequired to present the earnings effect of the hedging instrument in the sameincome statement line item in which the earnings effect of the hedged item isreported.

• Amends existing income statement disclosures to focus on the effects of hedgeaccounting on individual income statement line items

• Adds new balance sheet disclosures regarding fair value hedge basisadjustments

• Allows an entity to perform subsequent assessments of hedge effectivenessqualitatively for instances in which initial quantitative testing is required

• For all entities, extends the date by which the initial prospective quantitativeassessment of hedge effectiveness must be performed to the first quarterlyeffectiveness date using the data applicable as of hedge inception

• Allows private companies that are not financial institutions and certain not-for-profit entities until the time that the next interim (if applicable) or annualfinancial statements are available to be issued to perform the initial quantitativeand all quarterly effectiveness tests and designate the method of assessinghedge effectiveness

¶407


• Allows an entity to assume that the hedging derivative matures at the same timeas the forecasted transactions if both the derivative maturity and the forecastedtransactions occur within the same 31-day period or fiscal month for purposes ofevaluating the qualifying criteria for the critical terms match method

• Allows an entity to document a long-haul method of assessing effectiveness athedge inception that the entity may use if it determines that use of the shortcutmethod was not or no longer is appropriate

Effective dates. For public entities, the new guidance is effective for fiscal yearsbeginning after December 15, 2018, and interim periods within those fiscal years. For allother entities, it is effective for fiscal years beginning after December 15, 2019, andinterim periods beginning after December 15, 2020. Early application is allowed in anyinterim period after the issuance of the update.

The Tax Cuts and Jobs Act

On December 22, 2017, the U.S. federal government enacted, H.R.1, An Act to Providefor Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on theBudget for Fiscal Year 2018 (Tax Cuts and Jobs Act). As a result of this act, stakehold-ers gave the FASB feedback on the following financial reporting issues:

• Current GAAP requires that deferred tax liabilities and assets be adjusted forthe effect of a change in tax laws or rates.

• That effect would be included in income from continuing operations in thereporting period that includes the enactment date of the change.

• Stakeholders in the banking and insurance industries submitted unsolicitedcomment letters to the FASB and expressed concerns with applying this gui-dance to deferred tax liabilities and assets related to items presented in accumu-lated other comprehensive income (OCI).

Implementation issues related to the Tax Cuts and Jobs Act and income tax reportinginclude:

• Whether private companies and not-for-profits can apply SEC Staff AccountingBulletin (SAB) 118

• Whether to discount the tax liability on the deemed repatriation

• Whether to discount alternative minimum tax credits that become refundable

• Accounting for the base erosion anti-abuse tax

• Accounting for global intangible low-taxed income

Stakeholders were concerned about current GAAP guidance that requires deferred taxliabilities and assets to be adjusted for the effect of a change in tax laws or rates with theeffect included in income from continuing operations in the reporting period thatincludes the enactment date. That guidance applies even when the related income taxeffects of items in accumulated OCI were originally recognized as OCI (rather than inincome from continuing operations). The stakeholders noted that because the adjust-ment of deferred taxes due to the reduction of the historical corporate income tax rateto the newly enacted corporate income tax rate is required to be included in incomefrom continuing operations, the tax effects of items within accumulated OCI do notreflect the appropriate tax rate. In response, the FASB issued ASU 2018-02, IncomeStatement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain TaxEffects from Accumulated Other Comprehensive Income.

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ASU 2018-02 affects any entity that is required to apply the provisions of Topic 220and has OCI for which the related tax effects are presented in OCI as required byGAAP. The amendments allow a reclassification from accumulated OCI to retainedearnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. ASU 2018-02eliminates the “stranded tax effects� caused by the act and is designed to make theinformation reported to financial statement users more useful. However, because theamendments in the update relate only to the reclassification of the income tax effects ofthe Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of achange in tax laws or rates be included in income from continuing operations is notaffected. The ASU 2018-02 amendments also mandate certain disclosures aboutstranded tax effects.

OBSERVATION: The FASB issued five Staff Q&A documents that addressvarious financial accounting and reporting implementation issues related to theTax Cuts and Jobs Act. The Staff Q&As address the following topics:

• Whether Private Companies and Not-for-Profits Can Apply SAB 118

• Whether to Discount the Tax Liability on the Deemed Repatriation

• Whether to Discount Alternative Minimum Tax Credits That BecomeRefundable

• Accounting for the Base Erosion Anti-Abuse Tax

• Accounting for Global Intangible Low-Taxed Income

Effective dates. ASU 2018-02’s amendments are effective for all entities for fiscal yearsbeginning after December 15, 2018, and interim periods within those fiscal years. Earlyadoption of the amendments is allowed, including adoption in any interim period (1) forpublic business entities for reporting periods for which financial statements have not yetbeen issued and (2) for all other entities for reporting periods for which financialstatements have not yet been made available for issuance. ASU 2018-02 should beapplied either in the period of adoption or retrospectively to each period in which theeffect of the change in the U.S. federal corporate income tax rate in the Tax Cuts andJobs Act is recognized.

STUDY QUESTIONS

3. Under ASU _______, organizations must measure all expected credit losses forfinancial instruments held at the reporting date based on historical experience, currentconditions, and reasonable and supportable forecasts.

a. 2018-02

b. 2017-12

c. 2016-13

d. 2014-09

4. Which of the following was issued in in response to stakeholder concerns aboutproblems associated with the not-for-profit financial reporting model?

a. ASU 2016-14

b. ASU 2016-02

c. ASU 2015-14

d. FASB Statement 123(R)

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¶408 FUTURE GUIDANCE AND CHALLENGES AHEADLeasing Practical ExpedientsThe FASB is expected to issue guidance that will reduce cost and ease implementationof the leases standard for financial statement preparers without compromising thequality of information provided to investors. It will simplify the transition requirementsand, for lessors, will provide several practical expedients for the separation of nonleasecomponents from lease components and for the accounting and reporting of certainlessor costs. Specifically, the amendments will add:

• An option that would permit an organization to apply the transition provisions ofthe new standard at its adoption date instead of at the earliest comparativeperiod presented in its financial statements.

• A practical expedient that would permit lessors to not separate nonlease compo-nents from the associated lease components if certain conditions are met. Thispractical expedient could be elected by class of underlying assets; if elected,certain disclosures would be required.

• Two other practical expedients that would permit lessors to account for andreport sales taxes and certain lessor costs in a manner that is more closelyaligned with the new revenue guidance.

Disclosure FrameworkThe FASB plans to issue four final documents intended to improve the effectiveness ofdisclosures in notes to financial statements. They include:

• A new chapter in the FASB’s conceptual framework on disclosures

• An update to an existing chapter of the conceptual framework that aligns theFASB’s definition of materiality with other definitions

• An update to fair value measurement disclosure requirements

• An update to defined benefit plan disclosure requirements

Non-Employee Stock CompensationDuring the second quarter of 2018, the FASB is expected to issue a new standard thatwill simplify the accounting for nonemployee share-based awards. The guidance willexpand the scope of Topic 718, Compensation—Stock Compensation, which currentlyincludes only share-based awards granted to employees, to also include share-basedawards granted to nonemployees in exchange for goods and services to be used in agrantor’s own operations.

Consequently, the accounting for nonemployee share-based awards will be sub-stantially aligned with the accounting for employee share-based awards. The standardwould supersede Subtopic 505-50, Equity—Equity Based Payments to Non-Employees.The accounting for nonemployee share-based awards was identified as an area forsimplification through:

• Ideas submitted to the FASB as part of its Simplification Initiative

• The Private Company Council’s ongoing dialogue about making improvementsto accounting for share-based awards

• The post-implementation review of FASB Statement 123(R), Share-BasedPayment.

¶408


The standard will be effective for public business entities for fiscal years beginningafter December 15, 2018, including interim periods within that fiscal year. For otherorganizations, the amendments are effective for fiscal years beginning after December15, 2019, and interim periods within fiscal years beginning after December 15, 2020.Early adoption is permitted, but no earlier than an organization’s adoption date of Topic606.

Challenges AheadKen Tysiac, the editorial director for the Journal of Accountancy, wrote an articleconcerning six key areas of change for accountants and auditors. In the article headdressed important issues for accountants and auditors. He stated, “The pace ofchange in the accounting profession has become so fast that even some standard settersrecognize it’s time to slow down.� In regard to the challenges accountants and auditorsface, Russell Golden, FASB Chairman, has stated, “Over the past few years, the FASBhas thrown a lot of change your way. We know that. We are working to ease thetransition.� Major challenges ahead include the following.

• Lease compliance. Some entities have tens of thousands of leases. Conse-quently, some entities may need new accounting systems to accommodate thenew lease standard. Such systems should be capable of locating all leases andextracting the data needed to comply with the new standard.

• Revenue recognition. Public companies are to adopt the new revenue recogni-tion standards at beginning of 2018; private companies have until 2019. Theissue of disclosures might be a problem for entities. Data may not have beenotherwise compiled, and entities will have to look at disclosures in-depth ratherthan just a high-level overview.

• Credit losses. The new standard has a “forward-looking approach.� Implemen-tation will primarily affect financial institutions and insurance companies. Ex-pected losses are to be reported on historical experience, current conditions,and reasonable and supportable forecasts. Best practices may include forming acurrent expected credit loss (CECL) Committee and devising a project plan.TRG stakeholders’ concerns about capital reserve requirements must beconsidered

• GASB rules for Other Postemployment Benefits (OPEB). Entities will facedifficult challenges in implementing the new OPEB standards. Preparers mayneed more time with human resources to sufficiently document their OPEBplan. Obtaining high-quality actuarial estimates is a must. Stakeholders must beeducated about potential additions to the balance sheet of liabilities that may besubstantial.

• New auditor’s reporting model requirements. To comply with new require-ments from the International Auditing and Assurance Standards Board (IAASB),Public Company Accounting Oversight Board (PCAOB), and (soon) the Ameri-can Institute of Certified Public Accountants (AICPA), auditors will need tooperate under both accounting standards changes and auditing standardschanges. Auditors will be implementing the biggest overhaul of the auditor’sreport in more than 70 years. The first phase includes disclosing an audit firm’stenure as the auditor and form changes. The second phase requires communica-tion of “critical audit matters.�

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• Going concerns. The FASB and GASB went first on management’s responsibil-ity for assessing going concern, as well as the IAASB. Now nonpublic companyauditors must implement standards that require the auditor to conclude whetherthere is substantial doubt about an entity’s ability to continue as a goingconcern. The standard makes it clearer that the issues of going concern andwhether substantial doubt exists are separate. It also adds requirements whensupport by third parties or entities’ owner-managers are present.

Despite these challenges, opportunities exist for accountants and auditors. Emergingtechnologies are enabling the accounting profession to provide unprecedented levels ofinsight and assurance. As stated by Kimberly Ellison-Taylor, the AICPA Board chair for2016–2017, “New technology may change the services we provide and how we deliverthem, but it will not change the need for our services. While change may be dauntingand the new brave world of technology is no exception, we must stand ready to embraceit.�

STUDY QUESTIONS

5. The new rules for other postemployment benefits (OPEB) were issued by:

a. FASB

b. GASB

c. IASB

d. IASC

6. For private companies, the new revenue recognition guidance is required for annualreporting periods beginning after:

a. December 15, 2016

b. December 15, 2017

c. December 15, 2018

d. December 15, 2019

¶408

61

MODULE 1: TOP ACCOUNTING ISSUES—CHAPTER 5: CECL Model¶501 WELCOMEThis chapter discusses the current expected credit loss (CECL) model for losses and/or impairments as presented in Financial Accounting Standards Board (FASB) Account-ing Standards Update (ASU) 2016-13. It also gives an overview of ASU 2016-01, whichincludes significant changes in authoritative professional standards concerning financialinstruments (financial assets and financial liabilities) and their measurements, impair-ments, and disclosures.



• Recognize the main objectives of ASU 2016-01 and ASU 2016-13

• Identify the steps for implementing the CECL model

• Identify ASU 2016-01 and ASU 2016-13 effective dates, reporting requirements,disclosure requirements, and related matters

¶503 INTRODUCTIONPrior to the global economic crisis that started in 2008, the FASB and the InternationalAccounting Standards Board (IASB) began a joint project to improve and converge theirstandards on accounting for financial instruments. The project resulted in the release ofnew guidance. The FASB’s main objective in developing ASU 2016-01 was to enhancethe reporting model for financial instruments to give financial statement users moreuseful information to make decisions.

With regard to credit losses, current U.S. generally accepted accounting principles(GAAP) requires an “incurred loss� method for recognizing such losses, which delaystheir recognition until it is probable a loss has been incurred. Financial institutions andusers of their financial statements had expressed concerns that this method restrictedthe ability to record credit losses that are expected but do not yet meet the “probable�threshold. The global economic crisis underscored these concerns because usersanalyzed credit losses by using forward-looking information to assess an entity’s allow-ance for credit losses on the basis of their own expectations. In the years leading up tothe economic crisis, users were making estimates of expected credit losses and deval-uing financial institutions before accounting losses were recognized, highlighting thedifference between users’ information needs and the information required by U.S.GAAP.

The FASB issued ASU 2016-13 to replace the incurred loss impairment method incurrent GAAP with one that reflects expected credit losses and requires considerationof a broader range of reasonable and supportable information to inform credit lossestimates.

The following sections provide an overview of each of these ASUs.

¶504 ASU 2016-01Released in January 2016, ASU 2016-01, Financial Instruments—Overall (Subtopic825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, is

¶504


designed to improve the recognition and measurement of financial instruments. Theupdate impacts public and private companies, not-for-profit organizations, and employeebenefit plans that hold financial assets or owe financial liabilities. Consequently, it willimpact practically every professional accountant that deals with accounting issues andfinancial assets and financial liabilities. More specifically, ASU 2016-01:

• Requires equity investments (except those accounted for under the equitymethod of accounting, or those that result in consolidation of the investee) to bemeasured at fair value with changes in fair value recognized in net income

• Requires public business entities to use the exit price notion when measuringthe fair value of financial instruments for disclosure purposes

• Requires separate presentation of financial assets and financial liabilities bymeasurement category and form of financial asset (i.e., securities or loans andreceivables) on the balance sheet or in notes that accompany the financialstatements

• Eliminates the requirement to disclose the fair value of financial instrumentsmeasured at amortized cost for organizations that are not public businessentities

• Eliminates the requirement for public business entities to disclose the methodsand significant assumptions used to estimate the fair value that is required to bedisclosed for financial instruments measured at amortized cost on the balancesheet

• Requires a reporting entity to present separately in other comprehensive incomethe portion of the total change in the fair value of a liability resulting from achange in the instrument-specific credit risk (also referred to as “own credit�)when the entity has elected to measure the liability at fair value in accordancewith the fair value option for financial instruments.

Effective DatesThe new guidance is effective for public business entities for fiscal years that begin afterDecember 15, 2017, including interim periods within those fiscal years. For all otherentities, it will be effective for fiscal years that begin after December 15, 2018, and forinterim periods within fiscal years beginning after December 15, 2019. ASU 2016-01permits early adoption of the “own credit� provision. In addition, the new guidancepermits early adoption of the provision that exempts private entities and not-for-profitorganizations from having to disclose fair value information about financial instrumentsmeasured at amortized cost.

COMMENT: A public business entity is a business entity meeting any one ofthe following criteria. Neither a not-for-profit entity nor an employee benefit plan isa business entity.

• It is required by the U.S. Securities and Exchange Commission (SEC) to file orfurnish financial statements, or does file or furnish financial statements (includ-ing voluntary filers with the SEC).

• It is required by the Securities Exchange Act of 1934, as amended, or rules orregulations promulgated under the act, to file or furnish financial statementswith a regulatory agency other than the SEC.

• It is required to file or furnish financial statements with a foreign or domesticregulatory agency in preparation for the sale of or for purposes of issuingsecurities that are not subject to contractual restrictions on transfer.

• It has issued, or is a conduit bond obligor for, securities that are traded, listed,or quoted on an exchange or an over-the-counter market.

¶504

63MODULE 1 - CHAPTER 5 - CECL Model

• It has one or more securities that are not subject to contractual restrictions ontransfer, and it is required by law, contract, or regulation to prepare U.S. GAAPfinancial statements (including footnotes) and make them publicly available on aperiodic basis (for example, interim or annual periods). An entity must meetboth of these conditions to meet this criterion.

An entity may meet the definition of a public business entity solelybecause its financial statements or financial information is included inanother entity’s filing with the SEC. In that case, the entity is only a publicbusiness entity for purposes of financial statements that are filed orfurnished with the SEC.

¶505 ASU 2016-13The FASB released ASU 2016-13, Financial Instruments—Credit Losses (Topic 326):Measurement of Credit Losses on Financial Instruments, in June 2016 to improve financialreporting by requiring timelier recording of credit losses on loans and other financialinstruments held by financial institutions and other organizations.

Implementing the new guidance, known as the CECL model, is expected to be oneof the largest accounting projects entities will undertake over the next several years.Accounting and financial reporting professionals must evaluate the CECL requirementsto avoid falling behind in meeting critical implementation milestones. For many entities,adopting and applying the CECL model will have broad effects across the entire entity,including operations, credit modeling, information systems, and internal control/auditfunctions. Therefore, multiple business units will need to participate in the implementa-tion. The new model will likely have significant effects on impairment estimates,financial and regulatory capital ratios, and earnings volatility.

The new guidance requires the measurement of all expected credit losses forfinancial assets held at the reporting date (excluding available-for-sale debt securities)based on historical experience, current conditions, and reasonable and supportableforecasts. Forward-looking information will be used to generate credit loss estimates.

The amendments in ASU 2016-13 apply to all entities and affect entities that holdfinancial assets and net investments in leases that are not accounted for at fair valuewith changes in fair value reported in net income. The amendments affect loans, debtsecurities, trade receivables, net investments in leases, off-balance-sheet credit expo-sures, reinsurance recoverables, and any other financial assets not excluded from thescope that have the contractual right to receive cash.

ASU 2016-13 will affect entities to varying degrees depending on the credit qualityof the assets held, their duration, and how the entity applies current U.S. GAAP.

STUDY QUESTIONS

1. Based on the requirements prescribed by ASU 2016-13, each of the following iscorrect except:

a. It maintains the “incurred loss� method for recognizing credit losses

b. It requires consideration of a broader range of supportable information toestimate credit losses

c. It requires timelier recording of credit losses on loans

d. It requires entities to use forward-looking information to estimate credit losses

¶505


2. Which of the following is considered a public business entity?

a. A not-for-profit hospital

b. An employee benefit plan

c. An entity required by the SEC to furnish financial statements

d. A nongovernmental entity without stock traded on a public exchange

Main ProvisionsThe amendments in ASU 2016-13 replace the incurred loss impairment methodologywith a methodology that reflects expected credit losses and requires consideration of abroader range of reasonable and supportable information to inform credit lossestimates.

ASU 2016-13 establishes Topic 326, Financial Instruments–Credit Losses. Subtopic326-20, Financial Instruments–Credit Losses–Measured at Amortized Cost, provides gui-dance on the measurement of expected credit losses on financial instruments measuredat amortized cost and on leases. Subtopic 326-30, Financial Instruments–Credit Losses–Available-for-Sale Debt Securities, provides guidance on the measurement of creditlosses on available-for-sale debt securities.

The amendments in ASU 2016-13 also supersede the guidance in Subtopic 310-30,Receivables–Loans and Debt Securities Acquired with Deteriorated Credit Quality. Gui-dance for credit losses for purchased financial assets with a more-than-insignificantamount of credit deterioration is included in Subtopic 326-20. Guidance for purchasedavailable-for-sale debt securities with a more-than-insignificant amount of credit deterio-ration is included in Subtopic 326-30.

Assets Measured at Amortized CostThe amendments in ASU 2016-13 require a financial asset or group of financial assetsmeasured at amortized cost basis to be presented at the net amount expected to becollected. The allowance for credit losses is a valuation account that is deducted fromthe amortized cost basis of the financial asset(s) to present the net carrying value at theamount expected to be collected on the financial asset.

At each reporting date, an allowance for credit losses should be recorded in scopefinancial assets. The amount necessary to adjust the allowance for credit losses formanagement’s current estimate of expected credit losses on financial assets should bereported in net income as a credit loss expense. The income statement reflects themeasurement of credit losses for newly recognized financial assets, as well as theexpected increases or decreases of credit losses that have taken place during theperiod.

The measurement of expected credit losses is based on relevant information aboutpast events, including historical experience, current conditions, and reasonable andsupportable forecasts that affect the collectability of the reported amount. Judgmentmust be used in determining the relevant information and estimation methods that areappropriate in its circumstances.

The amendments in ASU 2016-13 also broaden the information that must beconsidered in developing an expected credit loss estimate for assets measured eithercollectively or individually. The use of forecasted information incorporates more timelyinformation in the estimate of expected credit loss.

An economic forecast need not be created over the entire contractual life of long-dated financial assets. The amendments in ASU 2016-13 allow an entity to revert to

¶505


historical loss information that reflects the contractual term (considering the effect ofprepayments) for periods that are beyond the time frame for which the entity is able todevelop reasonable and supportable forecasts.

ASU 2016-13 does not specify a method for measuring expected credit losses; itallows the application of methods that reasonably reflect expectations of the credit lossestimate. The update supersedes the impairment guidance in Subtopic 310-10, Receiv-ables–Overall, and places the credit loss guidance for assets measured at amortized costin Subtopic 326-20.

The guidance relating to assets measured at amortized cost applies to thefollowing:

• Financial assets measured at amortized cost basis, including

— Financing receivables

— Held-to-maturity debt securities

— Receivables that result from revenue transactions

— Reinsurance recoverables that result from insurance transactions

— Receivables relating to repurchase agreements and securities lendingagreements

• Net investments in leases recognized by a lessor

• Off-balance-sheet credit exposures not accounted for as insurance

However, the guidance relating to assets measured at amortized cost does not apply to:

• Financial assets measured at fair value through net income

• Available-for-sale debt securities

• Loans made to participants by defined contribution employee benefit plans

• Policy loan receivables of an insurance entity

• Promises to give (pledges receivable) of a not-for-profit entity

• Loans and receivables between entities under common control

The amortized cost basis is the amount at which a financing receivable or invest-ment is originated or acquired, adjusted for applicable accrued interest, accretion, oramortization of premium, discount, and net deferred fees or costs, collection of cash,write-offs, foreign exchange, and fair value hedge accounting adjustments.

STUDY QUESTION

3. The guidance for assets measured at amortized cost applies to each of the followingtransactions, except?

a. Financing receivables

b. Debt securities that are held to maturity

c. Net investments in leases

d. Loans between entities under common control

Financing receivable. A financing receivable is a financing arrangement that both:

• Represents a contractual right to receive money either on demand, or on fixedor determinable dates, and

• Is recognized as an asset in the balance sheet.

¶505


Examples of financing receivables include loans, trade accounts receivable, notesreceivable, credit cards, receivables relating to a lessor’s rights to payments from aleveraged lease recognized as an asset, and lease receivables arising from sales-typeleases or direct financing leases.

Credit losses for purchased financial assets. The allowance for credit losses forpurchased financial assets with a more-than-insignificant amount of credit deteriorationsince origination that are measured at amortized cost basis is determined in a similarmanner to other financial assets measured at amortized cost basis. The initial allowancefor credit losses, however, is added to the purchase price rather than being reported asa credit loss expense. Only subsequent changes in the allowance for credit losses arerecorded as a credit loss expense for these assets. Interest income should be recog-nized based on the effective interest rate, excluding the discount embedded in thepurchase price that is attributable to the acquirer’s assessment of credit losses atacquisition.

DisclosuresThe amendments in ASU 2016-13 retain many of the disclosure amendments in ASU2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of FinancingReceivables and the Allowance for Credit Losses. The amendments, however, wereupdated to reflect the change from an incurred credit loss methodology to an expectedcredit loss methodology.

In addition, the disclosures of credit quality indicators in relation to the amortizedcost of financing receivables, a current disclosure requirement, are further disaggre-gated by year of origination (or vintage). The vintage information will be useful forfinancial statement users to better assess changes in underwriting standards and creditquality trends in asset portfolios over time and the effect of those changes on creditlosses. However, the disaggregation by year of origination will be optional for entitiesthat are not public business entities.

For assets measured at amortized cost, disclosures on credit risk and the measure-ment of expected credit losses are required for:

• Credit quality information

• Allowance for credit losses

• Past-due status

• Nonaccrual status

• Purchased financial assets with credit deterioration

• Collateral-dependent financial assets

• Off-balance-sheet credit exposures

Available-for-Sale Debt SecuritiesAvailable-for-sale debt securities are investments not classified as either trading securi-ties or as held-to-maturity securities. The CECL model does not apply to available-for-sale debt securities.

ASU 2016-13 made targeted improvements to the impairment model in Topic 320,Investments in Debt Securities, and eliminated the concept of “other than temporary�from that model. The impairment guidance for available-for-sale debt securities wasmoved from Topic 320 and placed in Subtopic 326-30, Financial Instruments–CreditLosses–Available-for-Sale Debt Securities. Credit losses on available-for-sale debt securi-ties should be measured in a manner similar to current U.S. GAAP. When the fair valueof an investment is less than its amortized cost basis, the investment is impaired.

¶505


In assessing whether a credit loss exists, the present value of cash flows expectedto be collected from the security should be compared with the amortized cost basis ofthe security. If the present value of cash flows expected to be collected is less than theamortized cost basis of the security, a credit loss exists and an allowance for creditlosses should be recorded for the credit loss (limited by the amount that the fair value isless than amortized cost basis). Credit losses on an impaired security should continueto be measured using the present value of expected future cash flows.

Furthermore, an entity must determine whether a decline in fair value below theamortized cost basis has resulted from a credit loss or from other factors. Impairmentrelating to credit losses should be recorded through an allowance for credit losses(limited by the amount that the fair value is less than the amortized cost basis).Impairment that has not been recorded through an allowance for credit losses shouldbe recorded through other comprehensive income, net of applicable taxes.

The amendments in ASU 2016-13 require that credit losses be presented as anallowance rather than as a write-down. Under this approach, reversals of credit losses(in situations where the estimate of credit losses declines) are recorded in currentperiod net income. This is intended to align the income statement recognition of creditlosses with the reporting period in which changes occur. Current U.S. GAAP prohibitsreflecting those improvements in current-period earnings.

The length of time a security has been in an unrealized loss position should not beused to avoid recording a credit loss. In addition, in determining whether a credit lossexists, the amendments also remove the requirements to consider the historical andimplied volatility of the fair value of a security and recoveries or declines in fair valueafter the balance sheet date.

The allowance for credit losses for purchased available-for-sale securities with amore-than-insignificant amount of credit deterioration since origination is determined ina similar manner to other available-for-sale debt securities. The initial allowance forcredit losses, however, is added to the purchase price rather than reported as a creditloss expense. Only subsequent changes in the allowance for credit losses are recordedin credit loss expense. Interest income should be recognized based on the effectiveinterest rate, excluding the discount embedded in the purchase price that is attributableto the acquirer’s assessment of credit losses at acquisition.

STUDY QUESTIONS

4. ASU 2016-13 made improvements to the impairment model in which of the followingASC topics?

a. ASC Topic 310b. ASC Topic 320c. ASC Topic 326d. ASC Topic 960

5. Which of the following statements regarding impairment is incorrect?a. The impairment guidance for available-for-sale debt securities was moved from

Topic 320.b. An investment is impaired when its fair value is more than its amortized cost

basis.c. Impairment relating to credit losses should be recorded through an allowance

for credit losses.d. ASU 2016-13 superseded the impairment guidance in Subtopic 310-10, Receiv-

ables–Overall

¶505


Effective Dates

The amendments in ASU 2016-13 are effective for public business entities that meet thedefinition of a SEC filer, for fiscal years beginning after December 15, 2019 (January 1,2020, for a calendar-year entity) including interim periods within those fiscal years. Forpublic business entities that do not meet the definition of an SEC filer, the amendmentsare effective for fiscal years beginning after December 15, 2020 (January 1, 2021, for acalendar-year entity) including interim periods within those fiscal years.

The amendments in ASU 2016-13 are effective for all other entities, including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965on plan accounting, for fiscal years beginning after December 15, 2020 (January 1, 2021,for a calendar-year entity) and interim periods within fiscal years beginning afterDecember 15, 2021.

Early application of the amendments in ASU 2016-13 is permitted for fiscal yearsbeginning after December 15, 2018, including interim periods within those fiscal years.

COMMENT: An SEC filer is an entity that is required to file or furnish itsfinancial statements with either the SEC, or, with respect to an entity subject toSection 12(i) of the Securities Exchange Act of 1934, as amended, the appropriateagency under that Section. Financial statements for other entities that are nototherwise SEC filers whose financial statements are included in a submission byanother SEC filer are not included within this definition.

STUDY QUESTION

6. For public business entities that meet the definition of a SEC filer, ASU 2016-13 iseffective for fiscal years beginning after:


b. April 15, 2019



Implementation & Transition

Entities should apply the amendments in ASU 2016-13 through a cumulative-effectadjustment to retained earnings as of the beginning of the first reporting period inwhich the amendments are effective (i.e., a modified-retrospective approach). Becausethe task of implementing the new accounting and financial reporting rules outlined inASU 2016 is significant, entities are encouraged to perform the following tasks as soonas practical:

• Understand the accounting and financial reporting requirements to determinedata needs and implementation options.

• Determine the instruments that fall within the scope of the CECL.

• Review existing credit models and methods and determine if they comply withCECL.

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• Determine data needs for the CECL model and assess current available datasources.

• Determine the ability of information technology systems to provide requiredCECL data.

• Determine the impact of implementing the CECL model on financial results andratios, internal control requirements, and internal/external audit needs.

CPE NOTE: When you have completed your study and review of chapters 1-5, whichcomprise Module 1, you may wish to take the Final Exam for this Module. Go tocchcpelink.com/printcpe to take this Final Exam online.

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71

MODULE 2: TOP AUDITING ISSUES—CHAPTER 6: Regulation S-K¶601 WELCOMEThis chapter discusses key information related to Regulation S-K with a particular focuson the more frequently used sections of the regulation.



• Identify key history as it relates to Regulation S-K

• Understand requirements of Regulation S-K that are applicable to common SECforms

• Identify some of the key guidance throughout Regulation S-K

• Recognize current developments related to Regulation S-K

¶603 OVERVIEWStandard instructions for filing forms under the Securities Act of 1933, the SecuritiesExchange Act of 1934 and the Energy Policy and Conservation Act of 1975 (17 CFR Part229), known as Regulation S-K, is extensive, and this chapter is not meant to be adetailed overview of the regulation and all of its respective rules. Instead, this sectionreviews some key facts about the regulation.

Regulation S-K dictates the reporting requirements for various Securities andExchange Commission (SEC) filings used by public companies. It was mandated by theSecurities Act of 1933 and applies to SEC forms such as Form S-1, the registrationstatement companies file with the SEC during their initial public offering, as well as toongoing reporting requirements such as Forms 10-K and 8-K. Regulation S-K alsoapplies to:

• Annual or other reports

• Going-private transaction statements

• Tender offers

• Proxy statements

• Other required filings under the Securities Exchange Act of 1934

The regulation works in concert with other rules and regulations that companiesmust comply with when filing with the SEC. Regulation S-K lays out the form andcontent of financial reports—specifically, the financial statements of public companies.

Regulation S-K versus Regulation S-XRegulation S-K and Regulation S-X are closely related and have some key similarities.Regulation S-K can be found within Title 17, Chapter 2, Part 229. Title 17 relates tocommodity and security exchanges, Chapter 2 is applicable to the SEC, and Part 229 iswhere the actual text of the regulation is maintained. Within Part 229, the regulation isfurther broken down into subparts and items.

The official title of Regulation S-X (17 CFR Part 210) is “Form and Content of andRequirements for Financial Statements, Securities Act of 1933, Securities Exchange Act

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of 1934, Investment Company Act of 1940, Investment Advisers Act of 1940, and EnergyPolicy and Conservation Act of 1975.� Regulation S-X is broad-reaching in that it alsoencompasses all notes to financial statements and all related schedules. Regulation S-Xextends the meaning of the term financial statement to include all notes to thestatements and all related schedules. Regulation S-X affects internal and externalaccountants and auditors, and the directors, officers and officials, employees, andcontractors of publicly reporting companies. Rule 1-02 of Regulation S-X also addressesaccountants and auditors, requiring that they be registered and in good standing underthe laws of the place of their residence of their principal office.

¶604 FORM S-1Regulation S-K dictates the reporting requirements for various SEC filings used bypublic companies, one of which is Form S-1. Form S-1 is the initial registration form fornew securities required by the SEC for public companies. Simply put, any security thatmeets the criteria must have an S-1 filing before shares can be listed on a nationalexchange. Form S-1 requires companies to provide a great deal of information to theSEC, including:

• The planned use of capital proceeds

• Details of the current business model and competition

• A brief prospectus of the planned security itself, offering price methodology andany dilution that will occur to other listed securities

Regulation S-K is not the only regulation that provides guidance with respect toForm S-1. Other regulations, including Regulation C, Regulation S-T, and Regulation S-X, also provide such guidance. Regulation S-K sets forth all the disclosure requirementsfor all the sections of the Form S-1. This can be thought of simply as the who, what,where, when, and how requirements to complete the S-1. Key parts of Form S-1 whereRegulation S-K requirements govern include:

• Description of business, properties, and legal proceedings

• Securities of the registrant

• Financial information

• Management and certain security holders

• Registration statement and prospectus provisions

• Other exhibits

Once the Form S-1 is effective, the issuing company can proceed with the saleprocess. From this standpoint, a sale is completed much the same way as in a privateoffering.

STUDY QUESTION

1. Which of the following forms relates to the initial registration for new securitiesrequired by the SEC?

a. Form S-1

b. Form 8-K

c. Form 10-Q

d. Form 10-K

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73MODULE 2 - CHAPTER 6 - Regulation S-K

¶605 FORM 10-QForm 10-Q is a quarterly report mandated by the SEC to be filed by publicly tradedcorporations. Similar information is included as in the annual Form 10-K; however, theinformation is generally less detailed and the financial statements are generallyunaudited. There are two key parts to a 10-Q filing. The first part contains relevantfinancial information covering the period. The second part contains all other informa-tion, such as information on legal proceedings, unregistered sales of equity securities,the use of proceeds from the sale of unregistered sales of equity, and defaults uponsenior securities.

There are several key areas of the Form 10-Q where the requirements of Regula-tion S-K are applicable. For example, three items within Part 1 of the Form 10-Q are:

• Management’s Discussion and Analysis of Financial Condition and Results ofOperations (Item 2)

• Quantitative and Qualitative Disclosures About Market Risk (Item 3)

• Controls and Procedures (Item 4)

For the MD&A section of the 10-Q, the instructions direct preparers to refer toItem 303 of Regulation S-K. Similarly, for the market risk item, preparers are referred toItem 305 of Regulation S-K. There are also several items in Part 2 of Form 10-Q wherethe requirements are prescribed by Regulation S-K. These include items such as legalproceedings (Item 1), unregistered sales of equity securities (Item 2), mine safetydisclosures (Item 4), other information (Item 5), and exhibits (Item 6). The detailedrequirements are outside the scope of this chapter, but it is important to note howRegulation S-K links to these other SEC forms.

¶606 FORM 8-KForm 8-K is a broad form used to notify investors in U.S. public companies of specifiedevents that may be important to shareholders or the SEC. It is one of the mostcommonly filed SEC forms. The number of events that are reported through Form 8-Kare fairly extensive. Some of these include:

• Signing, amending, or terminating material definitive agreements not made inthe ordinary course of business

• Material asset acquisition or sale

• Creating certain financial obligations

• Material impairments

COMMENT: A full listing of the events that require submission of a Form 8-Kto the SEC can be found within the instructions to Form 8-K, which can beretrieved from the SEC’s website or through a simple Internet search.

The relationship between Form 8-K and Regulation S-K is similar to the onebetween Regulation S-K and Form 10-Q. For example, Item 1.01 of Form 8-K relates to amaterial definitive agreement. In other words, this is one of the events that triggers therequirement to file Form 8-K with the SEC. For this particular item, if a company hasentered into a material definitive agreement not made in the ordinary course ofbusiness, the company must disclose the date on which the agreement was entered intoor amended as well as the identity of the parties to the agreement and a briefdescription of any material relationship between the company and any of the parties. Itis also required to disclose a brief description of the terms and conditions of theagreement.

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Other such Form 8-K events include the creation of a direct financial obligation oran obligation under an off-balance-sheet arrangement (Item 2.03), the unregisteredsales of equity securities (Item 3.02), changes in a company’s independent accountant(Item 4.01), and changes in control (Item 5.01). Again, these are events that trigger thefiling of an 8-K where the requirements are governed by Regulation S-K. Additionalexamples of events that trigger a Form 8-K filing where the requirements are sourcedfrom Regulation S-K include the departure of certain directors or officers (Item 5.02),amendments to the articles of incorporation of a company (Item 5.03), temporarysuspension of trading under a company’s employee benefit plans (Item 5.04), and thefiling of financial statements and exhibits (Item 9.01).

STUDY QUESTION

2. Which of the following Form 8-K items relates to unregistered sales of equitysecurities?

a. Item 1.01

b. Item 2.03

c. Item 3.02

d. Item 4.01

¶607 SUBPART 229.1: GENERALAs mentioned earlier in this chapter, the text of Regulation S-K is lengthy and its rulesand requirements are extensive. Therefore, this chapter touches only on key topics andexplores some of the rules of the major sections.

Key topics in the general or introductory section of the regulation include rulesaround projections, security ratings, and non-GAAP measures. The SEC sets forthinformation on both the basis and formatting of projections. The SEC believes thatmanagement must have the option to present in SEC filings its good-faith assessment ofa company’s future performance. Although a history of operations or experience inprojecting may be among the factors providing a basis for management’s assessment,the SEC does not believe that a company must always have had such a history orexperience in order to formulate projections with a reasonable basis. In determining theappropriate format for projections included in SEC filings, consideration must be givento, among other things, the financial items to be projected, the period to be covered, andthe manner of presentation to be used. Although projections traditionally have beengiven for three financial items generally considered to be of primary importance toinvestors—revenues, net income (loss), and earnings (loss) per share—projectioninformation need not necessarily be limited to these three items.

Security ratings are another area addressed in the general section of Regulation S-K. Simply put, given the importance of security ratings to investors and the market-place, the SEC permits companies to disclose, on a voluntary basis, ratings assigned byrating organizations to classes of debt securities, convertible debt securities, andpreferred stock in registration statements and periodic reports.

One of the more important topics in this section relates to non-GAAP measures.When a company uses a non-GAAP measure in a filing, it must include the followingitems:

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• A presentation, with equal or greater prominence, of the most directly compara-ble financial measure or measures calculated and presented in accordance withGAAP

• A reconciliation (by schedule or other clearly understandable method), whichshall be quantitative for historical non-GAAP measures presented

• A statement disclosing the reasons why the registrant’s management believesthat presentation of the non-GAAP financial measure provides useful informationto investors

There are also things a company should not do when it includes a non-GAAPmeasure in an SEC filing. For example, a registrant must not:

• Exclude charges or liabilities that required, or will require, cash settlement, orwould have required cash settlement absent an ability to settle in anothermanner, from non-GAAP liquidity measures, other than the measures earningsbefore interest and taxes (EBIT) and earnings before interest, taxes, deprecia-tion, and amortization (EBITDA)

• Adjust a non-GAAP performance measure to eliminate or smooth items

• Present non-GAAP financial measures on the face of the registrant’s financialstatements prepared in accordance with GAAP or in the accompanying notes

• Use similar titles or descriptions of non-GAAP financial measures that are thesame as GAAP financial measures

Again, these are only some of the highlights of the rules and procedures outlined inRegulation S-K related to non-GAAP measures. Professionals should review the regula-tion in detail for a more thorough appreciation of all the rules.

Also included in the general section is information for smaller companies wheresome of the sections are scaled back. A smaller reporting company may comply witheither the requirements applicable to smaller reporting companies or the requirementsapplicable to other companies for each item, unless the requirements for smallerreporting companies specify that smaller reporting companies must comply with thesmaller reporting company requirements. Regulation S-K also defines what a smallerreporting company is.

¶608 SUBPART 229.100: BUSINESSThe first main subpart of Regulation S-K is titled “Business.� The items that make upthis subpart are listed below.

• Item 101: Description of Business

• Item 102: Description of Property

• Item 103: Legal Proceedings

• Item 104: Mine Safety Disclosure

This section of the chapter discusses some of these items, but not all. This will also bethe case for future subparts explored in this chapter.

Item 101: Description of BusinessItem 101 relates to a description of the business. It includes information related togeneral development of the business, financial information about segments, and anarrative description of the business and financial information about geographic areas.As far as general development of the business, a company should describe the generaldevelopment of the business of the company, its subsidiaries, and any predecessorsduring the past five years, or such shorter period as the company may have been

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engaged in business. A company should report for each segment the revenues fromexternal customers, a measure of profit or loss, and total assets for each of the last threefiscal years or for as long as it has been in business, whichever period is shorter. In thenarrative description, a company should describe the business performed and intendedto be performed by the company, focusing on the dominant segment or each reportablesegment about which financial information is presented in the financial statements.Finally, there is a significant amount of information that should be furnished related tothe geographic areas. This information is outlined in detail within the regulation.

Item 102: Description of PropertyThe next item in this subpart relates to a description of the property. For this item, acompany should state briefly the location and general character of its principal plants,mines, and other materially important physical properties of the company. In addition, itshould identify the segments that use the properties described.

Item 103: Legal ProceedingsA company should briefly describe any material pending legal proceedings, other thanordinary routine litigation incidental to the business, to which it or any of its subsidiar-ies is a party or of which any of its property is the subject. In addition, it should includethe name of the court or agency in which the proceedings are pending, the dateinstituted, the principal parties, a description of the factual basis alleged to underlie theproceeding, and the relief sought.

¶609 SUBPART 229.200: SECURITIES OF THEREGISTRANTThe next subpart, Securities of the Registrant, includes the following items, but thischapter will focus solely on Item 202.

• Item 201: Market Price of and Dividends on the Registrant’s Common Equityand Related Stockholder Matters

• Item 202: Description of Registrant’s Securities

Item 202: Description of Registrant’s SecuritiesWithin this item are sections with requirements for various types of securities includingcapital stock, debt securities, warrants and rights, and other securities, as well asmarket information for securities other than common equity. For capital stock, acompany should state the title of the class of stock. Other required information includesdividend rights, terms of conversion, sinking fund provisions, redemption provisions,voting rights, and so on. A key point is that although much information is required, acomplete legal description of the securities need not be given. For debt securities,certain information must be included. This includes the title of such securities, theprincipal amount being offered, and, if a series, the total amount authorized and the totalamount outstanding as of the most recent practicable date.

STUDY QUESTION

3. Which of the following items of Regulation S-K requires that the title of the class ofcapital stock be stated?

a. Item 101b. Item 102c. Item 201d. Item 202

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¶610 SUBPART 229.300: FINANCIAL INFORMATIONThis is a fairly large subpart of the Regulation S-K. All the items under this subpart arelisted below, but this section will discuss key points of only a few of the items.

• Item 301: Selected Financial Data• Item 302: Supplementary Financial Information• Item 303: Management’s Discussion and Analysis of Financial Condition and

Results of Operations• Item 304: Changes in and Disagreements with Accountants on Accounting and

Financial Disclosure• Item 305: Quantitative and Qualitative Disclosures About Market Risk• Item 307: Disclosure Controls and Procedures• Item 308: Internal Control over Financial Reporting

Item 301: Selected Financial DataItem 301 states that companies should furnish in comparative columnar form theselected financial data for the registrant for each of the last five fiscal years of theregistrant. These include net sales or operating revenues, income or loss from continu-ing operations, income or loss from continuing operations per common share, totalassets, long-term obligations and redeemable preferred stock including long-term debt,capital leases, and redeemable preferred stock, as well as cash dividends declared percommon share.

Item 302: Supplementary Financial InformationDisclosures that relate to annual periods should be presented for each annual period forwhich an income statement is required and should be presented as of the date of eachaudited balance sheet required. Furthermore, disclosures required as of the beginningof an annual period should be presented as of the beginning of each annual period forwhich an income statement is required. These disclosures include:

• Net sales• Gross profit• Income (loss)• Net income (loss) and net income (loss) attributable to the registrant, for each

full quarter within the two most recent fiscal years

In addition to these required disclosures, there are incremental disclosures in-volved in oil and gas producing activities.

Item 303: Management’s Discussion and Analysis of FinancialCondition and Results of OperationsA company’s discussion and analysis should be of the financial statements and otherstatistical data that the company believes will enhance a reader’s understanding of itsfinancial condition, changes in financial condition, and results of operations. Generally,the discussion should cover the three-year period covered by the financial statementsand should use year-to-year comparisons or any other formats that in the company’sjudgment enhance a reader’s understanding.

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The purpose of the discussion and analysis is to provide to investors and otherusers with information relevant to an assessment of the financial condition and results ofoperations of the company as determined by evaluating the amounts and certainty ofcash flows from operations and from outside sources. The discussion and analysisshould focus specifically on material events and uncertainties known to managementthat would cause reported financial information not to be necessarily indicative of futureoperating results or of future financial condition. Key requirements include liquidity,capital resources, results of operations, and off-balance sheet arrangements. In additionto these, a tabular disclosure of contractual obligations is also required, which identifieslong-term debt obligations, capital lease obligations, operating lease obligations, andpurchase obligations.

Item 305: Quantitative and Qualitative Disclosures About MarketRiskItem 305 is another important area within Regulation S-K. In short, this subpart statesthat a company should provide quantitative information about market risk as of the endof the latest fiscal year, in accordance with one of the following three disclosurealternatives:

• Tabular presentation of information related to market risk sensitive instruments

• Sensitivity analysis disclosures that express the potential loss in future earnings,fair values, or cash flows of market risk sensitive instruments

• Value at risk disclosures that express the potential loss in future earnings, fairvalues, or cash flows of market risk sensitive instruments

Qualitative risks that should be discussed by companies within their respectiveSEC filings include risks related to market risk, interest rate risk, foreign currencyexchange rate risk, commodity price risk, and other relevant market rate or price riskssuch as equity price risk.

Item 307: Disclosure Controls and ProceduresA company is required to disclose the conclusions of the registrant’s principal executiveand principal financial officers, or persons performing similar functions, regarding theeffectiveness of the registrant’s disclosure controls and procedures.

Item 308: Internal Control over Financial ReportingIt is important to note that if the company is an accelerated filer or a large acceleratedfiler, or otherwise includes in its annual report a registered public accounting firm’sattestation report on internal control over financial reporting, that report should include:

• A statement of management’s responsibility for establishing and maintainingadequate internal control over financial reporting as well as the framework used

• Management’s assessment of the effectiveness of the registrant’s internal con-trol over financial reporting as of the end of the registrant’s most recent fiscalyear

• A statement that the registered public accounting firm that audited the financialstatements included in the annual report containing the disclosure required bythis Item has issued an attestation report on the registrant’s internal control overfinancial reporting (accelerated or large accelerated filers only)

Furthermore, the attestation report of the registered public accounting firm shouldprovide the registered public accounting firm’s attestation report on the registrant’sinternal control over financial reporting in the registrant’s annual report containing thedisclosure. In addition, a company should disclose any change in the registrant’sinternal control over financial reporting that occurred during the registrant’s last fiscalquarter.

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STUDY QUESTION

4. Each of the following sets of financial data is required to be included for the last fivefiscal years, except:

a. Net sales

b. Operating revenues

c. Long-term obligations

d. Nonredeemable preferred stock

¶611 SUBPART 229.400: MANAGEMENT ANDCERTAIN SECURITY HOLDERSThe next subpart of Regulation S-K includes the following items. Several are discussedin this section.

• Item 401: Directors, Executive Officers, Promoters, and Control Persons

• Item 402: Executive Compensation

• Item 403: Security Ownership of Certain Beneficial Owners and Management

• Item 404: Transactions with Related Persons, Promoters and Certain ControlPersons

• Item 405: Compliance with Section 16(A) of the Exchange Act

• Item 406: Code of Ethics

• Item 407: Corporate Governance

Item 401: Directors, Executive Officers, Promoters, and ControlPersonsItem 401 states that companies need to list the names and ages of all directors of thecompany and all persons nominated or chosen to become directors, as well as indicateall positions and offices with the company held by each such person. In addition, thedirector’s term of office and any periods during which he or she has served should bestated. Similar information is required for executive officers.

For certain significant employees, such as production managers, sales managers,or research scientists who are not executive officers but who make (or are expected tomake) significant contributions to the business, the company is required to identifythem and disclose background information to the same extent as executive officers.Companies also need to describe the business experience of these individuals anddiscuss their involvement in legal proceedings, if any. Item 401 lists a significantnumber of examples of legal proceedings that are required to be disclosed.

Item 402: Executive CompensationItem 402 is one of the lengthiest items in Regulation S-K. Only a selected few arecovered here. This item requires clear, concise, and understandable disclosure of allplan and nonplan compensation awarded to, earned by, or paid to the named executiveofficers. Covered persons include the chief executive officer (CEO), principal financialofficer, and the three highest compensated individuals other than the CEO and principal

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financial officer who were serving as executive officers at the end of the last completedfiscal year.

One of the key requirements relates to the overall compensation discussion andanalysis. In short, companies are required to explain all material elements of thecompany’s compensation of the named executive officers. This includes:

• The objectives of the registrant’s compensation programs

• What the compensation program is designed to reward

• Each element of compensation

• Why the registrant chooses to pay each element

• How the registrant determines the amount and how each compensation elementand the registrant’s decisions regarding that element fit into the registrant’soverall compensation objectives

• Whether and, if so, how the registrant has considered the results of the mostrecent shareholder advisory vote on executive compensation

One of the more helpful aspects of this item are the example tables that areprovided to assist companies in providing the required information, such as the exampleof a summary compensation table. This table includes elements such as base salary,bonus, and stock awards.

Summary Compensation Table

The next table relates to grants of plan-based awards. It includes elements such asestimated future payouts under non-equity incentive plan awards, estimated futurepayouts under equity incentive plan awards, other stock awards, and the grant date fairvalue.

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Grants of Plan-Based Awards

Item 402 also provides a sample of the outstanding equity awards at fiscal year-endtable. Like the previous table, this table lists the top five executives and includes certainsummary compensation information. Note that it includes the number of securitiesunderlying unexercised options that are both exercisable and unexercisable, optionexercise price, expiration date, and so on.

Outstanding Equity Awards at Fiscal Year-End

Another sample table provided in Item 402 is for options exercised and stockvested. For option awards, it provides the number of shares acquired on exercise as wellas the value realized at exercise. For stock awards, it lists the number of sharesacquired at vesting as well as the value realized by each executive at vesting.

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Options Exercised and Stock Vested

Additional example tables included in the regulation include those for pensionbenefits, nonqualified defined contribution and other nonqualified deferred compensa-tion plans, potential payments upon termination or change-in-control, and compensationof directors.

Item 403: Security Ownership of Certain Beneficial Owners andManagementItem 403 differentiates between certain beneficial owners and management. Informationthat must be provided includes the title of class, the name and address of the person,the amount and nature of beneficial ownership, and the percent of class. In addition tothese tabular disclosures, this item also requires disclosures related to change incontrol. These include any arrangements known to the company, including any pledgeby any person of securities of the company or any of its parents, the operation of whichmay at a subsequent date result in a change in control of the company.

Item 406: Code of EthicsThis item states that a company must disclose whether it has adopted a code of ethicsthat applies to its principal executive officer, principal financial officer, principal account-ing officer or controller, or persons performing similar functions. If it has not adopted acode of ethics, it must disclose the reason. A company must also do the following:

• File with the SEC a copy of its code of ethics that applies to the registrant’sprincipal executive officer, principal financial officer, principal accounting officeror controller, or persons performing similar functions, as an exhibit to its annualreport.

• Post the text of such code of ethics on its website and disclose, in its annualreport, its internet address and the fact that it has posted such code of ethics onits website.

• Undertake in its annual report filed with the SEC to provide to any personwithout charge, upon request, a copy of its code of ethics and explain themanner in which such request may be made.

Item 407: Corporate GovernanceCompanies are required to identify each director and, when the disclosure is beingpresented in a proxy or information statement relating to the election of directors, each

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nominee for director that is independent under the independence standards applicableto the company. In addition, with respect to board meetings and committees, companiesare required to state the total number of meetings of the board of directors, includingregularly scheduled and special meetings that were held during the last full fiscal year.They should also name each incumbent director who during the last full fiscal yearattended fewer than 75 percent of the aggregate of the total number of meetings of theboard of directors and the total number of meetings held by all committees of the boardon which he or she served.

There are also specific requirements applicable to the nominating committee aswell as the audit committee. For example, an audit committee must state whether it has:

• A charter

• Reviewed and discussed the audited financial statements with management

• Discussed with the independent auditors the matters required to be discussed

• Received the written disclosures and the letter from the independent accountantrequired by applicable requirements of the PCAOB regarding the independentaccountant’s communications with the audit committee concerningindependence

Finally, companies should state whether the company’s board of directors providesa process for security holders to send communications to the board of directors. If acompany does not have such a process, it should state the basis for the view of theboard of directors that it is appropriate for the company not to have such a process.

STUDY QUESTION

5. Regarding its code of ethics, the entity must:

a. Disclose whether it has adopted a code of ethics that applies to the CEO.

b. Post the text of the code of ethics on all external communications.

c. Include the code of ethics in all proxy statements issued.

d. Provide text of the code of ethics in each quarterly 10-Q report.

¶612 SUBPART 229.500: REGISTRATION STATEMENTAND PROSPECTUS PROVISIONSThe items in this subpart relate directly to the Form S-1 discussed earlier. The full list ofitems in this subpart follows, but only some are discussed here.

• Item 501: Forepart of Registration Statement and Outside Front Cover Page ofProspectus

• Item 502: Inside Front and Outside Back Cover Pages of Prospectus

• Item 503: Prospectus Summary, Risk Factors, and Ratio of Earnings to FixedCharges

• Item 504: Use of Proceeds

• Item 505: Determination of Offering Price

• Item 506: Dilution

• Item 507: Selling Security Holders

• Item 508: Plan of Distribution

• Item 509: Interests of Named Experts and Counsel

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• Item 510: Disclosure of Commission Position on Indemnification for SecuritiesAct Liabilities

• Item 511: Other Expenses of Issuance and Distribution

• Item 512: Undertakings

Item 503: Prospectus Summary, Risk Factors, and Ratio of Earningsto Fixed ChargesOverall, companies are required to furnish information in plain English. With regard tothe prospectus summary, companies should provide a summary of the information inthe prospectus where the length or complexity of the prospectus makes a summaryuseful. Furthermore, the summary should be brief, should not merely repeat the text ofthe prospectus, and should provide a brief overview of the key aspects of the offering.

COMMENT: This means that companies should carefully consider and iden-tify those aspects of the offering that are the most significant and determine howbest to highlight them in clear, plain language.

In addition to the prospectus summary, companies should also include, either on thecover page or in the summary section of the prospectus, the complete mailing addressand telephone number of its principal executive offices.

The regulation also requires companies to include certain information on riskfactors. Where appropriate, companies should provide under the caption “Risk Factors�a discussion of the most significant factors that make the offering speculative or risky.This discussion must be concise and organized logically. Companies should not presentrisks that could apply to any issuer or any offering. Instead, they should explain how therisk affects the issuer or the securities being offered. Note that the risk factor discus-sion must immediately follow the summary section. If there is no summary section, therisk factor section must immediately follow the cover page of the prospectus or thepricing information section that immediately follows the cover page. Examples of riskfactors include a company’s:

• Lack of an operating history

• Lack of profitable operations in recent periods

• Financial position

• Business or proposed business

Item 504: Use of ProceedsA company should state the principal purposes for which the net proceeds to thecompany from the securities to be offered are intended to be used and the approximateamount intended to be used for each such purpose. However, if there is no plan for theproceeds, the company should directly state this fact and discuss the principal reasonsfor the offering.

Note that details of proposed expenditures need not be given. For example, acompany needs to furnish only a brief outline of any program of construction or additionof equipment. Furthermore, consideration should be given to the need to include adiscussion of certain matters addressed in the discussion and analysis of the company’sfinancial condition and results of operations, such as liquidity and capital expenditures.

Item 508: Plan of DistributionIf the securities are to be offered through underwriters, the company should name theprincipal underwriters and state the respective amounts underwritten. It should alsoidentify each such underwriter having a material relationship with the company and

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state the nature of the relationship. Finally, it should also state briefly the nature of theobligation of the underwriter(s) to take the securities.

Included within Item 508 are additional requirements related to these areas. Theseinclude new underwriters, other distributions, offerings on exchange, underwriter’scompensation, underwriter’s representative on the board of directors, and indemnifica-tion of underwriters.

EXAMPLE: For underwriter’s compensation, a company should provide atable that sets out the nature of the compensation and the amount of discounts andcommissions to be paid to the underwriter for each security and in total. The tablemust show the separate amounts to be paid by the company and the sellingshareholders. In addition, the company should include in the table all other itemsconsidered by the National Association of Securities Dealers to be underwritingcompensation for purposes of that association’s Rules of Fair Practice.

¶613 SUBPART 229.600: EXHIBITSThe only item under this subpart is Item 601, Exhibits. Each registration statement orreport should contain an exhibit index, which must appear before the required signa-tures in the registration statement or report. The exhibit table included under Item 601indicates those documents that must be filed as exhibits to the respective forms listed.For example, in the event that there is correspondence from an independent accountantregarding nonreliance on a previously issued audit report or completed interim review,this exhibit is required to be filed with the exchange act Form 8-K.

¶614 OTHER KEY PARTS OF REGULATION S-KOther key subparts of Regulation S-K include the following:

• 700: Miscellaneous

• 800: List of Industry Guides

• 900: Roll-Up Transactions

• 1000: Mergers and Acquisitions (Regulation M-A)

• 1100: Asset Backed Securities (Regulation AB)

• 1200: Disclosure by Registrants Engaged in Oil and Gas Producing Activities

While this chapter will not discuss these subparts in detail, note that Subpart 1200is an extensively used subpart of Regulation S-K for entities that are involved in oil andgas producing activities. The items Subpart 1200 are:

• Item 1201: General Instructions to Oil and Gas Industry-Specific Disclosures

• Item 1202: Disclosure of Reserves

• Item 1203: Proved Undeveloped Reserves

• Item 1204: Oil and Gas Production, Production Prices and Production Costs

• Item 1205: Drilling and Other Exploratory and Development Activities

• Item 1206: Present Activities

• Item 1207: Delivery Commitments

• Item 1208: Oil and Gas Properties, Wells, Operations, and Acreage

¶615 RECENT DEVELOPMENTSThis section touches briefly on key recent developments with respect to Regulation S-K.On October 17, 2017, the SEC voted to propose amendments to modernize and simplifydisclosure requirements for public companies, investment advisers, and investment

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companies and to implement a mandate under the Fixing America’s Surface Transporta-tion (FAST) Act. The proposed amendments would:

• Revise rules or forms to update, streamline, or otherwise improve the SEC’sdisclosure framework by eliminating the risk factor examples listed in thedisclosure requirement and revising the description of property requirement toemphasize the materiality threshold.

• Update rules to account for developments since their adoption or last amend-ment by eliminating certain requirements for undertakings in registrationstatements.

• Simplify disclosures or the disclosure process, including proposed changes toexhibit filing requirements and the related process for confidential treatmentrequests and changes to Management’s Discussion and Analysis that wouldallow for flexibility in discussing historical periods.

• Incorporate technology to improve access to information by requiring datatagging for items on the cover page of certain filings and the use of hyperlinksfor information that is incorporated by reference and available on EDGAR

Regulation S-K is an extensive set of information that spreads across many facets ofa company’s regulation filings. This chapter covered key items included in the regula-tion. To learn more about the regulation and better understand its detailed rules andrequirements, please access the regulation through the SEC’s website.

STUDY QUESTION

6. Items included within Subpart 1200 of Regulation S-K apply to entities involved inwhich of the following activities?

a. Oil and gas producing activities

b. Information technology

c. Mining

d. Real estate

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87

MODULE 2: TOP AUDITING ISSUES—CHAPTER 7: Auditor Reporting Models¶701 WELCOMEThis chapter discusses significant changes in the authoritative professional standardsconcerning audit reporting in the area of forming an opinion and reporting on financialstatements. It also identifies future changes to auditor reporting.



• Understand selected new auditor reporting models

• Identify key audit matters in the independent auditor’s report

• Recognize the new form and content of modifications to the opinion in theindependent auditor’s report

• Identify anticipated changes to auditor reporting

¶703 INTRODUCTIONThis chapter provides an update on selected auditor reporting models. Although ittouches on some international and Public Company Accounting Oversight Board(PCAOB) standards, the main focus is Statements on Auditing Standards (SASs) fromthe American Institute of Certified Public Accountants (AICPA). Most of the majorchanges affect industries that are nonpublic.

Coming changes to auditor reporting are also covered. These changes are impor-tant not only for auditors, but also for managers, chief financial officers, and any otherfinancial officers in companies that are being audited, especially nonpublic companies,because the auditor reports and models will change dramatically.

¶704 PROPOSED CHANGES IN AUDITOR REPORTINGMany changes to the auditor reporting model have been proposed, both in the UnitedStates and worldwide. Users of financial statements and the auditor’s report have askedfor more information about significant aspects of the audit. For example, in response tousers’ concerns, one change is that the Opinion section of the audit report has beenmoved from the end of the report to the first paragraph. The Accounting StandardsBoard (ASB) has been monitoring changes related to the auditor reporting model in theUnited States and internationally, including projects of the International Auditing andAssurance Standards Board (IAASB) and PCAOB. The ASB formed the Auditor Report-ing Task Force to study these projects.

In response to proposals and requests for public comment from these standardsetters relating to changes to the auditor’s report, the Task Force asked for input fromregulators, corporate governance organizations, auditors, and others. Several keythemes emerged from that process, some significant and others quite minor.

Users of financial statements said they value the pass or fail nature of the auditor’sopinion but that they consider the rest of the report as boilerplate, giving littletransparency into the audit. Some users said they want better information for parts ofthe audit that pose higher risks of material misstatement, that involve significant

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judgment by management and the auditor, or that relate to significant transactions.Some of these users and stakeholders also supported expanding the description in theauditor’s report about management (i.e., what is management, what are its responsibili-ties, etc.). Some auditors raised the issue about whether to continue to address thelong-standing expectations gap.

In January 2016, the ASB issued SAS 131, Amendment to Statement on AuditingStandards No. 122 Section 700, Forming an Opinion and Reporting on FinancialStatements. It addresses which form of the auditor’s report to use when the audit isconducted in accordance with PCAOB standards but is not within the PCAOB’sjurisdiction. In April of the same year, the ASB issued an interpretation to addressissues that might arise when an auditor conducts an audit under both U.S. generallyaccepted auditing standards (GAAS) and the new and revised International Standardson Auditing (ISAs). Remember that GAAS for nonpublic entities is from the AICPA’sASB, and the ISAs are issued by the International Auditing and Assurance StandardsBoard (IAASB), which is the counterpart to both the ASB and the PCAOB.

International auditors have indicated that approximately 90 to 95 percent of theiraudits come from private companies, so there is a true relationship between the ISAsand the GAAS that comes from the United States. Frequently, auditors want to issueone report but refer to both sets of standards. Consequently, the ASB has consideredthe revisions to audit reports resulting from both the IAASB and the PCAOB auditorreporting projects. The ASB believes these changes will increase the informationalvalue and relevance to the users of the audit, and therefore they are in the publicinterest.

Related IAASB Auditor Reporting ProjectThe changes that resulted from the IAASB auditor reporting project are important asthe ASB plans to incorporate them into U.S. auditing standards. In January 2015, theIAASB issued new and revised ISAs relating to reporting on audited financial state-ments. The ISAs are effective for audits of financial statements for periods ending on orafter December 15, 2016. The new and revised ISAs include the following:

• ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements

• ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report

• ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’sReport

• ISA 706 (Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphsin the Independent Auditor’s Report

• ISA 570 (Revised), Going Concern

• ISA 260 (Revised), Communication with Those Charged with Governance

ISA 700 (Revised) includes a significant change related to communicating key auditmatters (KAMs) in the auditor’s report. It requires the auditor to communicate KAMs inthe auditor’s report for audits of complete sets of general-purpose financial statementsfor listed entities in accordance with ISA 701, which also applies when the auditor isrequired by law or regulation or decides to communicate KAMs in the report. KAMs aredefined in ISA 701 as matters that, in the auditor’s professional judgment, were mostsignificant in the audit of the financial statements for the current period.

The ASB used ISAs 700, 701, 705, and 706 as a base for its proposed revisions tothe U.S. standards. However, in making the proposed revisions to the accompanyingproposed SASs, it altered some of the language from the ISAs to reflect terms orphrases that are more common in the United States and to customize examples and

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89MODULE 2 - CHAPTER 7 - Auditor Reporting Models

guidance to the U.S. environment. The ASB believes that such changes will not createsubstantive differences in application between the ISAs and SASs.

STUDY QUESTIONS

1. To study the auditor reporting model projects conducted by the IAASB and PCAOB,the ASB formed the:

a. Emerging Issues Task Force

b. Auditor Reporting Task Force

c. Group Audits Task Force

d. Disclosures Task Force

2. Which of the following ISAs includes a significant change related to communicatingkey audit matters (KAMs) in the auditor’s report?

a. ISA 700 (Revised)

b. ISA 701

c. ISA 705 (Revised)

d. ISA 706 (Revised)

New PCAOB Auditor Reporting ModelThe PCAOB issued AS 3101, The Auditor’s Report on an Audit of Financial StatementsWhen the Auditor Expresses an Unqualified Opinion, along with related amendments toits existing auditing standards, on June 1, 2017. AS 3101 keeps the pass or fail nature ofthe auditor’s opinion and is intended to “enhance the relevance and usefulness of theauditor’s report by providing additional and important information to investors.�

Because AS 3101 and the IAASB’s changes to the auditor’s report are modeled aftereach other, they are very similar. They both require the Opinion section to be presentedfirst in the auditor’s report (rather than at the end), and the Basis for Opinion section tofollow. Both require an explicit reference to auditor independence in the Basis ofOpinion section. In other words, there must be an indication in that section as towhether the auditor is independent. But there also are some differences between thePCAOB and the IAASB forms of the auditor’s report. One is that the IAASB requires amore extensive description of management’s responsibility for preparation of the finan-cial statements and of the auditor’s responsibility for the preparation of the audits.

The new PCAOB standard also requires a discussion of critical audit matters, orCAMs, in the auditor’s report, although some audits will not have a scope engagementthat brings this discussion of CAMs into play. A CAM is defined as “any matter arisingfrom the audit of the financial statements that was communicated or was required to becommunicated to the audit committee, and that relates to accounts or disclosures thatare material to the financial statements and involved especially challenging, subjective,or complex auditor judgment.�

Referring to the IAASB’s approach to determining KAMs, the PCAOB stated that“although the processes of identifying these matters vary across jurisdictions, there arecommonalities in the underlying criteria regarding matters to be communicated and thecommunication requirements, such that expanded auditor reporting could result in thecommunication of many of the same matters under the various approaches.�

The new PCAOB standard’s requirements are very similar to those in the PCAOB’sMay 2016 reproposal of the auditor reporting standard for public comment. While

¶704


developing its proposed SASs and related amendments, the ASB took into accountthose reproposal requirements. Many changes were made to the proposed SASs andamendments because of the auditor reporting model from the PCAOB, but the primaryfocus was not on PCAOB convergence but on convergence with the ISAs. The ASB istrying to converge with the ISAs because it believes there is a closer connection withthe ISAs than with other standards; that is, the ASB’s and IAASB’s missions for auditorsin the nonpublic arena are more closely aligned than the missions of the ASB andPCAOB.

The U.S. Securities and Exchange Commission (SEC), which has oversight overthe PCAOB, approved the final standard and amendments on October 23, 2017. Theeffective date for all elements of the PCAOB auditor’s report—other than CAMs—is foraudits for fiscal years ending on or after December 15, 2017. The effective date forCAMs for audits of large accelerated filers is for fiscal years ending on or after June 30,2019. For audits of all other companies to which the new PCAOB standard applies, theeffective date for CAMS is for fiscal years ending on or after December 15, 2020.

STUDY QUESTIONS

3. A ________ is defined as “any matter arising from the audit of the financial state-ments that was communicated or was required to be communicated to the auditcommittee, and that relates to accounts or disclosures that are material to the financialstatements and involved especially challenging, subjective, or complex auditorjudgment.�

a. Significant event

b. Key audit matter (KAM)

c. Critical audit matter (CAM)

d. Going concern

4. Which of the following statements is correct regarding AS 3101, The Auditor’s Reporton an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion?

a. It was issued by the IAASB in June 2017.

b. It eliminates the pass/fail nature of the auditor’s opinion.

c. It requires the Opinion section to be presented at the end of the auditor’sreport.

d. It requires a discussion of critical audit matters (CAMs) in the auditor’s report.

New DisclosuresIn addition to the form and content of the report, the ASB also formed a disclosures taskforce to consider making changes to the AU-C sections to converge with the IAASBpronouncement Addressing Disclosures in the Audit of Financial Statements—RevisedISAs and Related Conforming Amendments, which was issued in July 2015. The objectiveof this project was to focus auditors’ attention on disclosures in the early stages of (andthroughout) a financial statement audit. Although management is responsible for mostof the disclosures, the auditor must review them for appropriateness and relevance.Changes include the following:

• Stronger requirements in ISA 315, Assessing the Risks of Material MisstatementThrough Understanding the Entity and Its Environment; ISA 330, The Auditor’sResponses to Assessed Risks; and ISA 700 (Revised), Forming an Opinion andReporting on Financial Statements

• Enhanced application material in these and other ISAs to help auditors addresschallenges arising from the disclosures

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The IAASB had completed its auditor reporting project before beginning thisdisclosures project. Therefore, many of the changes to the disclosures came as amend-ments to other pronouncements. And because the ASB looked at this reporting projectin consideration of converging with concurrent IASB disclosures, relevant proposedchanges arising from the disclosures project have been incorporated in the proposedSAS, Forming an Opinion and Reporting on Financial Statements.

¶705 OTHER PROJECTS RELATED TO AUDITORREPORTING

Other InformationThere are also several other important projects related to auditor reporting. Forexample, the IAASB issued ISA 720 (Revised), The Auditor’s Responsibilities Relating toOther Information, in April 2015. The ASB formed a task force to review this ISA anddetermine whether AU-C section 720, Other Information in Documents ContainingAudited Financial Statements, should be revised to converge with ISA 720 (Revised).The ASB subsequently issued the proposed SAS, The Auditor’s Responsibilities Relatingto Other Information Included in Annual Reports, for public comment in November 2017.

This proposed SAS focuses more on the auditor’s responsibility relating to otherinformation, whether financial or nonfinancial information (other than financial state-ments and the auditor’s report on them), included in an entity’s annual report. Itincludes a new requirement to identify in an Other Information section whether, beforethe date of the auditor’s report, the auditor obtained other information.

The appendix to proposed SAS, “Amendments to Various Sections in SAS No. 122,Statements on Auditing Standards: Clarification and Recodification, as amended, andSAS No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a GoingConcern,� includes a proposed amendment to AU-C section 210 (new paragraph .A17)relating to proposed SAS The Auditor’s Responsibilities Relating to Other InformationIncluded in Annual Reports.

AU-C 800 SeriesThe ASB realized it needed to consider the potential effect of this exposure draft on thefollowing AU-C sections (the 800 series):

• AU-C section 800, Special Considerations—Audits of Financial Statements Pre-pared in Accordance With Special Purpose Frameworks

• AU-C section 805, Special Considerations—Audits of Single Financial Statementsand Specific Elements, Accounts, or Items of a Financial Statement

• AU-C section 810, Engagements to Report on Summary Financial Statements

As a result, it decided to address the 800 series after it receives feedback on theproposed SASs in this exposure draft. If changes to the 800 series are needed, the ASBwill propose them in a separate exposure draft and align the effective dates of all thereporting standards to the extent possible.

Employee Benefit PlansThe U.S. Department of Labor (DOL) made some negative comments about theeffectiveness or correctness of auditor’s reports on employee benefit plans (EBPs). Forsome small CPA firms’ audits of employee benefit plans, the DOL said the discrepancieswere 50% or 60% of the audit. In April 2017, in response to such concerns, the ASB

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released an exposure draft for a new auditing standard, Forming an Opinion andReporting on Financial Statements of Employee Benefit Plans Subject to ERISA (proposedEBP reporting standard), that addresses the auditor’s responsibilities to form an opinionand report on ERISA plan financial statements.

The ASB recognized it had to take into account the effect this auditor reportingexposure draft might have on the proposed EBP reporting standard and will considerchanges that may need to be made to the proposed EBP standard.

Proposed Statement on Auditing Standards Omnibus Statement onAuditing Standards—2018Another proposed statement on auditing standards, Proposed Statement on AuditingStandards Omnibus Statement on Auditing Standards—2018 (omnibus SAS exposuredraft), was issued in November 2017. Since the ASB had completed its auditingstandards clarity project, in which it clarified GAAS and converged those standards withthe ISAs, the PCAOB issued AS 1301, Communication With Audit Committees; AS 2701,Supplementary Information; and AS 2410, Related Parties. These standards includedconforming amendments to other PCAOB auditing standards.

After looking at whether these three standards included material that, if included inthe requirements or application material of GAAS, would enhance audit quality foraudits of financial statements of nonissuers in an efficient manner, the ASB issued itsexposure draft, Proposed Statement on Auditing Standards Omnibus Statement on Audit-ing Standards—2018.

OBSERVATION: Some of the AU-C sections amended by this auditor report-ing exposure draft are also amended by the omnibus SAS exposure draft. Forexample, the text and paragraph numbering of AU-C section 260 is affected by bothexposure drafts.

Depending on when the proposed standards and amendments are finalized, theireffective date would be no earlier than for audits of financial statements for periodsending on or after June 15, 2019. Because so many of these proposed standards andamendments are related, they all would have to be adopted concurrently. Early imple-mentation likely will not be permitted.

Proposed SAS Forming an Opinion and Reporting on FinancialStatements (AU-C Section 700)This proposed SAS is intended to converge with ISA 700 (Revised). If finalized, it willchange the form and content for all auditor’s reports issued for audits of non-issuers.These changes would reflect the changes to the auditor’s report resulting from theIAASB’s new and revised ISAs and would be consistent with the new PCAOB auditorreporting model regarding placement of the Opinion and Basis for Opinion sections inthe auditor report.

The proposed SAS would generally keep the existing requirements for forming anopinion on the financial statements and for the form of the opinion. According to thePCAOB, the major changes in the proposed SAS from the current AU-C section 700 areas follows:

• The Opinion section must be presented first in the auditor’s report, followed bythe Basis for Opinion section (unless otherwise required by law or regulation).

• The Basis for Opinion section of the auditor’s report must include an affirmativestatement about the auditor’s independence and fulfillment of the auditor’s otherethical responsibilities in accordance with relevant ethical requirements relatingto the audit.

¶705


• The auditor must report in accordance with proposed amendments to AU-Csection 570, The Auditor’s Consideration of an Entity’s Ability to Continue as aGoing Concern.

• KAMs would have to be communicated for audits of nonissuers. But if the termsof the audit engagement include reporting KAMs, the auditor must communi-cate KAMs in accordance with proposed SAS Communicating Key Audit Mattersin the Independent Auditor’s Report.

• The auditor must report in accordance with proposed SAS, The Auditor’s Respon-sibilities Relating to Other Information Included in Annual Reports.

• The description of the responsibilities of management for the preparation andfair presentation of the financial statements is expanded. It includes a require-ment to identify the parties responsible for overseeing the financial reportingprocess if they differ from the parties responsible for preparing the financialstatements.

• The descriptions of the auditor’s responsibilities and the key features of an auditare expanded.

Proposed SAS Communicating Key Audit Matters in the IndependentAuditor’s Report (Proposed New AU-C Section 701)Although proposed SAS Forming an Opinion and Reporting on Financial Statementswould not require that KAMs be communicated for audits of nonissuers, if this is doneas part of the terms of the audit engagement, the auditor would have to communicateKAMs in accordance with this proposed SAS.

The ASB decided that a separate standard is needed to give auditors guidance insituations where it would be most appropriate to communicate KAMs in the auditor’sreport. Proposed SAS Communicating Key Audit Matters in the Independent Auditor’sReport is very similar to ISA 701.

Proposed SAS Modifications to the Opinion in the IndependentAuditor’s Report (AU-C Section 705)This proposed SAS is intended to converge with ISA 705 (Revised). Major changes tothe current AU-C section 705 relate to the form and content of the auditor’s report whenthe opinion is modified consistent with the requirements in proposed SAS Forming anOpinion and Reporting on Financial Statements. Current requirements for circum-stances in which a modification to the auditor’s opinion is required, and for determiningthe type of modification to the auditor’s opinion, are not changed.

Proposed SAS Emphasis-of-Matter and Other-Matter Paragraphs inthe Independent Auditor’s Report (AU-C Section 706)This proposed SAS is intended to converge with ISA 706 (Revised). Major changes tocurrent AU-C section 706 relate to clarifying the relationship between emphasis-of-matter paragraphs and the communication of KAMs in the auditor’s report. If proposedSAS Communicating Key Audit Matters in the Independent Auditor’s Report applies, anemphasis-of-matter paragraph is not a substitute for a description of individual KAMs.Proposed SAS Emphasis-of-Matter and Other-Matter Paragraphs in the IndependentAuditor’s Report also requires auditors to include a heading for an emphasis-of-matterparagraph that includes the words “Emphasis of Matter.� The auditor would be allowedto add more text to that heading to provide more detail.

¶705


STUDY QUESTIONS

5. Which of the following proposed standards include a requirement that KAMs becommunicated for audits of nonissuers?

a. Proposed SAS Forming an Opinion and Reporting on Financial Statements (AU-C Section 700)

b. Proposed SAS Communicating Key Audit Matters in the Independent Auditor’sReport (Proposed New AU-C Section 701)

c. Proposed SAS Modifications to the Opinion in the Independent Auditor’s Report(AU-C Section 705)

d. Proposed SAS Emphasis-of-Matter and Other-Matter Paragraphs in the Indepen-dent Auditor’s Report (AU-C Section 706)

6. The ASB is focusing on converging its auditor reporting standards with:

a. International standards

b. PCAOB standards

c. FASB standards

d. GASB standards

¶706 SIGNIFICANT PROPOSED AMENDMENTS TOEXISTING AUDITOR REPORTING STANDARDSThe following proposed amendments reflect major changes that will result from all theauditor reporting standards proposals being issued.

AU-C Section 570, Going ConcernProposed amendments to AU-C section 570 (SAS 132) change the auditor reportingrequirements on going concern to make them consistent with the correspondingrequirements in ISA 570 (Revised). The underlying auditor performance requirementsrelating to going concern will not change, however.

If, after considering some conditions or events, an auditor concludes that substan-tial doubt remains about an entity’s ability to continue as a going concern for areasonable period of time, the auditor should include in the auditor’s report a separatesection titled “Substantial Doubt About the Entity’s Ability to Continue as a GoingConcern� instead of an emphasis-of-matter paragraph. This section’s content will besimilar to the content included in the emphasis-of-matter paragraph.

AU-C Section 260, Communications With Those Charged WithGovernanceOne of the most significant changes to the existing AU-C Section 260 is a requirementfor the auditor to communicate with those charged with governance about the signifi-cant risk identified by the auditor. This communication would be part of the requiredcommunication of the overview, scope, and timing of the audit. The proposed amend-ments to this section also require the auditor to communicate with those charged withgovernance about circumstances that affect the form and content of the auditor’s report.

¶706


AU-C Section 210, Terms of EngagementThe proposed amendments to this section modify some of the terms of the engagementthat relate to the form and content of the engagement letter, making them consistentwith the changes to the elements of the auditor’s report in proposed SAS Forming anOpinion and Reporting on Financial Statements. In addition, the amendments add a newapplication material paragraph that provides guidance when management has asked theauditor to communicate KAMs in the auditor’s report and guidance regarding theacknowledgment of this in the engagement letter.

¶707 ILLUSTRATIONS OF AUDITOR’S REPORTS ONFINANCIAL STATEMENTSMost of the following illustrations are reproduced from the actual proposals or theauditing standards. These sample auditor’s reports on financial statements show howsome of the changes discussed thus far in this chapter would be incorporated in thereport. Each illustration is preceded by a list of circumstances that will impact thecontent of the auditor’s report.

Auditor’s Report on Comparative Financial Statements inAccordance with GAAP in the United StatesCircumstances. Audit of a complete set of general purpose financial statements(comparative). The audit is not a group audit.

• Management is responsible for the preparation of the financial statements inaccordance with accounting principles generally accepted in the United States ofAmerica as promulgated by the Financial Accounting Standards Board.

• The terms of the audit engagement reflect the description of management’sresponsibility for the financial statements in AU-C section 210.

• The auditor has concluded that an unmodified (that is, “clean�) opinion isappropriate based on the audit evidence obtained.

• Based on the audit evidence obtained, the auditor has concluded that there areno conditions or events, considered in the aggregate, that raise substantialdoubt about the entity’s ability to continue as a going concern for a reasonableperiod of time in accordance with AU-C section 570.

• The auditor has obtained all of the other information prior to the date of theauditor’s report and has not identified a material misstatement of the otherinformation included in the annual report.

• Those responsible for oversight of the financial statements differ from thoseresponsible for the preparation of the financial statements.

• The auditor has not been engaged to communicate key audit matters in theauditor’s report.

Independent Auditor’s Report

[Appropriate Addressee]

Report on the Audit of the Financial Statements

Opinion

We have audited the financial statements of ABC Company, which comprisethe balance sheets as of December 31, 20X1 and 20X0, and the related

¶707


statements of income, changes in stockholders’ equity, and cash flows forthe years then ended, and the related notes to the financial statements.

In our opinion, the accompanying financial statements present fairly, in allmaterial respects, the financial position of ABC Company as of December31, 20X1 and 20X0, and the results of its operations and its cash flows for theyears then ended in accordance with accounting principles generally ac-cepted in the United States of America.

Basis for Opinion

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Financial Statements section of our report. We areindependent of ABC Company, and have fulfilled our other ethical responsi-bilities, in accordance with the relevant ethical requirements relating to ouraudit. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our audit opinion.

Other Information [or another title if appropriate, such as “InformationOther Than the Financial Statements and Auditor’s Report Thereon�]

[Reporting in accordance with the reporting requirements in proposed SASThe Auditor’s Responsibilities Relating to Other Information Included in An-nual Reports; see illustration 1 of that proposed SAS.]

Responsibilities of Management and Those Charged With Governancefor the Financial Statements

Management is responsible for the preparation and fair presentation of thefinancial statements in accordance with accounting principles generallyaccepted in the United States of America; this includes the design, imple-mentation, and maintenance of internal control relevant to the preparationand fair presentation of financial statements that are free from materialmisstatement, whether due to fraud or error.

In preparing the financial statements, management is responsible for assess-ing ABC Company’s ability to continue as a going concern in accordancewith accounting principles generally accepted in the United States ofAmerica, and using the going concern basis of accounting unless manage-ment either intends to liquidate ABC Company or to cease operations, orhas no realistic alternative but to do so.

Those charged with governance are responsible for overseeing ABC Com-pany’s financial reporting process.

Auditor’s Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the finan-cial statements as a whole are free from material misstatement, whether dueto fraud or error, and to issue an auditor’s report that includes our opinion.Reasonable assurance is a high level of assurance but is not absoluteassurance and therefore is not a guarantee that an audit conducted inaccordance with GAAS will always detect a material misstatement when itexists. Misstatements can arise from fraud or error and are consideredmaterial if, individually or in the aggregate, they could reasonably beexpected to influence the economic decisions of users made on the basis ofthese financial statements.

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As part of an audit in accordance with GAAS, we exercise professionaljudgment and maintain professional skepticism throughout the audit. Wealso:

• Identify and assess the risks of material misstatement of the finan-cial statements, whether due to fraud or error, design and performaudit procedures responsive to those risks, and obtain audit evi-dence that is sufficient and appropriate to provide a basis for ouropinion. The risk of not detecting a material misstatement resultingfrom fraud is higher than for one resulting from error, as fraud mayinvolve collusion, forgery, intentional omissions, misrepresentations,or the override of internal control.

Proposed SAS Modifications to the Opinion in the Independent Audi-tor’s Report

• Obtain an understanding of internal control relevant to the audit inorder to design audit procedures that are appropriate in the circum-stances, but not for the purpose of expressing an opinion on theeffectiveness of ABC Company’s internal control. Accordingly, nosuch opinion is expressed.

• Evaluate the appropriateness of accounting policies used and thereasonableness of significant accounting estimates made by manage-ment, as well as evaluating the overall presentation of the financialstatements.

• Conclude on ABC Company’s ability to continue as a going concernand conclude on the appropriateness of management’s use of thegoing concern basis of accounting.

We communicate with those charged with governance regarding, amongother matters, the planned scope and timing of the audit and significantaudit findings, including any significant deficiencies and material weak-nesses in internal control that we identified during our audit.

Report on Other Legal and Regulatory Requirements

[The form and content of this section of the auditor’s report would varydepending on the nature of the auditor’s other reporting responsibilities.]

[Signature of the auditor’s firm]

[Auditor’s city and state]

[Date of the auditor’s report]

Auditor’s Report Containing a Qualified Opinion for InadequateDisclosureCircumstances. Audit of a complete set of general purpose financial statements(comparative). The audit is not a group audit.



¶707


• The financial statements have inadequate disclosures. The auditor has con-cluded that

— it is not practicable to present the required information and

— the effects are such that an adverse opinion is not appropriate. Accordingly,the auditor’s report contains a qualified opinion.


• The auditor has obtained all of the other information prior to the date of theauditor’s report, and the matter giving rise to the qualified opinion on thefinancial statements also affects the other information included in the annualreport.


• The auditor has been engaged to communicate key audit matters in the audi-tor’s report.

COMMENT: The subtitle “Report on the Audit of the Financial Statements� isunnecessary in circumstances in which the second subtitle, “Report on Other Legaland Regulatory Requirements,� is not applicable.




Qualified Opinion

We have audited the financial statements of ABC Company, which comprisethe balance sheets as of December 31, 20X1 and 20X0, and the relatedstatements of income, changes in stockholders’ equity, and cash flows forthe years then ended, and the related notes to the financial statements.

In our opinion, except for the omission of the information described in theBasis for Qualified Opinion section of our report, the accompanying finan-cial statements present fairly, in all material respects, the financial positionof ABC Company as of December 31, 20X1 and 20X0, and the results of itsoperations and its cash flows for the years then ended in accordance withaccounting principles generally accepted in the United States of America.

Basis for Qualified Opinion

The Company’s financial statements do not disclose [describe the nature ofthe omitted information that is not practicable to present in the auditor’sreport]. In our opinion, disclosure of this information is required by account-ing principles generally accepted in the United States of America.

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Financial Statements section of our report. We areindependent of ABC Company, and have fulfilled our other ethical responsi-bilities, in accordance with the relevant ethical requirements relating to our

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audit. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our qualified audit opinion.

Key Audit Matters

Key audit matters are those matters that were communicated with thosecharged with governance and, in our professional judgment, were of mostsignificance in our audit of the financial statements of the current period.These matters were addressed in the context of our audit of the financialstatements as a whole, and in forming our opinion thereon, and we do notprovide a separate opinion on these matters.

[Description of each key audit matter in accordance with proposed SASCommunicating Key Audit Matters in the Independent Auditor’s Report]


[Reporting in accordance with the reporting requirements in proposed SASThe Auditor’s Responsibilities Relating to Other Information Included in An-nual Reports; see illustration 3 in the appendix of that proposed SAS. Thelast paragraph of the Other Information section in illustration 3 of thatproposed SAS would be customized to describe the specific matter givingrise to the qualified opinion that also affects the other information.]







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Auditor’s Report Containing an Adverse Opinion Due to a MaterialMisstatement of the Financial StatementsCircumstances. Audit of a complete set of consolidated general purpose financialstatements (single year). The audit is a group audit. The auditor is not makingreference to a component auditor in the auditor’s report.

• Management is responsible for the preparation of the consolidated financialstatements in accordance with accounting principles generally accepted in theUnited States of America as promulgated by the Financial Accounting StandardsBoard.


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• The consolidated financial statements are materially misstated due to the non-consolidation of a subsidiary. The material misstatement is deemed to bepervasive to the consolidated financial statements. Accordingly, the auditor’sreport contains an adverse opinion. The effects of the misstatement on thefinancial statements have not been determined because it was not practicable todo so.


• The auditor has obtained all of the other information prior to the date of theauditor’s report and the matter giving rise to the adverse opinion on theconsolidated financial statements also affects the other information included inthe annual report.


• The auditor is precluded from communicating key audit matters in the auditor’sreport when issuing an adverse opinion.



Report on the Audit of the Consolidated Financial Statements

Adverse Opinion

We have audited the consolidated financial statements of ABC Company andits subsidiaries, which comprise the consolidated balance sheet as of De-cember 31, 20X1, and the related consolidated statements of income,changes in stockholders’ equity, and cash flows for the year then ended, andthe related notes to the financial statements.

In our opinion, because of the significance of the matter discussed in theBasis for Adverse Opinion section of our report, the accompanying consoli-dated financial statements do not present fairly the consolidated financialposition of ABC Company and its subsidiaries as of December 31, 20X1, orthe results of their operations or their cash flows for the year then ended inaccordance with accounting principles generally accepted in the UnitedStates of America.

Basis for Adverse Opinion

As described in Note X, the Company has not consolidated the financialstatements of subsidiary XYZ Company that it acquired during 20X1 be-cause it has not yet been able to ascertain the fair values of certain of thesubsidiary’s material assets and liabilities at the acquisition date. Thisinvestment is therefore accounted for on a cost basis by the Company.Under accounting principles generally accepted in the United States ofAmerica, the subsidiary should have been consolidated because it is con-trolled by the Company. Had XYZ Company been consolidated, manyelements in the accompanying consolidated financial statements would havebeen materially affected. The effects on the consolidated financial state-ments of the failure to consolidate have not been determined.

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We conducted our audit in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Consolidated Financial Statements section of ourreport. We are independent of ABC Company, and have fulfilled our otherethical responsibilities, in accordance with the relevant ethical requirementsrelating to our audit. We believe that the audit evidence we have obtained issufficient and appropriate to provide a basis for our adverse audit opinion.


[Reporting in accordance with the reporting requirements in proposed SASThe Auditor’s Responsibilities Relating to Other Information Included in An-nual Reports; see illustration 4 in the appendix of that proposed SAS. Thelast paragraph of the Other Information section in illustration 4 of thatproposed SAS would be customized to describe the specific matter givingrise to the adverse opinion that also affects the other information.]

Responsibilities of Management and Those Charged With Governancefor the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of theconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America; this includes the design,implementation, and maintenance of internal control relevant to the prepara-tion and fair presentation of consolidated financial statements that are freefrom material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, management is responsi-ble for assessing ABC Company’s ability to continue as a going concern inaccordance with accounting principles generally accepted in the UnitedStates of America, and using the going concern basis of accounting unlessmanagement either intends to liquidate ABC Company or to cease opera-tions, or has no realistic alternative but to do so.


Auditor’s Responsibilities for the Audit of the Consolidated FinancialStatements

Our objectives are to obtain reasonable assurance about whether the consol-idated financial statements as a whole are free from material misstatement,whether due to fraud or error, and to issue an auditor’s report that includesour opinion. Reasonable assurance is a high level of assurance but is notabsolute assurance and therefore is not a guarantee that an audit conductedin accordance with GAAS will always detect a material misstatement when itexists. Misstatements can arise from fraud or error and are consideredmaterial if, individually or in the aggregate, they could reasonably beexpected to influence the economic decisions of users made on the basis ofthese consolidated financial statements.


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• Identify and assess the risks of material misstatement of the consoli-dated financial statements, whether due to fraud or error, design andperform audit procedures responsive to those risks, and obtain auditevidence that is sufficient and appropriate to provide a basis for ouropinion. The risk of not detecting a material misstatement resultingfrom fraud is higher than for one resulting from error, as fraud mayinvolve collusion, forgery, intentional omissions, misrepresentations,or the override of internal control.



• Evaluate the appropriateness of accounting policies used and thereasonableness of significant accounting estimates made by manage-ment, as well as evaluating the overall presentation of the consoli-dated financial statements.








Auditor’s Report Containing a Qualified Opinion Due to theAuditor’s Inability to Obtain Sufficient Appropriate Audit EvidenceCircumstances. Audit of a complete set of general purpose financial statements (singleyear). The audit is not a group audit.



• The auditor was unable to obtain sufficient appropriate audit evidence regardingan investment in a foreign affiliate. The possible effects of the inability to obtainsufficient appropriate audit evidence are deemed to be material but not perva-sive to the financial statements. Accordingly, the auditor’s report contains aqualified opinion.

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• The auditor has obtained all of the other information prior to the date of theauditor’s report and the matter giving rise to the qualified opinion on thefinancial statements also affects the other information included in the annualreport.






Qualified Opinion

We have audited the financial statements of ABC Company, which comprisethe balance sheet as of December 31, 20X1, and the related statements ofincome, changes in stockholders’ equity, and cash flows for the year thenended, and the related notes to the financial statements.

In our opinion, except for the possible effects of the matter described in theBasis for Qualified Opinion section of our report, the accompanying finan-cial statements present fairly, in all material respects, the financial positionof ABC Company as of December 31, 20X1, and the results of its operationsand its cash flows for the year then ended in accordance with accountingprinciples generally accepted in the United States of America.

Basis for Qualified Opinion

ABC Company’s investment in XYZ Company, a foreign affiliate acquiredduring the year and accounted for under the equity method, is carried at$XXX on the balance sheet at December 31, 20X1, and ABC Company’sshare of XYZ Company’s net income of $XXX is included in ABC Company’snet income for the year then ended. We were unable to obtain sufficientappropriate audit evidence about the carrying amount of ABC Company’sinvestment in XYZ Company as of December 31, 20X1, and ABC Company’sshare of XYZ Company’s net income for the year then ended because wewere denied access to the financial information, management, and theauditors of XYZ Company. Consequently, we were unable to determinewhether any adjustments to these amounts were necessary.

We conducted our audit in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Financial Statements section of our report. We areindependent of ABC Company, and have fulfilled our other ethical responsi-bilities, in accordance with the relevant ethical requirements relating to ouraudit. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our qualified audit opinion.

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[Reporting in accordance with the reporting requirements in proposed SASThe Auditor’s Responsibilities Relating to Other Information Included in An-nual Reports; see illustration 3 in the appendix of that proposed SAS. Thelast paragraph of the Other Information section in illustration 3 of thatproposed SAS would be customized to describe the specific matter givingrise to the qualified opinion that also affects the other information.]









• Obtain an understanding of internal control relevant to the audit inorder to design audit procedures that are appropriate in the circum-stances, but not for the purpose of expressing an opinion on the

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effectiveness of the ABC Company’s internal control. Accordingly,no such opinion is expressed.










Auditor’s Report Containing a Disclaimer of Opinion Due to theAuditor’s Inability to Obtain Sufficient Appropriate Audit EvidenceAbout a Single Element of the Financial StatementsCircumstances. Audit of a complete set of general purpose financial statements (singleyear). The audit is not a group audit.



• The auditor was unable to obtain sufficient appropriate audit evidence about asingle element of the financial statements. That is, the auditor was unable toobtain audit evidence about the financial information of a joint venture invest-ment accounted for under the proportionate consolidation approach. The invest-ment represents over 90 percent of the Company’s net assets. The possibleeffects of this inability to obtain sufficient appropriate audit evidence are deemedto be both material and pervasive to the financial statements. Accordingly, theauditor’s report contains a disclaimer of opinion.

• The auditor concluded that it was unnecessary to include in the auditor’s reportspecific amounts for the Company’s proportional share of the assets, liabilities,income, and expenses of the joint venture investment because the investmentrepresents over 90 percent of the Company’s net assets, and that fact isdisclosed in the auditor’s report.

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• The auditor is precluded from including an Other Information section in theauditor’s report when disclaiming an opinion on the financial statements.


• The auditor is precluded from communicating key audit matters in the auditor’sreport when disclaiming an opinion on the financial statements.

• A more limited description of the Auditor’s Responsibilities section is requiredbecause of the disclaimer of opinion.




Disclaimer of Opinion

We were engaged to audit the financial statements of ABC Company, whichcomprise the balance sheet as of December 31, 20X1, and the relatedstatements of income, changes in stockholders’ equity, and cash flows forthe year then ended, and the related notes to the financial statements.

We do not express an opinion on the accompanying financial statements ofABC Company. Because of the significance of the matter described in theBasis for Disclaimer of Opinion section of our report, we have not been ableto obtain sufficient appropriate audit evidence to provide a basis for an auditopinion on these financial statements.

Basis for Disclaimer of Opinion

The Company’s investment in XYZ Company, a joint venture, is carried at$XXX on the Company’s balance sheet, which represents over 90 percent ofthe Company’s net assets as of December 31, 20X1. We were not allowedaccess to the management and the auditors of XYZ Company. As a result,we were unable to determine whether any adjustments were necessaryrelating to the Company’s proportional share of XYZ Company’s assets thatit controls jointly, its proportional share of XYZ Company’s liabilities forwhich it is jointly responsible, its proportional share of XYZ Company’sincome and expenses for the year, and the elements making up the state-ments of changes in stockholders’ equity and cash flows.



In preparing the financial statements, management is responsible for assess-ing ABC Company’s ability to continue as a going concern in accordancewith accounting principles generally accepted in the United States ofAmerica and using the going concern basis of accounting, unless manage-ment either intends to liquidate ABC Company or to cease operations, orhas no realistic alternative but to do so.

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Our responsibility is to conduct an audit of ABC Company’s financialstatements in accordance with auditing standards generally accepted in theUnited States of America and to issue an auditor’s report. However, becauseof the matter described in the Basis for Disclaimer of Opinion section of ourreport, we were not able to obtain sufficient appropriate audit evidence toprovide a basis for an audit opinion on these financial statements.

We are independent of ABC Company, and have fulfilled our other ethicalresponsibilities, in accordance with the relevant ethical requirements relat-ing to our audit.






Auditor’s Report Containing a Disclaimer of Opinion Due to theAuditor’s Inability to Obtain Sufficient Appropriate Audit EvidenceAbout Multiple Elements of the Financial StatementsCircumstances. Audit of a complete set of general purpose financial statements (singleyear). The audit is not a group audit.



• The auditor was unable to obtain sufficient appropriate audit evidence aboutmultiple elements of the financial statements. That is, the auditor was unable toobtain audit evidence about the entity’s inventories and accounts receivable. Thepossible effects of this inability to obtain sufficient appropriate audit evidenceare deemed to be both material and pervasive to the financial statements.Accordingly, the auditor’s opinion contains a disclaimer of opinion.

• The auditor is precluded from including an Other Information section in theauditor’s report when disclaiming an opinion on the financial statements.


• The auditor is precluded from communicating key audit matters in the auditor’sreport when disclaiming an opinion on the financial statements.

• A more limited description of the Auditor’s Responsibilities section is requiredbecause of the disclaimer of opinion.

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Disclaimer of Opinion

We were engaged to audit the financial statements of ABC Company, whichcomprise the balance sheet as of December 31, 20X1, and the relatedstatements of income, changes in stockholders’ equity, and cash flows forthe year then ended, and the related notes to the financial statements.

We do not express an opinion on the accompanying financial statements ofABC Company. Because of the significance of the matters described in theBasis for Disclaimer of Opinion section of our report, we have not been ableto obtain sufficient appropriate audit evidence to provide a basis for an auditopinion.

Basis for Disclaimer of Opinion

We were not engaged as auditors of the Company until after December 31,20X1, and, therefore, did not observe the counting of physical inventories atthe beginning or end of the year. We were unable to satisfy ourselves byother auditing procedures concerning the inventory held at December 31,20X1, which is stated in the balance sheet at $XXX. In addition, the introduc-tion of a new computerized accounts receivable system in September 20X1resulted in numerous misstatements in accounts receivable. As of the dateof our audit report, management was still in the process of rectifying thesystem deficiencies and correcting the misstatements. We were unable toconfirm or verify by alternative means accounts receivable included in thebalance sheet at a total amount of $XXX at December 31, 20X1. As a result ofthese matters, we were unable to determine whether any adjustments mighthave been found necessary in respect of recorded or unrecorded inventoriesand accounts receivable, and the elements making up the statements ofincome, changes in stockholders’ equity, and cash flows.






Our responsibility is to conduct an audit of ABC Company’s financialstatements in accordance with auditing standards generally accepted in theUnited States of America and to issue an auditor’s report. However, because

¶707


of the matters described in the Basis for Disclaimer of Opinion section ofour report, we were not able to obtain sufficient appropriate audit evidenceto provide a basis for an audit opinion on these financial statements.

We are independent of ABC Company, and have fulfilled our other ethicalresponsibilities, in accordance with the relevant ethical requirements relat-ing to our audit.

Auditor’s Report in Which the Auditor Is Expressing an UnmodifiedOpinion in the Prior Year and a Modified Opinion (QualifiedOpinion) in the Current YearCircumstances

• Certain lease obligations have been excluded from the financial statements inthe current year. The effect of the exclusion is material but not pervasive. Theauditor expressed an unmodified opinion in the prior year and is expressing amodified opinion (qualified opinion) in the current year.







Qualified Opinion


In our opinion, except for the effects on the accompanying 20X1 financialstatements of not capitalizing certain lease obligations as described in theBasis for Qualified Opinion section of our report, the financial statementspresent fairly, in all material respects, the financial position of ABC Com-pany as of December 31, 20X1 and 20X0, and the results of its operationsand its cash flows for the years then ended in accordance with accountingprinciples generally accepted in the United States of America.

Basis for Qualified Opinion on the 20X1 Financial Statements

The Company has excluded, from property and debt in the accompanying20X1 balance sheet, certain lease obligations that were entered into in 20X1which, in our opinion, should be capitalized in accordance with accountingprinciples generally accepted in the United States of America. If these leaseobligations were capitalized, property would be increased by $XXX, long-term debt by $XXX, and retained earnings by $XXX as of December 31,

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20X1, and net income and earnings per share would be increased (de-creased) by $XXX and $XXX, respectively, for the year then ended.

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Financial Statements section of our report. We areindependent of ABC Company, and have fulfilled our other ethical responsi-bilities, in accordance with the relevant ethical requirements relating to ouraudit. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our qualified opinion on the 20X1 financialstatements and for our opinion on the 20X0 financial statements.








• Identify and assess, the risks of material misstatement of the finan-cial statements, whether due to fraud or error, design and performaudit procedures responsive to those risks, and obtain audit evi-dence that is sufficient and appropriate to provide a basis for ouropinion. The risk of not detecting a material misstatement resultingfrom fraud is higher than for one resulting from error, as fraud mayinvolve collusion, forgery, intentional omissions, misrepresentations,or the override of internal control.

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Auditor’s Report in Which the Auditor Is Expressing an UnmodifiedOpinion in the Current Year and a Disclaimer of Opinion on thePrior-Year Statements of Income, Changes in Stockholders’ Equity,and Cash FlowsCircumstances. Audit of a complete set of general purpose financial statements(comparative). The audit is not a group audit.



• The auditor was unable to observe the physical inventory as of December 31,20X0, because at that time the auditor had not been engaged. Accordingly, theauditor was unable to obtain sufficient appropriate audit evidence regarding thenet income and cash flows for the year ended December 31, 20X1. The effects ofthe inability to obtain sufficient appropriate audit evidence are deemed materialand pervasive.

• The auditor expressed an unmodified opinion on the December 31, 20X2 and20X1, balance sheets and a disclaimer of opinion on the 20X1 statements ofincome, changes in stockholders’ equity, and cash flows.

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Opinion


In our opinion, the accompanying balance sheets of ABC Company as ofDecember 31, 20X2 and 20X1, and the statements of income, changes instockholders’ equity, and cash flows for the year ended December 31, 20X2,present fairly, in all material respects, the financial position of ABC Com-pany as of December 31, 20X2 and 20X1, and the results of its operationsand its cash flows for the year ended December 31, 20X2, in accordancewith accounting principles generally accepted in the United States ofAmerica.

Disclaimer of Opinion on 20X1 Operations and Cash Flows

We do not express an opinion on the accompanying results of operationsand cash flows for the year ended December 31, 20X1. Because of thesignificance of the matter described in the Basis for Disclaimer of Opinionsection of our report, we have not been able to obtain sufficient appropriateaudit evidence to provide a basis for an audit opinion on the results ofoperations and cash flows.

Basis for Opinion

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America (GAAS). Our responsibilitiesunder those standards are further described in the Auditor’s Responsibili-ties for the Audit of the Financial Statements section of our report. We areindependent of ABC Company, and have fulfilled our other ethical responsi-bilities, in accordance with the relevant ethical requirements relating to ouraudit. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our audit opinions on the balance sheetsas of December 31, 20X2 and 20X1, and the statements of income, changesin stockholders’ equity, and cash flows for the year ended December 31,20X2.

Basis for Disclaimer of Opinion on 20X1 Operations and Cash Flows

We did not observe the taking of the physical inventory as of December 31,20X0, because that date was prior to our engagement as auditors for theCompany, and we were unable to satisfy ourselves regarding inventory

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quantities by means of other auditing procedures. Inventory amounts as ofDecember 31, 20X0, enter into the determination of net income and cashflows for the year ended December 31, 20X1.










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¶708 CONCLUSIONThe changes in auditor’s reports are expected to be the most significant changes in 70years. In addition, there will be even more changes in disclosures and the form of Notesto the Financial Statements. Auditors and management must take the time to under-stand the changes and related responsibilities.

¶708

117

MODULE 2: TOP AUDITING ISSUES—CHAPTER 8: SSARS 24¶801 WELCOMEThis chapter provides an overview of selected preparation, compilation, and reviewstandards and discusses new Statements on Standards for Accounting and ReviewServices (SSARS) 24, Omnibus Statement on Standards for Accounting and ReviewServices—2018.



• Identify the requirements of revised SSARS 21, 22, and 23

• Recognize the revised compilation and review report requirements of SSARS 24

¶803 SSARS 21, SSARS 22, AND SSARS 23SSARS are issued by the AICPA’s Accounting and Review Services Committee (ARSC).The latest SSARS include SSARS 21, SSARS 22, SSARS 23, and SSARS 24.

SSARS 21SSARS 21, Statements on Standards for Accounting and Review Services: Clarification andRecodification, is a lengthy standard that includes major revisions affecting preparationengagements. SSARS 21 is the clarified version of the former SSARS 19. The followingtable summarizes the differences between preparation and compilation engagements.

Compilation versus Preparation Engagements

Compilation Preparation

When an accountant is engaged When an accountant is engagedWhen does the standard apply? to perform a compilation to prepare financial statements

Is an engagement letter required? Yes Yes

Is an independence determinationrequired? Yes No

Is disclosure of impairment ofindependence required? Yes NA

No (statement on financialsIs a report required? Yes required or disclaimer)

May financials go to users outsideof management? Yes Yes

As shown in the table, an engagement letter is required for both compilation andpreparation engagements. However, an independence determination is required for thecompilations but not for the preparation. Preparation engagements are nonattest func-tions. The AICPA defines an attest function as one that requires independence. There-fore, if an accountant is not independent, he has to disclose that impairment ofindependence in a compilation engagement. In a preparation engagement, however,such disclosure is not required.

¶803


An accountant must issue a report for a compilation engagement, but no suchreport is required for a preparation engagement. Although no report is required, astatement or legend that no assurance is provided on the prepared financials must beincluded in the financials themselves. For both compilation and preparation engage-ments, with no report and no assurance, the financials may go to users outside ofmanagement. The preparation engagement itself will indicate when the accountant isengaged by management to prepare financial statements.

Situations where SSARS 21 does not apply to a preparation engagement include thefollowing:

• The preparation of financial statements when the accountant is engaged toperform an audit, review, or compilation with respect to those financialstatements

• The preparation of tax returns or other data prepared solely to be submitted totaxing authorities

• Personal financial statements that are prepared to be included in written per-sonal financial plans prepared by the accountant

• Financial statements prepared in conjunction with litigation services that involvelegal or regulatory proceedings

As mentioned earlier, preparation engagements must include a statement or legendregarding assurance on each page of the financial statement. Examples of such state-ment include “No assurance is provided by any CPA on these financial statements,� or“These financial statements have not been compiled, reviewed or audited, and no CPAexpresses an opinion or a conclusion or provides any assurance on them.�

With regard to the compilation report, language has been changed to make thereport more streamlined. A single paragraph (reproduced below) states that the reportis in full accordance with generally accepted accounting principles (GAAP) and thatthere are no significant issues.

Management is responsible for the accompanying financial statements ofXYZ Company, which comprise the balance sheet as of December 31, 20X1,and the related statements of income, changes in stockholders’ equity, andcash flows for the year then ended, and the related notes to the financialstatements in accordance with accounting principles generally accepted inthe United States of America. I (We) have performed a compilation engage-ment in accordance with Statements on Standards for Accounting andReview Services promulgated by the Accounting and Review Services Com-mittee of the AICPA. I (We) did not audit or review the financial statementsnor was (were) I (we) required to perform any procedures to verify theaccuracy or completeness of the information provided by management.Accordingly, I (we) do not express an opinion, a conclusion, nor provide anyform of assurance on these financial statements.

The review engagement requirements in SSARS 21 are basically a redraft of thosein SSARS 19. An engagement letter is required. The scope includes:

• Specified elements, accounts, or items

• Supplementary information

• Required supplementary information

• Financial information included in a tax return

¶803

119MODULE 2 - CHAPTER 8 - SSARS 24

STUDY QUESTION

1. Which of the following statements represents a difference between compilationengagements and preparation engagements?

a. A compilation engagement requires an engagement letter; a preparation en-gagement does not.

b. A preparation engagement requires a disclosure of impairment of indepen-dence; a compilation engagement does not.

c. A compilation engagement requires a report; a preparation engagement doesnot.

d. For a compilation engagement, financials may go to users outside of manage-ment; for a preparation engagement, they may not.

SSARS 22SSARS 22 addresses pro forma financial information, revising AR section 120, Compila-tion of Pro Forma Financial Information, by putting the requirements and guidance inclarity format.

The accountant’s objective in a compilation of pro forma financial information is toapply accounting and financial reporting expertise to help management present the proforma information. Such presentation simply shows what the significant effects onhistorical financial information might have been if a consummated or proposed transac-tion event took place at an earlier date. This does not mean taking something today andbringing it forward. It means going back in history, making a change, and bringing thechanges forward. This presentation shows something in hindsight, that is, what wouldhave happened had a consummated or proposed transaction occurred earlier. This is avery important distinction. SSARS 22 is effective on or after May 1, 2017.

SSARS 23SSARS 23, Omnibus Statement on Standards for Accounting and Review Services—2016,makes SSARSs applicable to engagements performed on certain subject matter otherthan financial statements. It revises some of the general requirements for compilationand review in AR-C Section 60 and AR-C Section 90. It also includes revisions to AR-CSection 70 in regard to preparation engagements, and some other paragraphs areeffective for prospective financial information prepared on or after May 1, 2017. SSARS23’s revisions to AR-C Section 80 are effective for compilation reports on prospectivefinancial information dated on or after May 1, 2017.

¶804 SSARS 24At a meeting in January 2018, the ARSC voted to approve the issuance of SSARS 24,Omnibus Statement on Standards for Accounting and Review Services—2018. However,the ARSC decided to delay the issuance of the new SSARS until late May 2018 in orderto avoid the busy tax filing season for practitioners.

SSARS 24 creates a new AR-C section and revises, clarifies, and expands content ina number of additional AR-C sections.

International ReportingSSARS 24 adds new AR-C Section 100, Special Considerations—International ReportingIssues. AR-C Section 100 includes guidance and requirements for compilation or reviewengagements in the following circumstances:

¶804


• The financial statements have been prepared in accordance with a financialreporting framework generally accepted in another country not adopted by abody designated by the Council of the AICPA (Council) to establish generallyaccepted accounting principles; and

• The engagement is to be performed in accordance with SSARS and another setof compilation and review standards, such as International Standard on RelatedServices (ISRS) 4410 (Revised), Compilation Engagements; or International Stan-dard on Review Engagements (ISRE) 2400 (Revised), Engagements to ReviewHistorical Financial Statements.

SSARS 24 also includes application and other explanatory material, includingguidance on reporting and illustrations of compilation and review reports on financialstatements prepared in accordance with a financial reporting framework generallyaccepted in another country performed in accordance with SSARSs and another set ofcompilation or review standards. The illustrative reports are reproduced at the end ofthis chapter.

Amendments to AR-C Section 60SSARS 24 also revises AR-C Section 60, General Principles for Engagements Performed inAccordance With Statements on Standards for Accounting and Review Services. Theamendments to AR-C Section 60 follow:

• Define fair presentation framework and revise the definition of financial reportingframework

• Clarify that if the accountant accepts responsibility for the design, implementa-tion, and maintenance of internal control, accepting such responsibility wouldimpair the accountant’s independence. Therefore, if an accountant accepts suchresponsibility, the accountant would be precluded from performing a review ofthe financial statements.

Amendments to AR-C Section 90The new SSARS also amends AR-C Section 90, Review of Financial Statements, whichaddresses the accountant’s responsibilities when engaged to review financial state-ments. Under the amendments, AR-C Section 90, paragraph .39 conforms the require-ments on the contents of the accountant’s review report to the illustrative examples inexhibit C of AR-C Section 90.

SSARS 24 also includes other amendments to AR-C Section 90. For example,paragraph .05 has been revised to include a definition of reasonable period of time, andnew application paragraph.A10 offers guidance with respect to the new definition.Paragraph .34 includes a specific written representation regarding disclosure of allinformation relevant to the use of the going concern assumption in the financialstatements. This is important because this type of disclosure will be found in some ofthe new auditing standard proposals.

New paragraph .65 requires that if the applicable financial reporting frameworkincludes a requirement for management to evaluate the entity’s ability to continue as agoing concern for a reasonable period of time in preparing financial statements, theaccountant must perform review procedures related to whether the going concern basisof accounting is appropriate.

SSARS 24 provides additional guidance on requirements for going concern. If theapplicable financial reporting framework—in other words, other than GAAP—does notrequire management to evaluate whether the entity can continue as a going concern fora reasonable period of time in preparing the financial statements, and events that raisesubstantial doubt to continue existed at the date of the prior period of financialstatements, or, in the course of performing review procedures on the current financial

¶804


statements the accountant becomes aware of such events, then the accountant must dothe following: ask management whether the going concern basis of accounting isappropriate, ask about management’s plans for dealing with the adverse effects of theevents, and consider the adequacy of the disclosures about such events in the financialstatements.

Another paragraph is added to require the accountant to include an emphasis-of-matter paragraph in the review report. If, after considering conditions or events, theaccountant concludes that substantial doubt remains, appropriate comments must beincluded. The standard precludes the accountant from referencing, in the review report,the review or audit report of another accountant if the other accountant’s reportincludes an alert that restricts the use of such information.

Revisions to another paragraph include a requirement that the accountant of thereporting entity communicate with the other accountants and determine whether theother accountants understand the ethical requirements relevant in the engagement, andin particular determine if the accountants are independent. SSARS 24 also includesconforming amendments to other sections.

Effective DatesAR-C Section 100 and most of the other amendments are effective for compilations andreviews of financial statements for periods ending on or after June 15, 2019. Theamendment to AR-C Section 90, paragraph .39, is effective upon issuance. Early imple-mentation is permitted.

STUDY QUESTIONS

2. Which of the following SSARS added new AR-C Section 100, Special Considera-tions—International Reporting Issues?

a. SSARS 21

b. SSARS 22

c. SSARS 23

d. SSARS 24

3. Which of the following identifies the time period the AICPA’s Accounting andReview Services Committee (ARSC) voted to approve the issuance of SSARS 24?

a. May 2017

b. January 2018

c. May 2018

d. June 2019

4. Which of the following statements regarding AR-C sections amended by SSARS 24 iscorrect?

a. The amendments to AR-C Section 100 revise the definition of financial report-ing framework.

b. The amendments to AR-C Section 90 provide the definition of fair presentationframework.

c. The amendments to AR-C Section 90 provide the definition of reasonable periodof time.

d. The amendments to AR-C Section 90 are effective on June 15, 2019.

¶804


International IssuesThe SSARS standards, the auditing standards from the AICPA and the Public CompanyAccounting Oversight Board (PCAOB), and the International Standards on Auditing(ISAs) are continuing to converge. This convergence addresses several internationalreporting issues. As mentioned earlier, SSARS 24 provides guidance when an account-ant is engaged to do a compilation and review on a financial statement in either of thefollowing circumstances:

• The financial statements have been prepared in accordance with the financialreporting framework generally accepted in another country, not adopted by abody designated by the Council of the AICPA.

• The compilation or review engagement is to be performed in accordance withboth SSARSs and another set of compilation or review standards.

This type of reporting can be intense when the accountant is preparing compilation orreviews on these categories.

OBSERVATION: The Council of the AICPA comprises approximately 250 to300 CPAs chosen by states across the country to meet three or four times a year.They designate certain issues to discuss based on research and study, and thentake a vote. The Council has made the FASB the authoritative issuer of GAAP, andit has also made the Auditing Standards Board the authoritative issuer of auditingstandards for nonpublic entities. The Council has also recognized InternationalFinancial Reporting Standards from the International Accounting Standards Board(IASB) as authoritative.

With regard to the Compliance With Standards Rule (ET sec. 1.310.001) and theAccounting Principles Rule (ET sec. 1.320.001), the Council designates the bodies thatestablish GAAP. This does not apply to financial statements that are prepared inaccordance with financial reporting frameworks established by the bodies the Councildesignated. The effective date for compilations and reviews of financial statements is forperiods ending on or after June 15, 2019.

When an accountant is performing a compilation or review with a financial report-ing framework that is generally accepted in another country or is in accordance withboth SSARs and another set of compilation or review standards, the accountant’sobjective is to address considerations that relate to the acceptance of the engagement,the planning and performance of it, and reporting on the financial statements. Manage-ment always should select the framework. If the accountant selects the framework, hehas lost his independence. The accountant has performed a management function,which is a problem, particularly in a review. The accountant can recommend a frame-work to management, but should not decide which framework management should use.

When accepting an engagement and determining whether the financial reportingframework selected by management to prepare the financial statements is acceptable,the accountant should consider the following:

• Whether the framework chosen is a fair presentation framework

• Who the intended users of the financial statements are

• What steps management has taken to determine that the framework is accept-able in the circumstances

The accountant should also get an understanding of the applicable legal responsi-bilities involved when the compilation or review is to be performed in accordance withboth SSARS and another set of standards, and both of the following are true: thefinancials are intended for use only outside the United States, and the accountant plansto use the form and content of the compilation or review report of the other standards.

¶804


When an accountant performs a compilation or review in accordance with aframework from another country, the accountant must understand that framework andcomply with AR-C Sections 80 and 90. If the financial statements will be used onlyoutside of the United States, the accountant can use the report form and content of thecountry in which the financial statements will be used. If the terms of the engagementrequire that accountant use other compilation or review standards in addition toSSARSs, the accountant must understand and apply both those standards and theSSARSs.

ReportingAn accountant who is issuing a compilation or review report on financial statements

that will be used only outside the United States should use either:

• A report that is in accordance with SSARS and whose content includes elementsrequired by AR-C Sections 80 or 90 (as applicable) including the requirement toinclude a paragraph regarding financial statements prepared in accordance witha special purpose framework, or

• A report whose form and content is in accordance with another set of compila-tion or review standards (e.g., those set forth in the international standards), aslong as certain conditions are met:

• That type of report is issued by accountants in the other country in similarcircumstances;

• If a review engagement is performed, the accountant has obtained reviewevidence to support the conclusion expressed in the review report; or

• The accountant has complied with the reporting standards of the otherstandards and identified those standards in the report.

If the report is to be used in the United States, it must comply with SSARS.

With regard to a report for compilations or reviews conducted in accordance withboth SSARS and another set of standards, the accountant does not have to refer tohaving done so unless the compilation or review was conducted in accordance with bothsets of standards in their entirety. And when the accountant’s compilation or reviewrefers to both SSARS and another set of standards, the report should identify the otherset and its origin.

STUDY QUESTIONS

5. Which of the following organizations consist of a group of CPAs that meet severaltimes a year to study and vote on accounting issues?

a. AICPA Accounting and Review Services Committeeb. Public Company Accounting Oversight Boardc. Financial Accounting Standards Boardd. Council of the AICPA

6. Under SSARS 24, if an accountant performs a compilation or review in accordancewith a framework from a country other than the United States, and the financialstatements will be used only in that country, the accountant:

a. Can use the report form and content of the non-U.S. country.b. Must contact the Council of the AICPA for advice on which report form to use.c. Must use the report form and content provided by U.S. standards.d. Must use two report forms, one from the United States and one from the other

country.

¶804


¶805 ILLUSTRATIONS OF ACCOUNTANT’SCOMPILATION AND REVIEW REPORTS ON FINANCIALSTATEMENTSSSARS 24 includes the following sample accountant’s reports that illustrate how toincorporate the new requirements. Accountants who have not been reporting in accor-dance with these illustrative reports may need to update their report templates.

Illustration 1: Accountant’s Compilation Report on FinancialStatements Prepared in Accordance With a Financial ReportingFramework Generally Accepted in Another Country Performed inAccordance With SSARSs and Another Set of Compilation Standardsand the Financial Statements Are Intended for Use Only Outside theUnited States

Management is responsible for the accompanying financial statements ofXYZ Company, which comprise the balance sheets as of December 31, 20X2and 20X1, and the related statements of income, changes in stockholders’equity, and cash flows for the years then ended, and the related notes to thefinancial statements, which, as described in Note X to the financial state-ments, have been prepared in accordance with [specify the financial report-ing framework generally accepted] in [name of country]. I (We) haveperformed compilation engagements in accordance with Statements onStandards for Accounting and Review Services promulgated by the Account-ing and Review Services Committee of the AICPA and in accordance with[identify the other set of compilation standards]. I (We) did not audit or reviewthe financial statements nor was (were) I (we) required to perform anyprocedures to verify the accuracy or completeness of the information pro-vided by management. I (we) do not express an opinion, a conclusion, norprovide any assurance on these financial statements.

[Signature of accounting firm or accountant, as appropriate]

[Accountant’s city and state]

[Date of the accountant’s report]

Illustration 2: Independent Accountant’s Review Report on FinancialStatements Prepared in Accordance With a Financial ReportingFramework Generally Accepted in Another Country Performed inAccordance With SSARSs and Another Set of Review Standards andthe Financial Statements Are Intended for Use Only Outside theUnited States

¶805


Independent Accountant’s Review Report

[Appropriate addressee]

I (We) have reviewed the accompanying financial statements of XYZ Com-pany, which comprise the balance sheets as of December 31, 20X2 and20X1, and the related statements of income, changes in stockholders’equity, and cash flows for the years then ended, and the related notes to thefinancial statements. A review includes primarily applying analytical proce-dures to management’s (owners’) financial data and making inquiries ofcompany management (owners). A review is substantially less in scope thanan audit, the objective of which is the expression of an opinion regarding thefinancial statements as a whole. Accordingly, I (we) do not express such anopinion.

Management’s Responsibility for the Financial Statements

Management (Owners) is (are) responsible for the preparation and fairpresentation of these financial statements, which, as described in Note X tothe financial statements, have been prepared in accordance with [specify thefinancial reporting framework generally accepted] in [name of country]; thisincludes the design, implementation, and maintenance of internal controlrelevant to the preparation and fair presentation of financial statements thatare free from material misstatement whether due to fraud or error.

Accountant’s Responsibility

My (Our) responsibility is to conduct the review engagements in accor-dance with Statements on Standards for Accounting and Review Servicespromulgated by the Accounting and Review Services Committee of theAICPA and in accordance with [identify the other review standards]. Thosestandards require me (us) to perform procedures to obtain limited assur-ance as a basis for reporting whether I am (we are) aware of any materialmodifications that should be made to the financial statements for them to bein accordance with [specify the financial reporting framework generally ac-cepted] in [name of country]. I (We) believe that the results of my (our)procedures provide a reasonable basis for my (our) conclusion.

Accountant’s Conclusion

Based on my (our) reviews, I am (we are) not aware of any materialmodifications that should be made to the accompanying financial statementsin order for them to be in accordance with [specify the financial reportingframework generally accepted] in [name of country].



[Date of the accountant’s review report]

¶805


Illustration 3: Accountant’s Compilation Report on FinancialStatements Prepared in Accordance With a Financial ReportingFramework Generally Accepted in Another Country Performed inAccordance With SSARSs and Another Set of Compilation Standardsand the Financial Statements Are Also Intended for Use in the UnitedStates

Management is responsible for the accompanying financial statements ofXYZ Company, which comprise the balance sheets as of December 31, 20X2and 20X1, and the related statements of income, changes in stockholders’equity, and cash flows for the years then ended, and the related notes to thefinancial statements, which, as described in note X to the financial state-ments, have been prepared in accordance with [specify the financial report-ing framework generally accepted] in [name of country]. I (We) haveperformed compilation engagements in accordance with Statements onStandards for Accounting and Review Services promulgated by the Account-ing and Review Services Committee of the AICPA and in accordance with[identify the other compilation standards]. I (We) did not audit or review thefinancial statements nor was (were) I (we) required to perform any proce-dures to verify the accuracy or completeness of the information provided bymanagement. I (we) do not express an opinion, a conclusion, nor provideany assurance on these financial statements.

I (We) draw attention to Note X of the financial statements, which describesthe basis of accounting. The financial statements are prepared in accordancewith [specify the financial reporting framework generally accepted] in [name ofcountry], which is a basis of accounting other than accounting principlesgenerally accepted in the United States of America.



[Date of the accountant’s report]

Illustration 4: Independent Accountant’s Review Report on FinancialStatements Prepared in Accordance With a Financial ReportingFramework Generally Accepted in Another Country Performed inAccordance With SSARSs and Another Set of Review Standards andthe Financial Statements Are Also Intended for Use in the UnitedStates



I (We) have reviewed the accompanying financial statements of XYZ Com-pany, which comprise the balance sheets as of December 31, 20X2 and20X1, and the related statements of income, changes in stockholders’equity, and cash flows for the years then ended, and the related notes to the

¶805


financial statements. A review includes primarily applying analytical proce-dures to management’s (owners’) financial data and making inquiries ofcompany management (owners). A review is substantially less in scope thanan audit, the objective of which is the expression of an opinion regarding thefinancial statements as a whole. Accordingly, I (we) do not express such anopinion.


Management (Owners) is (are) responsible for the preparation and fairpresentation of these financial statements, which, as described in Note X tothe financial statements, have been prepared in accordance with [specify thefinancial reporting framework generally accepted] in [name of country]; thisincludes the design, implementation, and maintenance of internal controlrelevant to the preparation and fair presentation of financial statements thatare free from material misstatement whether due to fraud or error.


My (Our) responsibility is to conduct the review engagements in accor-dance with Statements on Standards for Accounting and Review Servicespromulgated by the Accounting and Review Services Committee of theAICPA and in accordance with [identify the other review standards]. Thosestandards require me (us) to perform procedures to obtain limited assur-ance as a basis for reporting whether I am (we are) aware of any materialmodifications that should be made to the financial statements for them to bein accordance with [specify the financial reporting framework generally ac-cepted] in [name of country]. I (We) believe that the results of my (our)procedures provide a reasonable basis for my (our) conclusion.


Based on my (our) reviews, I am (we are) not aware of any materialmodifications that should be made to the accompanying financial statementsin order for them to be in accordance with [specify the financial reportingframework generally accepted] in [name of country].

Basis of Accounting

I (We) draw attention to Note X of the financial statements, which describesthe basis of accounting. The financial statements are prepared in accordancewith [specify the financial reporting framework generally accepted] in [name ofcountry], which is a basis of accounting other than accounting principlesgenerally accepted in the United States of America. My (Our) conclusion isnot modified with respect to this matter.




¶805


Illustration 5: Independent Accountant’s Review Report on FinancialStatements Prepared in Accordance With SSARSs and in AccordanceWith International Financial Reporting Standards as Issued by theInternational Accounting Standards Board Performed in AccordanceWith SSARSs and International Standard on Review Engagements2400 (Revised) Issued by the International Auditing and AssuranceStandards Board and the Financial Statements Are Intended for UseOnly Outside the United States



I (We) have reviewed the accompanying financial statements of XYZ Com-pany, which comprise the statements of financial position as of December31, 20X2 and 20X1, and the related statements of comprehensive income,changes in equity, and cash flows for the years then ended, and the relatednotes to the financial statements. A review includes primarily applyinganalytical procedures to management’s (owners’) financial data and makinginquiries of company management (owners). A review is substantially lessin scope than an audit, the objective of which is the expression of an opinionregarding the financial statements as a whole. Accordingly, I (we) do notexpress such an opinion.


Management (Owners) is (are) responsible for the preparation and fairpresentation of these financial statements in accordance with InternationalFinancial Reporting Standards as issued by the International AccountingStandards Board; this includes the design, implementation, and mainte-nance of internal control relevant to the preparation and fair presentation ofthe financial statements that are free from material misstatement whetherdue to fraud or error.


My (our) responsibility is to conduct the review engagements in accordancewith Statements on Standards for Accounting and Review Services promul-gated by the Accounting and Review Services Committee of the AICPA andin accordance with International Standard on Review Engagements 2400(Revised), Engagements to Review Historical Financial Statements, issuedby the International Auditing and Assurance Standards Board. Those stan-dards require me (us) to perform procedures to obtain limited assurance asa basis for reporting whether I am (we are) aware of any material modifica-tions that should be made to the financial statements for them to be inaccordance with International Financial Reporting Standards as issued bythe International Accounting Standards Board. I (We) believe that theresults of my (our) procedures provide a reasonable basis for my (our)conclusion.


Based on my (our) reviews, I am (we are) not aware of any materialmodifications that should be made to the accompanying financial statements

¶805


in order for them to be in accordance with International Financial ReportingStandards as issued by the International Accounting Standards Board.

[Signature of accounting firm, or accountant, as appropriate]



CPE NOTE: When you have completed your study and review of chapters 6-8, whichcomprise Module 2, you may wish to take the Final Exam for this Module. Go tocchcpelink.com/printcpe to take this Final Exam online.

¶805


131

¶10,100 Answers to Study Questions¶10,101 MODULE 1—CHAPTER 1

1. a. Incorrect. The new rule, effective for expenses incurred or paid after December31, 2017, disallows the deduction of 100 percent of entertainment expenses. Thededuction was limited to 50 percent under prior law.

b. Incorrect. The provisions eliminate the two-year carryback period and make indefi-nite the carryforward period for a NOL.

c. Incorrect. The provisions eliminate the corporate AMT. Existing AMT credits canbe used or refunded in the future.

d. Correct. The new provisions lower the corporate income tax rate from 35percent to 21 percent, effective January 1, 2018.

2. a. Correct. The U.S. federal tax law changes resulting from the act affectcompanies in all industries. No industry is excluded.

b. Incorrect. Some provisions of the Tax Cuts and Jobs Act will not apply to somecompanies. For example, smaller companies are exempt from the provision that limitsthe deduction for net interest expense. However, the provisions do not specificallytarget financial services entities.

c. Incorrect. Large and small companies alike will be affected by the act’s changes tothe tax law. The number of employees is irrelevant.

d. Incorrect. The tax law changes apply to both publicly traded and privately heldcompanies.

3. a. Incorrect. The act decreased the 35 percent corporate tax rate; this is not the rateat which an organization necessarily records deferred tax liabilities.

b. Incorrect. The act decreased the corporate tax rate to 21 percent as of a certaineffective date, but this tax rate does not necessarily apply to the recording of alldeferred tax liabilities.

c. Correct. The future tax consequences are recorded based on tax law enactedat the date of the financial statements. This means that both deferred tax assetsand liabilities are recorded on the balance sheet at the corporate tax rate thatwas effective at the balance sheet date.

d. Incorrect. This is the date on which the act was signed into law. It is not related tothe recording of deferred tax liabilities.

4. a. Incorrect. The FASB Q&As address this topic—specifically, whether privatecompanies can follow SEC staff guidance on the measurement period for taxadjustments.

b. Correct. The FASB addresses so-called stranded tax effects embedded inaccumulated other comprehensive income in ASU 2018-02, not in the Q&As.

c. Incorrect. One of the Q&As examines whether to discount AMT credits thatbecome refundable.

d. Incorrect. The FASB Q&As explain how to account for the base erosion anti-abusetax (BEAT).

¶10,101


5. a. Incorrect. ASU 2018-02 permits, but does not require, companies to reclassifycertain stranded tax effects.

b. Incorrect. ASU 2018-02 applies to public and private companies in all industries.

c. Correct. The ASU’s effective date is fiscal years beginning after December 15,2018, and interim periods within those years.

d. Incorrect. The standards can be applied in the period of adoption or retrospectivelyto each period in which the effect of the change in corporate tax rates under the act isrecognized.

6. a. Correct. The Base Erosion and Anti-abuse Tax, or BEAT, is a new alterna-tive minimum tax that addresses the tax base erosion created by the ability todeduct certain payments to related foreign parties.

b. Incorrect. FDII stands for foreign-derived intangible income. The act encouragesgenerating foreign earnings using U.S.-based assets by creating a special deduction forFDII.

c. Incorrect. GILTI is an acronym for global intangible low-taxed income. The actcreates a new tax on GILTI.

d. Incorrect. The corporate AMT was included under prior law; it was not introducedby the Tax Cuts and Jobs Act.

¶10,102 MODULE 1—CHAPTER 21. a. Incorrect. Under ASC 842, a contract that meets the definition of a lease must beon the balance sheet, even if the lease is classified as an operating lease. ASC 842requires operating leases to recognize a ROU asset and a lease liability.

b. Incorrect. Both ASC 842 and previous guidance require capital leases to be on thebalance sheet.

c. Correct. Short-term leases, which are those with original terms of fewer than12 months, are generally not required to be on the balance sheet under ASC842.

d. Incorrect. According to the new terminology under ASC 842, capital leases arecalled finance leases Lessees must recognize finance leases on the balance sheet.

2. a. Correct. ASC 842 adds significant financial statement disclosure require-ments for both lessees and lessors, making the disclosure rules one of the fivemajor changes under the new standards. Both qualitative disclosures and spe-cific quantitative lease disclosures are required.

b. Incorrect. The reporting of capital leases is not a change introduced by the newstandards. The reporting of such leases was required by the previous guidance (Topic840) and continues to be required under the new standards.

c. Incorrect. While the new standards include some changes to the lessor accountingrules, they are not substantial enough to be considered one of the five biggest changesimplemented by the new standards.

d. Incorrect. While Topic 842 provides additional guidance on how to identify andseparate components, the definition of a component does not constitute one of the topfive major changes under the new standard.

3. a. Incorrect. ASC 2016-02 continues to apply the Topic 840 accounting model for aleveraged lease if the leveraged lease began before ASC 2016-02’s effective date.However, it does not specify classifying all cash payments in the statement of cash flowsfor a leveraged lease.

¶10,102

133ANSWERS TO STUDY QUESTIONS - Module 1 -Chapter 2

b. Incorrect. For a finance lease, ASC 2016-02 requires classifying repayments of theprincipal portion of the lease liability within financing activities and payments of intereston the lease liability and variable lease payments within operating activities in thestatement of cash flows.

c. Correct. For an operating lease, ASC 2016-02 requires a lessee to recognize aROU asset and a lease liability, initially measured at the present value of thelease payments, in the statement of financial position; recognize a single leasecost, calculated so that the cost of the lease is allocated over the lease term on agenerally straight-line basis; and classify all cash payments within operatingactivities in the statement of cash flows.

d. Incorrect. ASC 2016-02 does not require classifying cash payments in this mannerfor all leases, but rather only for certain types of leases.

4. a. Correct. The biggest difference is that Topic 842 requires the recognition oflease assets and lease liabilities by lessees for leases that were classified asoperating leases under previous GAAP, Topic 840.

b. Incorrect. Although Topic 842 updated some glossary terms that will affect a lesseeapplying the lessor guidance as a sublessor so that both lessee and lessor use the sameterminology, this is not the primary difference between the new and the old guidance.

c. Incorrect. There is not much difference between the criteria for distinguishingbetween finance and operating leases in Topics 840 and 842, other than the change of“capital lease� to “finance lease.�

d. Incorrect. The Topic 842 rules for recognition, measurement, and presentation ofexpenses and cash flows from a lease by a lessee are similar to those in previous GAAP.

5. a. Incorrect. The role of project manager is important, but it is not the mostimportant role on the team. The project manager’s duties include hosting recurringmeetings, issuing weekly status reports, and monitoring project risks.

b. Correct. Although the executive sponsor does not manage the day-to-dayaspects of the project, he or she acts as the advocate for the project, championingand communicating the rationale for a lease accounting initiative to the variousstakeholders in the business. Throughout the project, the executive sponsor alsohelps to clear obstacles that put milestones or project goals at risk. For these andother reasons, the executive sponsor has the most critical role the project team.

c. Incorrect. While the treasurer owns the financial strategy and policies for leasing toensure the company is making optimal use of its cash, he or she does not have the mostimportant role on the project team.

d. Incorrect. The IT manager is a valuable member of the project team because he orshe scopes upgrades of existing systems and defines requirements for purchases of newlease accounting software. However, this does not make the IT Manager’s role the mostimportant one on the team.

6. a. Incorrect. Plan A is generally chosen by companies with mature leasing pro-grams that need to implement additional systems, processes, and controls for compli-ance. The option is not the best one for Entity XYZ.

b. Correct. Because Entity XYZ’s leasing program has not been executed suc-cessfully and presents a risk for a SOX audit, it needs to enhance its programwhile complying with the new standards, using Plan B: Control.

¶10,102


c. Incorrect. Entities that choose Plan C want to comply with the standards. But theyalso realize that can save a significant amount money by overhauling their program atthe same time they redesign their systems, processes, and controls to comply with thenew standards. This option is not the best choice for Entity XYZ.

d. Incorrect. Performing a situational assessment is not one of the recommendedoptions for defining a lease project scope and strategy. Situational assessment should beperformed earlier, as the entity’s second step in starting its lease project.

¶10,103 MODULE 1—CHAPTER 3

1. a. Correct. This is the first step in the new revenue recognition model. Whilethis step may seem fairly straightforward, the FASB included additional criteriawithin this step that must be met before an entity would apply the revenuerecognition model. The additional criteria are largely derived from previousrevenue recognition guidance and other existing standards.

b. Incorrect. This is not the first step in the new revenue recognition model; it is thesecond step. The FASB ASC Master Glossary defines the term performance obligation asa promise in a contract with a customer to transfer the customer either a good orservice that is distinct or a series of distinct goods or services that are substantially thesame and that have the same pattern of transfer to the customer.

c. Incorrect. This is not the first step in the new revenue recognition model; it is thethird step. The FASB defines the term transaction price in the ASC Master Glossary asthe amount of consideration to which an entity expects to be entitled in exchange fortransferring promised goods or services to a customer, excluding amounts collected onbehalf of third parties. The FASB noted that the objective in determining the transactionprice at the end of each reporting period is to predict the total amount of considerationto which the entity will be entitled from the contract.

d. Incorrect. This is not the first step in the new revenue recognition model; it is thesecond to last. The overall objective with respect to this step is to allocate thetransaction price to each performance obligation in an amount that depicts the amountof consideration to which an entity expects to be entitled in exchange for transferringthe promised goods or services to the customer.

2. a. Correct. This is an incorrect statement. Entities cannot use multiplemeasures for multiple payment streams. This requirement eliminates the “mile-stone method” and certain other commonly used methods. For example, entitiescannot recognize upfront payment straight-line and activity-based paymentswhen activity occurs.

b. Incorrect. This is a correct statement. Entities should recognize revenue based on asingle measure of progress. Additionally, the method used must faithfully depict thetransfer of goods and services, even if the performance obligation includes multiplegoods and services.

c. Incorrect. This is a correct statement. Entities should focus on control instead ofrisk and rewards. Control is the ability to direct use of the asset and obtain substantiallyall benefits from it.

d. Incorrect. This is a correct statement. Entities should recognize revenue based on asingle measure of progress using an appropriate input method (e.g., cost, labor hours,time). Entities should ignore activities that do not relate to performance. For example,work before customization begins might be ignored in measuring progress.

¶10,103

135ANSWERS TO STUDY QUESTIONS - Module 1 - Chapter 4

3. a. Incorrect. Entities are required to disclose information about the methods,inputs, and assumptions used for assessing whether an estimate of variable considera-tion (not fixed consideration) is constrained.

b. Correct. Entities are required to disclose information about the methods,inputs, and assumptions used for determining the transaction price, whichincludes, but is not limited to, estimating variable consideration, adjusting theconsideration for the effects of the time value of money, and measuring noncashconsideration.

c. Incorrect. When an entity concludes that a contract includes a significant financingcomponent, the entity is required to adjust the promised consideration on account ofthe significant financing component. However, an entity is not required to disclose thediscount rate used.

d. Incorrect. Entities are not required to disclose information about the methods,inputs, and assumptions used for assessing the value of promised goods or services inmaterial contracts. Instead, entities are required to disclose information about themethods, inputs, and assumptions used for measuring obligations for returns, refunds,and other similar obligations.


1. a. Incorrect. Many worldwide jurisdictions have adopted the IFRS developed by theIASB.

b. Incorrect. Japan permits entities to choose from a variety of approaches to account-ing, including IFRS, U.S. GAAP, Japanese GAAP, and Japanese Modified InternationalStandards.

c. Incorrect. Although the AICPA Council approved IFRS as acceptable GAAP in theUnited States, there is no mandate that the United States adopt IFRS. In fact, FASBChairman Russell G. Golden noted in 2015 that “it has become increasingly clear thatthe United States is unlikely to adopt International Financial Reporting Standards.�

d. Correct. Currently, there is a strong connection between U.S. and IFRS, andthe two sets of standards are increasingly coming together.

2. a. Incorrect. TRGs are not established for all standards; they are most useful forcomprehensive standards that include broad, significant changes.

b. Incorrect. TRGs are formed by the FASB to help the FASB avoid having to makerevisions to a standard after it is issued, to reduce diversity in practice, and toproactively address preliminary cost-benefit concerns.

c. Correct. TRGs provide stakeholders with a forum to learn about a newstandard from others tasked with implementing it, such as financial statementpreparers, auditors, users, and regulators.

d. Incorrect. Technical inquiries (in the form of comment letters and other communi-cations) are submitted to the FASB by accounting professionals and other stakeholders,not by TRGs. The inquiries help the FASB determine which implementation issuesmight be raised and to identify recurring questions.

3. a. Incorrect. ASU 2018-02, Reporting Comprehensive Income (Topic 220): Reclassifi-cation of Certain Tax Effects from Accumulated Other Comprehensive Income, eliminatesthe “stranded tax effects� caused by the Tax Cuts and Jobs Act and is designed to makethe information reported to financial statement users more useful.

¶10,104


b. Incorrect. ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improve-ments to Accounting for Hedging Activities, addresses concerns about applying hedgeaccounting and its limitations for hedging both nonfinancial and financial risks.

c. Correct. ASU 2016-13, Financial Instruments—Credit Losses (Topic 326),was issued to improve financial reporting by requiring timelier recording ofcredit losses on loans and other financial instruments held by financial institu-tions and other organizations.

d. Incorrect. The objective of ASU 2014-09, Revenue from Contracts with Customers(Topic 606), is to establish principles to report useful information about the nature,amount, timing, and uncertainty of revenue from contracts with customers.

4. a. Correct. ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation ofFinancial Statements of Not-for-Profit Entities, issued on August 18, 2016, isintended to simplify how a not-for-profit organization classifies its net assets, andthe information it presents in financial statements and notes about its liquidity,financial performance, and cash flows.

b. Incorrect. ASU 2016-02, Leases (Topic 842), requires that organizations that leaseassets recognize on the balance sheet the assets and liabilities for the rights andobligations created by those leases.

c. Incorrect. ASU 2015-14, Revenue from Contracts with Customers (Topic 606), Defer-ral of the Effective Date, deferred the original effective date of ASU 2014-09.

d. Incorrect. FASB Statement 123(R) addresses share-based payment.

5. a. Incorrect. The FASB has released new guidance on topics such as revenuerecognition, credit losses, and leases, but not on OPEB.

b. Correct. The new OPEB standards were issued by the GASB. Entities mayface challenges in implementing these standards.

c. Incorrect. The IASB is an independent, privately funded accounting standard-setterbased in London that is responsible for developing IFRS and promoting their use andapplication. It did not issue the OPEB standards.

d. Incorrect. The IASC was an international standard-setting organization that wasreplaced by the IASB in 2001. It was not responsible for the OPEB standards.

6. a. Incorrect. The new revenue recognition guidance was originally effective forpublic (not private) companies for annual reporting periods beginning after December15, 2016. Private companies are required to apply the new guidance at a different time.

b. Incorrect. ASU 2015-14, Revenue from Contracts with Customers (Topic 606), Defer-ral of the Effective Date, deferred the original effective date of the revenue recognitionguidance for public (not private) companies to annual reporting periods beginning afterDecember 15, 2017. Private companies are required to apply the new guidance at adifferent time.

c. Correct. For private companies and organizations (including not-for-profits),the new guidance is required for annual reporting periods beginning after De-cember 15, 2018, and for interim and annual reporting periods after thosereporting periods.

d. Incorrect. Private companies must adopt the new revenue recognition guidanceearlier than for annual reporting periods beginning after December 15, 2019.

¶10,104



1. a. Correct. This statement is false. The FASB issued ASU 2016-13 to replacethe incurred loss impairment method in current GAAP with one that reflectsexpected credit losses.

b. Incorrect. This is a true statement. ASU 2016-13 requires entities to consider abroader range of reasonable and supportable information to inform credit lossestimates.

c. Incorrect. This is a true statement. The FASB issued ASU 2016-13 to improvefinancial reporting by requiring timelier recording of credit losses on loans and otherfinancial instruments held by financial institutions and other organizations.

d. Incorrect. This is a true statement. ASU 2016-13 requires the measurement of allexpected credit losses for financial assets held at the reporting date based on historicalexperience, current conditions, and reasonable and supportable forecasts.

2. a. Incorrect. Not-for-profit organizations, including not-for-profit hospitals, are notincluded in the definition of a public business entity.

b. Incorrect. To be considered a public business entity, an entity must meet certainrequirements related to filing financial statements. Employee benefit plans do not meetthese requirements.

c. Correct. To be considered a public business entity, an entity must meet atleast one of several criteria. One of these criteria is being required by the SEC tofurnish financial statements.

d. Incorrect. Entities whose stock is not traded on public exchanges are consideredprivate, not public business entities.

3. a. Incorrect. The guidance relating to assets measured at amortized cost applies tofinancial assets measured at amortized cost basis, including assets such as financingreceivables and receivables that result from revenue transactions.

b. Incorrect. Held-to-maturity debt securities are among the financial assets measuredat amortized cost basis; therefore, the guidance applies to them.

c. Incorrect. Net investments in leases recognized by a lessor are among the assetsmeasured at amortized cost to which the guidance applies. Other such assets includeoff-balance sheet credit exposures not accounted for as insurance.

d. Correct. The guidance relating to assets measured at amortized cost does notapply to several items, including loans between entities under common controland financial assets measured at fair value through net income.

4. a. Incorrect. Topic 310 provides guidance on receivables. It does not include animpairment model.

b. Correct. ASU 2016-13 made targeted improvements to the impairment modelin Topic 320, Investments in Debt Securities, including eliminating the conceptof “other than temporary” from that model.

c. Incorrect. While Topic 326 provides more decision-useful information about ex-pected credit losses on financial instruments, it does not contain the impairment modelto which ASU 2016-13 makes improvements.

d. Incorrect. Topic 960 addresses plan accounting for defined benefit pension plans.

¶10,105


5. a. Incorrect. This statement is true. The impairment guidance for available-for-saledebt securities was moved to Subtopic 326-30, Financial Instruments–Credit Losses–Available-for-Sale Debt Securities.

b. Correct. This statement is false. An investment is impaired when its fair valueis less, not more, than its amortized cost basis.

c. Incorrect. This statement is true. Impairment relating to credit losses should berecorded through an allowance for credit losses (limited by the amount that the fairvalue is less than the amortized cost basis). Impairment that has not been recordedthrough an allowance for credit losses should be recorded through other comprehen-sive income, net of applicable taxes.

d. Incorrect. This statement is true. ASU 2016-13 supersedes the impairment guidancein Subtopic 310-10, Receivables–Overall.

6. a. Incorrect. For public business entities that are SEC filers, the effective date forASU 2016-13 is later than fiscal years beginning on December 15, 2018.

b. Incorrect. The effective date for public business entities that meet the definition of aSEC filer is for certain fiscal years beginning in December, not in April.

c. Correct. For public business entities that are SEC filers, the ASU 2016-13amendments are effective for fiscal years beginning after December 15, 2019(January 1, 2020, for a calendar-year entity), including interim periods withinthose fiscal years.

d. Incorrect. Fiscal years beginning after December 15, 2020, is the amendments’effective date for public business entities that are not SEC filers.

¶10,106 MODULE 2—CHAPTER 61. a. Correct. The Form S-1 relates to the initial registration for new securitiesrequired by the SEC. Any security that meets the criteria must have an S-1 filingbefore shares can be listed on a national exchange.

b. Incorrect. Form 8-K does not relate to the initial registration for new securitiesrequired by the SEC. Instead, Form 8-K is a broad form used to notify investors in U.S.public companies of specified events that may be important to shareholders or the SEC.

c. Incorrect. Form 10-Q does not relate to the initial registration for new securitiesrequired by the SEC. Instead, Form 10-Q is a quarterly report mandated by the SEC tobe filed by publicly traded corporations.

d. Incorrect. Form 10-K does not relate to the initial registration for new securitiesrequired by the SEC. Instead, Form 10-K is an annual report required by the SEC thatgives a comprehensive summary of a company’s financial performance.

2. a. Incorrect. Item 1.01 of Form 8-K does not relate to unregistered sales of equitysecurities. Instead, Item 1.01 relates to an entry into a material definitive agreement.

b. Incorrect. Item 2.03 of Form 8-K does not relate to unregistered sales of equitysecurities. Instead, Item 2.03 relates to the creation of a direct financial obligation or anobligation under an off-balance-sheet arrangement of a registrant.

c. Correct. Item 3.02 of Form 8-K relates to unregistered sales of equity securi-ties. Another item, Item 5.01, relates to changes in control of a registrant. Theseare both examples of events that are disclosed through Form 8-K.

d. Incorrect. Item 4.01 of Form 8-K does not relate to unregistered sales of equitysecurities. Instead, Item 4.01 relates to changes in a registrant’s certifying accountant.

¶10,106


3. a. Incorrect. Item 101 does not require that the title of the class of capital stock bestated; Item 101 relates to the description of the business.

b. Incorrect. Item 102 relates to the description of the property. It does not require thatthe title of the class of capital stock be stated.

c. Incorrect. Item 201 does not require that the title of the class of capital stock bestated. Instead, Item 201 relates to the price of and dividends on the registrant’scommon equity and related stockholder matters.

d. Correct. Item 202, under subpart 200 of Regulation S-K, includes a require-ment that the title of the class of capital stock be stated. Other requirementsincluded in this item relate to debt securities, warrants and rights, other securi-ties, and market information for securities other than common equity.

4. a. Incorrect. Item 301 of Regulation S-K requires that companies furnish net sales incomparative columnar form. In addition, Item 302 includes requirements around certainquarterly data.

b. Incorrect. Item 301 of Regulation S-K requires that companies furnish operatingrevenues in comparative columnar form. In addition, Item 302 includes requirementsaround certain quarterly data such as net sales, gross profit, and per share data.

c. Incorrect. Item 301 of Regulation S-K requires that companies furnish, in compara-tive columnar form, its long-term obligations. In addition, Item 301 also requires thatcash dividends per common share be disclosed for the last five fiscal years.

d. Correct. Nonredeemable preferred stock is not required to be disclosed incomparative columnar form for the last five fiscal years. An example of some-thing that should be disclosed for the last five fiscal years is total assets.

5. a. Correct. This is a correct statement. Based on Item 406 of Regulation S-K,a company must disclose whether it has adopted a code of ethics that applies tothe registrant’s principal executive officer, principal financial officer, principalaccounting officer or controller, or persons performing similar functions.

b. Incorrect. A company is not required to post the text of the code of ethics on allexternal communications. However, if it has not adopted a code of ethics, it is requiredto disclose that fact.

c. Incorrect. Item 406 of Regulation S-K does not require that a company include acopy of its code of ethics in all proxy statements issued. Instead, it must file with theSEC a copy of its code of ethics that applies to the registrant’s principal executiveofficer, principal financial officer, principal accounting officer or controller, or personsperforming similar functions, as an exhibit to its annual report.

d. Incorrect. Item 406 of Regulation S-K does not require that a company provide thetext of the code of ethics in each quarterly 10-Q report. Instead, it must post the text ofsuch code of ethics on its website and disclose, in its annual report, its Internet addressand the fact that it has posted such code of ethics on its website.

6. a. Correct. Subpart 1200 of Regulation S-K includes rules and guidance withrespect to entities involved in oil and gas producing activities. Several items inthis subpart relate to disclosure of reserves, oil and gas production, productionprices and production costs, drilling and other exploratory activities, and deliv-ery commitments.

b. Incorrect. Subpart 1200 of Regulation S-K does not relate to entities involved ininformation technology activities. There are no specific subparts within Regulation S-Kthat prescribe requirements around information technology.

¶10,106


c. Incorrect. Subpart 1200 of Regulation S-K does not relate to entities involved inmining activities. Requirements related to mine safety disclosures are prescribed byItem 104 under the Business subpart.

d. Incorrect. Subpart 1200 of Regulation S-K does not relate to entities involved in realestate activities. There are no specific subparts within Regulation S-K that prescriberequirements around real estate activities.


1. a. Incorrect. The emerging issues task force (EITF) was formed in 1984 by theFinancial Accounting Standards Board (FASB) to provide assistance in improvingfinancial reporting.

b. Correct. The ASB Auditor Reporting Task Force was formed to consider theimplications of IAASB and PCAOB projects on auditor’s reports issued foraudits of nonissuers.

c. Incorrect. The Group Audits Task Force is an organization formed by the IAASB,not the ASB.

d. Incorrect. The ASB formed a Disclosures Task Force to review potential changes todisclosures for a financial statement audit.

2. a. Correct. ISA 700 (Revised) requires the auditor to communicate KAMs inthe auditor’s report for audits of complete sets of general-purpose financialstatements for listed entities in accordance with ISA 701, which also applieswhen the auditor is required by law or regulation or decides to communicateKAMs in the report.

b. Incorrect. ISA 701 defines KAMs but does not include a significant change relatedto communicating them.

c. Incorrect. ISA 705 (Revised) discusses modifications to the opinion in the indepen-dent auditor’s report.

d. Incorrect. ISA 706 (Revised) covers emphasis of matter paragraphs and othermatter paragraphs in an auditor’s report.

3. a. Incorrect. A significant event does not relate matters arising from an audit of thefinancial statements that was communicated or was required to be communicated to theaudit committee. There is a new term that is specific to this situation.

b. Incorrect. KAMs are defined in ISA 702 as matters that, in the auditor’s professionaljudgment, were most significant in the audit of the financial statements for the currentperiod.

c. Correct. This is the definition of a CAM for purposes of AS 3101, TheAuditor’s Report on an Audit of Financial Statements When the Auditor Ex-presses an Unqualified Opinion. This standard requires a discussion of CAMs inthe auditor’s report.

d. Incorrect. A going concern is a business that is making a profit

4. a. Incorrect. AS 3101 was issued by the PCAOB on June 17, 2017.

b. Incorrect. The opposite is true: AS 3101 retains the pass/fail nature of the auditor’sopinion and is intended to “enhance the relevance and usefulness of the auditor’s reportby providing additional and important information to investors.�

¶10,107


c. Incorrect. Both AS 3101 and the IAASB’s changes to the auditor’s report require theOpinion section to be presented first in the auditor’s report (rather than at the end).

d. Correct. AS 3101 requires that CAMs be discussed in the auditor’s report,although some audits might not have a scope engagement that brings thisdiscussion into play.

5. a. Correct. This proposed SAS includes significant changes from the currentAU-C section 700, including the requirement that KAMs be communicated foraudits of nonissuers.

b. Incorrect. Although proposed SAS Forming an Opinion and Reporting on FinancialStatements would not require that KAMs be communicated for audits of nonissuers, ifthis is done as part of the terms of the audit engagement, the auditor would have tocommunicate KAMs in accordance with this proposed SAS.

c. Incorrect. The changes proposed in this SAS relate to the form and content of theauditor’s report when the opinion is modified consistent with the requirements inproposed SAS Forming an Opinion and Reporting on Financial Statements.

d. Incorrect. The changes in this SAS relate to clarifying the relationship betweenemphasis-of-matter paragraphs and the communication of KAMs in the auditor’s report.

6. a. Correct. The ASB is trying to converge its standards with the internationalstandards (ISAs) because it believes there is close alignment between the ASB’smission for its auditors in the nonpublic arena and the ISAs.

b. Incorrect. The ASB believes its standards have a closer relationship with otherstandards than with the PCAOB’s and is thus focusing primarily on converging withthose other standards.

c. Incorrect. The FASB has little involvement with auditing standards. Therefore, theASB is not focusing on converging with FASB standards.

d. Incorrect. The ASB is using a certain set of auditing standards as a base indeveloping its standards; in other words, it is focusing on converging with thosestandards. It is not seeking to converge with GASB standards.


1. a. Incorrect. An engagement letter is required for both types of engagements.

b. Incorrect. The opposite is true. if an accountant is not independent, he has todisclose that impairment of independence in a compilation engagement. In a prepara-tion engagement, such disclosure is not required.

c. Correct. An accountant must issue a report for a compilation engagement, butsuch no report is required for a preparation engagement.

d. Incorrect. For both types of engagements, the financials may go to users outside ofmanagement.

2. a. Incorrect. SSARS 21 clarified former SSARS 19 and includes some other majorrevisions, but it did not add AR-C Section 100.

b. Incorrect. SSARS 22 put the requirements for pro forma financial information inclarity format but did not add AR-C Section 100.

c. Incorrect. SSARS 23 revised several AR-C sections but did not include a new AR-Csection.

¶10,108


d. Correct. SSARS 24 added AR-C Section 100 to provide guidance and require-ments for compilation or review engagements in certain circumstances.

3. a. Incorrect. This date does not apply to SSARS 24, but it does apply to SSARS 22.

b. Correct. The ARSC approved the issuance of SSARS 24 at its meeting inJanuary 2018. However, the standard’s actual issuance was delayed until a laterdate.

c. Incorrect. The issuance of SSARS 24 was approved before May of 2018.

d. Incorrect. Some of the SSARS 24 amendments are effective in June 2019; this is notthe date the standard’s issuance was approved.

4. a. Incorrect. The amendments to AR-C Section 60, General Principles for Engage-ments Performed in Accordance With Statements on Standards for Accounting and ReviewServices, include a revised definition of financial reporting framework.

b. Incorrect. The term fair presentation framework is defined in the amendments to AR-C Section 60, not AR-C Section 90.

c. Correct. Among the amendments to AR-C Section 90 is a revised paragraph.05 that includes a definition of reasonable period of time.

d. Incorrect. The AR-C Section 90 amendments are effective upon issuance. That dateis earlier than June 15, 2019.

5. a. Incorrect. The ARSC focuses on compilations or reviews and issues SSARS.

b. Incorrect. The PCAOB oversees the audits of public companies.

c. Incorrect. The FASB’s mission is to “establish and improve financial accounting andreporting standards to provide decision-useful information to investors and other usersof financial reports.�

d. Correct. The Council of the AICPA is composed of CPAs from across thecountry that meet three or four times a year. The Council researches and voteson important issues; for example, it made the FASB the authoritative issuer ofGAAP.

6. a. Correct. If the financial statements will be used only outside of the UnitedStates, SSARS 24 allows accountants to use the report form and content of thecountry where the financial statements will be used.

b. Incorrect. The AICPA’s Accounting and Review Services Committee (ARSC) hasprovided guidance on which report form and content to use in this situation. TheCouncil of the AICPA is not tasked with answering questions from CPAs.

c. Incorrect. When the financial statements will be used solely outside of the UnitedStates, the accountant is not required by SSARS 24 to use the U.S. report form andcontent.

d. Incorrect. The current guidance does not require an accountant to use two differentreport forms in this situation.

¶10,108

143

IndexReferences are to paragraph (¶ ) numbers.

ASU 2014-09, Revenue from Contracts withACustomers (Topic 606) . . . . . . . . . . . . . . . . . . 407

. issuance of . . . . . . . . . . . . . . . . . . . . . . . . . . 303Accelerated filer, internal control over financial

. transition considerations for . . . . . . . . . . . . . . . . 309reporting of . . . . . . . . . . . . . . . . . . . . . . . . . 610

ASU 2015-14, Revenue from Contracts withAccountantsCustomers (Topic 606), Deferral of the Effective Date . . .. conclusion of . . . . . . . . . . . . . . . . . . . . . . . . . 805

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 407. independence of . . . . . . . . . . . . . . . . . . . . . . . 804. key areas of change for . . . . . . . . . . . . . . . . . . . 408 ASU 2016-01, Financial Instruments—Overall. objective in foreign engagement of . . . . . . . . . . . . . 804 (Subtopic 825-10): Recognition and Measurement of

Financial Assets and Financial Liabilities . . 501, 503, 504. report templates of . . . . . . . . . . . . . . . . . . . . . 805. responsibilities of, for review of financial statements . 804, 805 ASU 2016-02 Leases (Topic 842) . . . . . . . . . . . . . . 203

. disclosures under . . . . . . . . . . . . . . . . . . . . . . 205Accounting policy for GILTI . . . . . . . . . . . . . . . . . 105

. effective date for . . . . . . . . . . . . . . . . . . . . . 205, 407Accounting Principles Rule . . . . . . . . . . . . . . . . . 804

. impact on financial reporting of . . . . . . . . . . . . . . . 206Accounting Standards Board (ASB) . implementation time from for . . . . . . . . . . . . . . 205, 206. auditing standards clarity project of . . . . . . . . . . . . 705 . issuance of . . . . . . . . . . . . . . . . . . . . . . . . . . 205. Auditor Reporting Task Force of . . . . . . . . . . . . . . 704 . major changes to leases under . . . . . . . . . . . . . 204, 407

. transition guidance in . . . . . . . . . . . . . . . . . . 205, 408. disclosures task force of . . . . . . . . . . . . . . . . . . 704

ASU 2016-08 . . . . . . . . . . . . . . . . . . . . . . . . . . 305Accrual basis accounting, GAAP for . . . . . . . . . . . . 403

ASU 2016-13, Financial Instruments—Credit LossesAccrued expenses leading to deferred tax assets . . 104, 105(Topic 326): Measurement of Credit Losses on Financial

Accumulated other comprehensive income (AOCI) . . . 104Instruments . . . . . . . . . . . . . . . . . . . . . . . 407, 503

Act to Provide for Reconciliation Pursuant to Titles II . amendments in . . . . . . . . . . . . . . . . . . . . . . . 505and V of the Concurrent Resolution on the Budget for . CECI model guidance for . . . . . . . . . . . . . . . . 501, 505Fiscal Year 2018, An. See Tax Cuts and Jobs Act . disclosures under . . . . . . . . . . . . . . . . . . . . . . 505

. effective dates for . . . . . . . . . . . . . . . . . . . . . . 505Adverse opinion due to material misstatement . . . . . . 707

. issuance of . . . . . . . . . . . . . . . . . . . . . . . . . . 505AICPA Council . main provisions of . . . . . . . . . . . . . . . . . . . . . . 505. approval of IFRS by . . . . . . . . . . . . . . . . . . . . . 403

ASU 2016-14, Not-for-Profit Entities (Topic 958):. composition of . . . . . . . . . . . . . . . . . . . . . . . . 804

Presentation of Financial Statements of Not-for-Profit. GAAP determinations by FASB approved by . . . . . . . 804

Entities . . . . . . . . . . . . . . . . . . . . . . . . . . . 407Alternative minimum tax (AMT)

ASU 2017-12, Derivatives and Hedging (Topic 815):. elimination of corporate . . . . . . . . . . . . . . . . . . . 104 Targeted Improvements to Accounting for Hedging. new, BEAT as . . . . . . . . . . . . . . . . . . . . . . . . 105 Activities . . . . . . . . . . . . . . . . . . . . . . . . . . 407

Alternative minimum tax credits ASU 2018-02. Income Statement—Reporting. refundable . . . . . . . . . . . . . . . . . . . . . . . . . . 407 Comprehensive Income (Topic 220): Reclassification of. use or refund of existing . . . . . . . . . . . . . . . . . . . 104 Certain Tax Effects from Accumulated Other

Comprehensive Income . . . . . . . . . . . . . . . . 104, 407American Institute of Certified Public Accountants (AICPA). Accounting and Review Services Committee of . . . . . . 805 Auditor. auditor’s requirements by . . . . . . . . . . . . . . . . 408, 703 . communication of, with those charged with. SSARS issued by PCAOB and . . . . . . . . . . . . . . . 804 governance . . . . . . . . . . . . . . . . . . . . . . . 706

. going concern issue addressed by . . . . . . . . . . . 408, 706Amortization of intangible assets . . . . . . . . . . . . 104, 105

. inability to obtain sufficient appropriate audit evidenceAS 2410, Related Parties . . . . . . . . . . . . . . . . . . . 705 by . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707AS 2701, Supplementary Information . . . . . . . . . . . 705 . key areas of change for . . . . . . . . . . . . . . . . . . . 408

. reporting models of . . . . . . . . . . . . . . . . . . . 701–708AS 3101, The Auditor’s Report on an Audit of

. responsibilities of . . . . . . . . . . . . . . . . . . . . . . 707Financial Statements When the Auditor Expresses an

. terms of engagement of . . . . . . . . . . . . . . . . . 706, 707Unqualified Opinion . . . . . . . . . . . . . . . . . . . . 704Auditor independence . . . . . . . . . . . . . . . . . . . . 704ASC 605, Revenue Recognition . . . . . . . . . . . . . . . 304Auditor reporting . . . . . . . . . . . . . . . . . . . . . 701–708ASC Topic 606, Revenue from Contracts with. AU-C 800 series affected by SAS for . . . . . . . . . . . 705Customers . . . . . . . . . . . . . . . . . . . . 204, 301–310. GASB model requirements for . . . . . . . . . . . . . . . 408

. contract costs in . . . . . . . . . . . . . . . . . . . . . 305, 306. projects related to . . . . . . . . . . . . . . . . . . . . 704–705

. disclosure requirements in . . . . . . . . . . . . . . . . . 308. proposed changes in . . . . . . . . . . . . . . . . . . . . 704

. new revenue recognition guidance in . . . . . . 303, 310, 407Auditor’s report. presentation guidance for balance sheet in . . . . . . . . 307. about management . . . . . . . . . . . . . . . . . . . . . 704. steps in revenue recognition under . . . . . . . . . . . . . 304. aspects of audit in . . . . . . . . . . . . . . . . . . . . . . 704. team to implement . . . . . . . . . . . . . . . . . . . . . . 310. for audit of non-issuers . . . . . . . . . . . . . . . . . . . 705

ASC Topic 740, Accounting for Income Taxes . . . . 104, 105 . effects of, on employee benefit plans . . . . . . . . . . . 705Assurance, statement or legend regarding . . . . . . . . 803 . illustrations of . . . . . . . . . . . . . . . . . . . . . . . . 707

AUD

144 INDEX

Auditor’s report—continued Corporate tax rate under new tax law—continued. impact of changes in standards for . . . . . . . . . . . . . 708 . on foreign earnings, . . . . . . . . . . . . . . . . . . . . . 105. key audit matters in . . . . . . . . . . . . . . . . . . . . . 704 Covered employees under new tax law . . . . . . . . . . 104. proposed SASs affecting form and content of . . . . . . . 705

Credit losses . . . . . . . . . . . . . . . . . . . . . 408, 501–505Auditor’s Responsibilities Relating to Other . allowance for, reporting . . . . . . . . . . . . . . . . . . . 505

Information Included in Annual Reports, The . . . . . 707 . assets measured at amortized cost basis for . . . . . . . 505Audits, FASB concepts applied in . . . . . . . . . . . . . 403 . estimates of . . . . . . . . . . . . . . . . . . . . . . . 503, 505

. for purchased financial assets . . . . . . . . . . . . . . . 505

B Credit quality indicators . . . . . . . . . . . . . . . . . . . 505

Credit risk . . . . . . . . . . . . . . . . . . . . . . . . . . . 505“Backdoor” alternative minimum tax . . . . . . . . . . . . 105

Critical audit matters (CAMs) . . . . . . . . . . . . . . . . 704“Backwards tracing” . . . . . . . . . . . . . . . . . . . . . 104

Current expected credit loss (CECL) model . . . 408, 501–505Bad debts, allowances for . . . . . . . . . . . . . . . . 104, 105. implementing . . . . . . . . . . . . . . . . . . . . . . . . 505

Balance sheetCustomer options . . . . . . . . . . . . . . . . . . . . . . . 305. contract asset or liability on . . . . . . . . . . . . . . . . . 307

. deferred tax assets and liabilities on . . . . . . . . . . 104, 105D. management responsibility for . . . . . . . . . . . . . . . 805

. reporting leases on . . . . . . . . . . . . . . . . . . . 206, 407Debt securities, available-for-sale . . . . . . . . . . . . . 505

Base erosion anti-abuse tax (BEAT) . . . . . . . . . . 104, 105Deemed paid foreign tax credit . . . . . . . . . . . . . . . 105

Base erosion payments . . . . . . . . . . . . . . . . . . . 105Deemed repatriation, tax liability on . . . . . . . . . . 105, 407

Basis of accounting . . . . . . . . . . . . . . . . . . . . . . 805Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . 307

Bill and hold sales . . . . . . . . . . . . . . . . . . . . . . . 305Deferred tax assets

Board of directors, security holder communication . for AMT credits . . . . . . . . . . . . . . . . . . . . . . . 104with . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 611 . realization of . . . . . . . . . . . . . . . . . . . . . . . . . 105

Breakage, ASC 606 guidance on . . . . . . . . . . . . . . 305 Deferred tax balances, existing . . . . . . . . . . . . . . . 104. discounts unavailable for . . . . . . . . . . . . . . . . . . 105

CDeferred tax expense or benefit . . . . . . . . . . . . . . . 104

Capital leases. See Finance leases Deferred tax liabilities . . . . . . . . . . . . . . . . . . 104, 105

Code of ethics disclosure . . . . . . . . . . . . . . . . . . 611 Defined contribution employee benefit plans, loansby . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505Communicating Key Audit Matters in the

Independent Auditor’s Report . . . . . . . . . . . . . . 705 Depreciation of buildings, machinery, andequipment . . . . . . . . . . . . . . . . . . . . . . . . 104, 105Compensation highly paid employees . . . . . . . . . . . 104

Director independence . . . . . . . . . . . . . . . . . . . . 611Compensation table, summary . . . . . . . . . . . . . . . 611Disclaimer of opinion, auditor’s report containing . . . . 707Compilation engagement, preparation engagement

versus . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803 Disclosures in financial statements, inadequate . . . . . 707

Compilation report Disclosures under ASC 606, qualitative and. illustrations of . . . . . . . . . . . . . . . . . . . . . . . . 805 quantitative . . . . . . . . . . . . . . . . . . . . . . . . . 308. used outside the United States . . . . . . . . . . . . . . . 804 Dividends-received deduction for foreign source

dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 105Compilations, FASB concepts applied in . . . . . . . . . 403

Compliance With Standards Rule . . . . . . . . . . . . . . 804E

Components, lease and nonlease . . . . . . . . . . . . . . 205

Earnings before interest, taxes, depreciation, andConsignment sales . . . . . . . . . . . . . . . . . . . . . . 305amortization (EBITDA) . . . . . . . . . . . . . . . . . . 206

Contract asset or liability . . . . . . . . . . . . . . . . . . . 307Emphasis-of-Matter and Other-Matter Paragraphs in. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308

the Independent Auditor’s Report . . . . . . . . . . . . 706Contract costs . . . . . . . . . . . . . . . . . . . . . . . 305, 306

Employee benefit plans, financial statements of . . . . . 705. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308Endowment funds, underwater . . . . . . . . . . . . . . . 407Contract, implicit loan in . . . . . . . . . . . . . . . . . . . 304Energy Policy and Conservation Act of 1975, filingContract modification . . . . . . . . . . . . . . . . . . . . . 304

instructions under . . . . . . . . . . . . . . . . . . . . . 603Contract performance obligations . . . . . . . . . . . 304, 307

Engagement letter for compilation and preparation. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308engagements . . . . . . . . . . . . . . . . . . . . . . . . 803

Contract transaction price . . . . . . . . . . . . . . . . . . 304Engagement of auditor, terms of . . . . . . . . . . . . . . 706. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308Entertainment expenses, disallowance of . . . . . . . . . 104Contract with customer, identifying . . . . . . . . . . . . 304Executive compensation under Regulation S-K . . . . . 611Contracts, combining . . . . . . . . . . . . . . . . . . . . . 304Executive sponsor of lease accounting team . . . . . . . 206Corporate tax rate under new tax law

. on domestic earnings . . . . . . . . . . . . . . . . . . . . 104 Export sales under new tax law . . . . . . . . . . . . . . . 105

AUD

145INDEX

Foreign subsidiaries, undistributed earnings of . . . . . 105FForming an Opinion and Reporting on Financial

Fair presentation framework, definition of . . . . . . . . . 804 Statements (AU-C Section 700) . . . . . . . . . . . 705, 706

Fair value of financial assets and liabilities . . . . . . 504, 505GFASB Accounting Standards Codification 842,

Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203Generally accepted accounting principles (GAAP), U.S.

Finance leases . . . . . . . . . . . . . . . . . . . . 204, 205, 407 . accounting for changes under new tax law requiredby . . . . . . . . . . . . . . . . . . . . . . . . . . . 103, 105Financial Accounting Standards Board (FASB)

. accrual basis accounting under . . . . . . . . . . . . . . . 403. Accounting Standards Updates (ASUs) issued by . . . . 403

. AICPA designation of bodies establishing . . . . . . . . . 804. Financial Crisis Advisory Group (FCAG) formed by

. APB 23 exception . . . . . . . . . . . . . . . . . . . . . . 105IASB and . . . . . . . . . . . . . . . . . . . . . . . . . 407

. auditor’s report on financial statements under . . . . . . . 707. future guidance by . . . . . . . . . . . . . . . . . . . . . . 408

. bill and hold sales under . . . . . . . . . . . . . . . . . . 305. guidance for Tax Cuts and Jobs Act by . . . . . . . . . . 407

. CECL model for . . . . . . . . . . . . . . . . . . . . . . . 505. implementation guidance by . . . . . . . . . . . . . . . . 407

. compilation report in accordance with . . . . . . . . . . . 803. initiatives of . . . . . . . . . . . . . . . . . . . . . . . . . 404

. consignment sales under . . . . . . . . . . . . . . . . . . 305. intellectual property guidance of . . . . . . . . . . . . . . 304

. contract asset or liability under . . . . . . . . . . . . . . . 307. joint project on standards of IASB and . . . . . . . . . . . 503

. creation of asset under . . . . . . . . . . . . . . . . . . . 306. mission of . . . . . . . . . . . . . . . . . . . . . . . . . . 404

. deferred tax liability and asset adjustments under . . . . 407. outlook of latest releases of . . . . . . . . . . . . . . . 401–408

. financial statement preparation under . . . . . . . . . . . 504. Q&A documents by, for implementing new tax law . . . . 104

. hedge accounting guidance in . . . . . . . . . . . . . . . 407. Simplification Initiative of . . . . . . . . . . . . . . . . . . 408

. incurred loss method for credit losses under . . . . . . . 503. stakeholder outreach by . . . . . . . . . . . . . . . . . . 405

. interim accounting for new tax rate under . . . . . . . . . 104. standard by, on income taxes recorded in

. leases under (Topic 840) . . . . . . . . . . 204, 205, 206, 407accumulated other comprehensive income . . . . . . 103

. materiality under . . . . . . . . . . . . . . . . . . . . . . . 403. technical inquiry service of . . . . . . . . . . . . . . . . . 406

. revenue recognition guidance by . . . . . . . . . . . . . . 407. Transition Resource Group (TRG) of . . . . . . . . . . . 406

. tax rate reconciliation under . . . . . . . . . . . . . . . . 104Financial data of companies under Regulation S-K . . . 610 . temporary differences for tax purposes and . . . . . . 104, 105

. use of, by businesses abroad . . . . . . . . . . . . . . . . 403Financial information disclosures under Regulation

. warranty guidance under . . . . . . . . . . . . . . . . . . 305S-K, supplementary . . . . . . . . . . . . . . . . . . . . 610

Generally accepted auditing standards (GAAS)Financial instruments. audits conducted in accordance with . . . . . . . . . . . . 707. fair value of . . . . . . . . . . . . . . . . . . . . . . . . . . 504. audits under ISAs and . . . . . . . . . . . . . . . . . . . . 704. professional standards concerning . . . . . . . . 501, 503, 504

Gift cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305Financial obligation, creation of direct . . . . . . . . . . . 606

Global intangible low-taxed income (GILTI)Financial reporting frameworkprovisions of new tax law . . . . . . . . . . . . . . . 104, 105. definition of . . . . . . . . . . . . . . . . . . . . . . . . . . 804

. generally accepted in another country . . . . . . . . . 804, 805 Going concern. accountant’s assumption of . . . . . . . . . . . . . . . . . 804Financial statements. See also Auditor’s report; Balance sheet;. auditor reporting requirements for . . . . . . . . 705, 706, 707Compilation report; Review report ;Statements of cash flow;. management’s evaluation of . . . . . . . . . . . . . . . . 804Statement of changes in stockholders’ equity; Statements of

income Going concern initiative. accountant’s responsibilities for review of . . . . . . . 804, 805 . of FASB . . . . . . . . . . . . . . . . . . . . . . . . . . . 404. aspects of audit in . . . . . . . . . . . . . . . . . . . . . . 704 . of FASB, GASB, and IAASB . . . . . . . . . . . . . . . . 408. auditor’s responsibilities for audit of . . . . . . . . . . . . 707 Goodwill due to acquisition . . . . . . . . . . . . . . . . . 104. changing form and content of . . . . . . . . . . . . . . . . 403

Grants of plan-based awards, table of . . . . . . . . . . . 611. comparative . . . . . . . . . . . . . . . . . . . . . . . . . 707. consolidated . . . . . . . . . . . . . . . . . . . . . . . . . 707

H. definition of . . . . . . . . . . . . . . . . . . . . . . . . . . 603. disclosures in notes to . . . . . . . . . . . . . . . . . . . . 408

Hedge accounting . . . . . . . . . . . . . . . . . . . . . . . 407. employee benefit plan’s . . . . . . . . . . . . . . . . . . . 705. going concern assumption in . . . . . . . . . . . . . . . . 804 Highly paid employees, compensation to . . . . . . . . . 104. illustrations of accountant’s reports on . . . . . . . . . . . 805. illustrations of auditor’s reports on . . . . . . . . . . . . . 707 I. inability to obtain sufficient appropriate audit evidence

for . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 IFRS 15, Revenue from Contracts with Customers . . . . 303. intended users of . . . . . . . . . . . . . . . . . . . . . . 804 IFRS 16, Leases . . . . . . . . . . . . . . . . . . . . . . . . 205. lease obligations excluded from . . . . . . . . . . . . . . 707

Inadequate disclosure, qualified opinion for . . . . . . . 707. management’s discussion and analysis of . . . . . . . . . 610. management’s responsibilities for . . . . . . . . . . . 707, 805 Income statement. of not-for-profit entities . . . . . . . . . . . . . . . . . . . 407 . deferred tax balances reported on . . . . . . . . . . . . . 105. notes to . . . . . . . . . . . . . . . . . . . . . . . 603, 708, 805 . measurement of credit losses on . . . . . . . . . . . . . . 505. preparation engagement for . . . . . . . . . . . . . . . . 803 Income taxes, accounting changes under new tax

Financing receivables . . . . . . . . . . . . . . . . . . . . 505 law for . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

Foreign-derived intangible income (FDII) . . . . . . . . . 105 Incurred loss impairment method for credit losses . . . 503

Foreign income, tax on low-taxed . . . . . . . . . . . . . . 105 Insurance entity, policy loan receivables of . . . . . . . . 505

INS

146 INDEX

Intangible assets, amortization of . . . . . . . . . . . . 104, 105 Lease obligations, exclusion in financial statementsof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707Intellectual property, revenue recognition for . . . . . . . 304

Lease origination costs . . . . . . . . . . . . . . . . . . . 204Interest expense, limiting deductions for . . . . . . . . . 104

Lease-versus-buy analysis . . . . . . . . . . . . . . . . . 206Internal control, accountant responsibility for . . . . . . 804

Leases . . . . . . . . . . . . 201–206. See also individual typesInternational Accounting Standards Board (IASB)

. definition of . . . . . . . . . . . . . . . . . . . . . . . . . . 206. IFRS issued by . . . . . . . . . . . . . . . . . . . . . . . 403

. determining whether arrangements are . . . . . . . . . . 204. intellectual property guidance of . . . . . . . . . . . . . . 304 . FASB guidance for . . . . . . . . . . . . . . . . . . . . . 408. joint project on standards of FASB and . . . . . . . . . . 503 . inventory of . . . . . . . . . . . . . . . . . . . . . . . . . . 206

. net investments in . . . . . . . . . . . . . . . . . . . . . . 505International Auditing and Assurance Standards Board

. options to renew and terminate . . . . . . . . . . . . . . . 407(IAASB). auditor reporting project of . . . . . . . . . . . . . . . . . 704 Leasing program, maturity of existing . . . . . . . . . . . 206. convergence of AU-C sections with pronouncement

Lessee accounting under ASU 2016-02 . . . . . . . . . . 205by . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 704. as counterpart to ASB and PCAOB . . . . . . . . . . . . 704 Lessor accounting under ASU 2016-02 . . . . . . . . 205, 407

International Auditing and Assurance Standards Leveraged leases . . . . . . . . . . . . . . . . . . . . . . . 205Board requirements . . . . . . . . . . . . . . . . . . . . 408

. for auditor reporting model . . . . . . . . . . . . . . . . . 704 M

International Financial Reporting Standards (IFRS) . . . 205Management’s responsibilities for financial

. adoption of . . . . . . . . . . . . . . . . . . . . . . . . . . 403statements . . . . . . . . . . . . . . . . . . . . . . . 707, 805

. AICPA Council approval of . . . . . . . . . . . . . . . . . 403Market risk, disclosures about . . . . . . . . . . . . . . . 610. balance sheet treatment of operating leases under . . . . 206

. Financial Crisis Advisory Group formed by FASB and . . 407 Material misstatement of financial statements . . . . . . 707

. revenue recognition guidance by . . . . . . . . . . . . . . 407Materiality

International reporting for compilations or reviews . . . 804 . FASB definition of . . . . . . . . . . . . . . . . . . . . . . 408. GAAP standards for . . . . . . . . . . . . . . . . . . . . . 403International Standards on Auditing (ISAs)

Meals, 50 percent deduction for . . . . . . . . . . . . . . . 104. audits under GAAS and . . . . . . . . . . . . . . . . . . . 704. convergence of standards by PCAOB and . . . . . . . . 804 Modifications to the Opinion in the Independent

Auditor’s Report . . . . . . . . . . . . . . . . . . . . . . 705Investment Advisers Act of 1940 . . . . . . . . . . . . . . 603

Investment Company Act of 1940 . . . . . . . . . . . . . . 603N

ISA 315, Assessing the Risks of MaterialMisstatement Through Understanding the Entity and Its Net asset classification for not-for-profit entities . . . . . 407Environment . . . . . . . . . . . . . . . . . . . . . . . . 704

Net interest expense changes under new tax law . . . . 104ISA 330, The Auditor’s Responses to Assessed Risks . 704 Net operating losses (NOLs) new tax law changes to . . 104ISA 700 (Revised), Forming an Opinion and Nominating committee under Regulation S-K . . . . . . . 611

Reporting on Financial Statements . . . . . . . . . 704, 705Non-employees, equity based payments to . . . . . . . . 408

ISA 701, Communicating Key Audit Matters in theNonpublic companies, revenue recognition for . . . . . 407Independent Auditor’s Report . . . . . . . . . . . . . . 704

Not-for-profit organizationsISA 705 (Revised), Modifications to the Opinion in the. financial reporting of . . . . . . . . . . . . . . . . . . . . . 407Independent Auditor’s Report . . . . . . . . . . . . 704, 705. pledges receivable of . . . . . . . . . . . . . . . . . . . . 505

ISA 720 (Revised), The Auditor’s Responsibilities . revenue recognition for . . . . . . . . . . . . . . . . . . . 407Relating to Other Information . . . . . . . . . . . . . . 705

ISRE 2400 (Revised), Engagements to Review OHistorical Financial Statements . . . . . . . . . . . . . 804

Off-balancer-sheet arrangement, financial obligationISRS 4410 (Revised), Compilation Engagements . . . . . 804

in . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

Off-balance-sheet credit exposures . . . . . . . . . . . . 505KOff-balance sheet leases . . . . . . . . . . . . . . . . . . . 204

Key audit matters (KAMs) . . . . . . . . . . . . . . . . 704, 705Oil and gas producing activities, disclosures for . . . . . 614

. illustration of , in auditor’s report . . . . . . . . . . . . . . 707Operating leases. ASC 842 for reporting . . . . . . . . . . . . . . . . . . 204–206L. ASU 2016-02 terms for lessee in . . . . . . . . . . . . . . 205. on balance sheet . . . . . . . . . . . . . . . . . . . . 206, 407Lease accounting implementation project . . . . . . . . . 206

Options exercised and stock vested, table of . . . . . . . 611Lease accounting software . . . . . . . . . . . . . . . . . 206

Other comprehensive income (OCI) . . . . . . . . . . . . 407Lease accounting standard (ASC 842) . . 204. See also ASU2016-02 (Topic 842) Other postemployment benefits (OPEB) . . . . . . . . . . 408

. understanding . . . . . . . . . . . . . . . . . . . . . . . . 206Outsourcing contracts . . . . . . . . . . . . . . . . . . . . 206

Lease compliance . . . . . . . . . . . . . . . . . . . . . . . 408 Outstanding equity awards at fiscal year-end, tableLease, definition of . . . . . . . . . . . . . . . . . . . . 205, 407 of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 611

INT

147INDEX

Regulation S-K—continuedP. Subpart 229.100: Business of . . . . . . . . . . . . . . . 608. Subpart 229.200: Securities of the Registrant of . . . . . 609Performance obligation in contract . . . . . . . . . . . 304, 307. Subpart 229.300: Financial Information of . . . . . . . . . 610. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308. Subpart 229.400: Management and Certain Security

Permanent difference creating effective tax rate . . . . . 104Holders of . . . . . . . . . . . . . . . . . . . . . . . . 611

Preparation engagement, engagement letter for . . . . . 803 . Subpart 229.500: Registration Statement andProspectus Provisions of . . . . . . . . . . . . . . . . 612Presentation and performance obligations, gross

. Subpart 229.600: Exhibits of . . . . . . . . . . . . . . . . 613versus net . . . . . . . . . . . . . . . . . . . . . . . . . . 305

. subparts of, other . . . . . . . . . . . . . . . . . . . . . . 614Presentation of contract asset or liability . . . . . . . . . 307

. underwriter information under . . . . . . . . . . . . . . . 612Pro forma financial information . . . . . . . . . . . . . . . 803 . use of proceeds under . . . . . . . . . . . . . . . . . . . 612

Project manager for lease accounting Regulation S-T . . . . . . . . . . . . . . . . . . . . . . . . . 604implementation project . . . . . . . . . . . . . . . . . . 206

Regulation S-X, Form and Content of andProposed Statement on Auditing Standards Omnibus Requirements for Financial Statements, Securities Act of

Statement on Auditing Standards—2018 . . . . . . . . 705 1933, Securities Exchange Act of 1934, InvestmentCompany Act of 1940, Investment Advisers Act of 1940,Prospectus summary . . . . . . . . . . . . . . . . . . . . . 612and Energy Policy and Conversation Act of 1975 . 603, 604

Public business entity, definition of . . . . . . . . . . . . 504Retained earnings, cumulative-effect adjustment to . . . 505

Public Company Accounting Oversight Board (PCAOB)Revenue recognition. auditor’s reporting model requirements of . . . . 408, 704, 705. disclosures for . . . . . . . . . . . . . . . . . . . . . . 308, 408. SSARS standards by AICPA and . . . . . . . . . . . . . 804. guidance for . . . . . . . . . . . . . . . . . . . . . . . 303, 407

Public organization, definition of . . . . . . . . . . . . . . 407. principle for . . . . . . . . . . . . . . . . . . . . . . . . 303, 304. steps in . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

Q . transfer of control in . . . . . . . . . . . . . . . . . . . . . 304

Revenue recognition standards . . . . . . . . . . 204, 301–310Qualified opinion, illustration of. contract costs in . . . . . . . . . . . . . . . . . . . . . 305, 306. for auditor’s inability to obtain sufficient appropriate. disclosure requirements in . . . . . . . . . . . . . . . . . 308audit evidence . . . . . . . . . . . . . . . . . . . . . . 707. new revenue recognition guidance in . . . . . . 303, 310, 407. for inadequate disclosure . . . . . . . . . . . . . . . . . . 707. presentation guidance for balance sheet in . . . . . . . . 307

Qualified property, full expensing of . . . . . . . . . . . . 104. steps in revenue recognition under . . . . . . . . . . . . . 304. team to implement . . . . . . . . . . . . . . . . . . . . . . 310

RReview engagement requirements . . . . . . . . . . . . . 803

Real estate lease administration . . . . . . . . . . . . . . 206 . to review ethical requirements with other accountants . . 804. to review going concern in financial statements . . . . . . 804Reasonable period of time, definition of . . . . . . . . . . 804

Review reportReasonably certain threshold for leases and. emphasis-of-matter in . . . . . . . . . . . . . . . . . . . . 804liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 205. illustrations of . . . . . . . . . . . . . . . . . . . . . . . . 805

Receivable, contract asset as . . . . . . . . . . . . . . . . 307 . used only outside United States . . . . . . . . . . . . 804, 805. disclosures for . . . . . . . . . . . . . . . . . . . . . . . . 308

Reviews, FASB concepts applied in . . . . . . . . . . . . 403Regulation C . . . . . . . . . . . . . . . . . . . . . . . . . . 604

Right-of-use (ROU) assets . . . . . . . . . . . . . . . . 204, 205Regulation S-K . . . . . . . . . . . . . . . . . . . . . . . 601–615

Rights of return for goods . . . . . . . . . . . . . . . . . . 305. beneficial owners and management under . . . . . . . . 611. code of ethics under . . . . . . . . . . . . . . . . . . . . . 611 Risk, credit . . . . . . . . . . . . . . . . . . . . . . . . . . . 505. corporate governance requirements of . . . . . . . . . . 611

Risk, disclosures under Regulation S-K about . . . . 610, 612. data tagging and hyperlinks under . . . . . . . . . . . . . 615

Risk factors, discussion of . . . . . . . . . . . . . . . . . . 612. description of business in . . . . . . . . . . . . . . . . . . 608. description of property in . . . . . . . . . . . . . . . . . . 608 Risk management activities . . . . . . . . . . . . . . . . . 407. description of registrant’s securities under . . . . . . . . . 609

Royalties from contracts . . . . . . . . . . . . . . . . . . . 304. director and significant employee information under . . . 611. disclosure controls and procedures under . . . . . . . 610, 615

S. equity market price and dividends under . . . . . . . . . . 609. event notifications under . . . . . . . . . . . . . . . . . . 606

SAB-99 by SEC . . . . . . . . . . . . . . . . . . . . . . . . 403. executive compensation disclosures under . . . . . . . . 611. legal proceedings under . . . . . . . . . . . . . . . . . . 608 SAB 118 by SEC . . . . . . . . . . . . . . . . . . . . . . 105, 407. mine safety disclosure under . . . . . . . . . . . . . . . . 608

Sale-leaseback transactions . . . . . . . . . . . . 204, 205, 407. non-GAAP measures under . . . . . . . . . . . . . . . . 607

Sarbanes-Oxley (SOX), lease accounting audit under . . 206. oil and gas producing activities under . . . . . . . . . . . 614. overview of . . . . . . . . . . . . . . . . . . . . . . . . . . 603 SAS 122, Statements on Auditing Standards:. projections under . . . . . . . . . . . . . . . . . . . . . . 607 Clarification and Recodification . . . . . . . . . . . . . 705. quarterly reports under requirements of . . . . . . . . . . 605

SAS 131, Amendment to Statement on Auditing. recent developments regarding . . . . . . . . . . . . . . 615Standards No. 122 Section 700, Forming an Opinion and. Regulation S-X versus . . . . . . . . . . . . . . . . . . . 603Reporting on Financial Statements . . . . . . . . . . . 704. reporting requirements for SEC dictated by . . . . . . . . 604

. security ratings under . . . . . . . . . . . . . . . . . . . . 607 SAS 132, The Auditor’s Consideration of an Entity’s

. Subpart 229.1: General of . . . . . . . . . . . . . . . . . 607 Ability to Continue as a Going Concern . . . . . . 705, 706

SAS

148 INDEX

SEC filer, definition of . . . . . . . . . . . . . . . . . . . . 505 Statements of income

. disclaimer of opinion on . . . . . . . . . . . . . . . . . . . 707SEC Form 8-K, shareholders and SEC notified ofevents using . . . . . . . . . . . . . . . . . . . . . . 603, 606 . management responsibility for . . . . . . . . . . . . . . . 805

SEC Form S-1, initial registration using . . . . . . . . 603, 604 Statements on Standards for Accounting andReview Services (SSARS) . . . . . . . . . . . . . . . . . . .. items on . . . . . . . . . . . . . . . . . . . . . . . . . . . 612

. . . . . . . . . . . . . . . . 801. See also individual SSARS

SEC Form 10-K . . . . . . . . . . . . . . . . . . . . . . . . 603 . AICPA and PCAOB issuance of . . . . . . . . . . . . . . 804

. illustrations of financial statements prepared inSEC Form 10-Q, quarterly report filed using . . . . . 605, 606accordance with . . . . . . . . . . . . . . . . . . . . . 805

SEC forms . . . . . . . . . . . . . . . . . . . . . . . . . 603–606Stock compensation, non-employee . . . . . . . . . . . . 408

Securities Act of 1933, filing instructions under . . . . . 603Stranded tax effects, disclosures about . . . . . . . . 104, 407

Securities and Exchange Commission (SEC)

. approval of AS 3101 of PCAOB by . . . . . . . . . . . . . 704 T

. disclosure requirements of . . . . . . . . . . . . . . . 610, 615Tax base erosion . . . . . . . . . . . . . . . . . . . . . . . 105

. financial statement filings to . . . . . . . . . . . . . . . . 504

Tax credit carryforwards . . . . . . . . . . . . . . . . . . . 104. Regulation S-K reporting requirements for . . . . . . . . 603

. Staff Accounting Bulletins by . . . . . . . . . . . . . . . . 403 Tax Cuts and Jobs Act

. transition for financial statement adjustments by . . . . . 103 . financial reporting issues under . . . . . . . . . . . . . . 407

. foreign earnings under . . . . . . . . . . . . . . . . . . . 105Securities, description under Regulation S-K of . . . . . 609

. overview of changes to domestic provisions ofSecurities Exchange Act of 1934 . . . . . . . . . . . . 504, 505

corporate tax law under . . . . . . . . . . . . . . . . . 104. filing instructions under . . . . . . . . . . . . . . . . . . . 603

. Q&A documents by FASB for implementing . . . . . . . . 104

Securities, Form S-1 for registering new . . . . . 603, 604, 612 . signing of . . . . . . . . . . . . . . . . . . . . . . . . . 103, 105

Service contract . . . . . . . . . . . . . . . . . . . . . . . . 304 Temporary differences for tax purposes and U.S.GAAP . . . . . . . . . . . . . . . . . . . . . . . . . . 104, 105

Share-based awards, accounting for . . . . . . . . . . . . 408Terms of engagement of auditor . . . . . . . . . . . . 706, 707

Short-term leases . . . . . . . . . . . . . . . . . . . . . . . 204Territorial system of taxing earnings . . . . . . . . . . . . 105

Software customization . . . . . . . . . . . . . . . . . . . 304Transaction price in contract . . . . . . . . . . . . . . . . 304

SSARS 19 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803Transition tax on foreign earnings . . . . . . . . . . . . . 105

SSARS 21, Statements on Standards for Accountingand Review Services: Clarification and Recodification . .

U. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803

SSARS 22, Compilation of Pro Form Financial Unbilled receivables . . . . . . . . . . . . . . . . . . . . . 307Information . . . . . . . . . . . . . . . . . . . . . . . . . 803

Underwriter information under Regulation S-K . . . . . . 612SSARS 23, Omnibus Statement on Standards for

Accounting and Review Services—2016 . . . . . . . . 803 Undistributed earnings of foreign subsidiaries . . . . . . 1095

SSARS 24, Omnibus Statement on Standards for Unmodified opinionAccounting and Review Services—2018 . . . . . . 801, 804 . in current year and disclaimer of opinion on prior year . . 707

. sample accountant’s reports in . . . . . . . . . . . . . . . 805 . in prior year and qualified opinion in current year . . . . . 707

Stakeholder outreach by FASB . . . . . . . . . . . . . . . 405

VStatement of financial position, lease liabilities in . . . . 407

Valuation allowancesStatement 123(R) (FASB), Share-Based Payment . . . . 408

. on NOLs . . . . . . . . . . . . . . . . . . . . . . . . . . . 104Statements on Auditing Standards (SASs) . . . . . . 703, 704

. not required on reduced regular tax liability . . . . . . . . 105Statements of cash flow

Variable lease payments . . . . . . . . . . . . . . . . . 205, 407. disclaimer of opinion on . . . . . . . . . . . . . . . . . . . 707

. management responsibility for . . . . . . . . . . . . . . . 805W

Statements of changes in stockholders’ equityWarranties, ASC 606 guidance on . . . . . . . . . . . . . 305. disclaimer of opinion on . . . . . . . . . . . . . . . . . . . 707

. management responsibility for . . . . . . . . . . . . . . . 805 Worldwide system of taxing foreign earnings . . . . . . . 105

SEC

149

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¶10,200




151

¶10,301 FINAL EXAM QUESTIONS: MODULE 1

1. Which of the following identifies the date the Tax Cuts and Jobs Act was signed intolaw?

a. January 1, 2018



d. January 1, 2017

2. Company A has a June 30 fiscal year-end. Under the Tax Cuts and Jobs Act, it wouldapply ___________ to its taxable income for the fiscal year ending June 30, 2018.

a. A rate of 35 percent

b. A rate of 21 percent

c. A blended rate of 28 percent (six months at 35 percent and six months at 21percent)

d. A rate of 14 percent (35 percent minus 21 percent)

3. Which of the following is correct with respect to carryforwards under the Tax Cutsand Jobs Act?

a. Carryforwards such as alternative minimum tax (AMT) represent taxdeductions.

b. Carryforwards such as R&D are affected by the change in corporate tax rate.

c. NOL carryforwards must be remeasured at the new corporate tax rate.

d. The act does not address carryforwards.

4. Which of the following statements with respect to ASU 2018-02 is correct?

a. It specifies what constitutes a stranded tax effect

b. It permits companies to reclassify stranded tax effects from accumulated othercomprehensive income to retained earnings

c. It requires companies to reclassify stranded tax effects from accumulated othercomprehensive income to retained earnings

d. It permits companies to reclassify the effect of the change in the federalcorporate income tax rate on gross valuation allowances that were originallycharged to income from continuing operations

5. As a result of the Tax Cuts and Jobs Act, the corporate income tax rate effectiveJanuary 1, 2018 is:

a. 40 percent

b. 35 percent

c. 34 percent

d. 21 percent

6. Which of the following identifies the effective tax rate on global intangible low-taxedincome (GILTI)?

a. 10.5 percent

b. 13.125 percent

c. Ranges from 10.5 percent to 13.125 percent

d. Ranges from 5 percent to 12.5 percent

¶10,301


7. The Tax Cuts and Jobs Act replaces the U.S. tax code’s long-standing worldwidesystem of taxing foreign earnings with a ________ system.

a. Partial territorial

b. Quasi worldwide

c. Transition

d. Repatriated

8. How does the Tax Cuts and Jobs act modify the tax deductibility of certain types ofcompensation to highly paid employees?

a. It removes the commission and performance-based compensation exclusionsof prior law.

b. It defines covered employees as the CEO, the CFO, and the three highest paidemployees.

c. It applies a tax deduction to a covered employee as long as the company payscompensation to that person or his beneficiaries.

d. All of the above

9. The transition tax under the Tax Cuts and Jobs Act

a. Addresses the tax base erosion created by the ability to deduct certain pay-ments to related foreign parties.

b. Is a new tax on U.S. export sales.

c. Is a one-time tax on undistributed, previously untaxed, foreign earnings andprofits.

d. Was eliminated by the Tax Cuts and Jobs Act.

10. How did the Tax Cuts and Jobs Act affect the corporate alternative minimum tax(AMT)?

a. It introduced an improved method of calculating the corporate AMT.

b. It eliminated the corporate AMT.

c. It made existing AMT credits nonrefundable.

d. It required that the AMT credit be classified as a receivable.

11. Which of the following identifies the fundamental concept of ASC Topic 842,Leases?

a. Capital leases and finance leases are the same.

b. Intangible assets are excluded.

c. A lessee should recognize the assets and liabilities from leases.

d. Improvements to real estate generally belong to the property owner.

12. Which entities must comply with the new leasing standards under ASC Topic 842beginning after December 15, 2018?

a. Employee benefit plans that file financial statements with the SEC

b. Nonprofit entities that have issued securities that are traded over-the-counter

c. Public businesses

d. All other entities

13. Which type of lease represents the majority of leases for most companies?

a. Operating leases

b. Finance leases

c. Leveraged leased

d. Capital leases

¶10,301

153FINAL EXAM QUESTIONS: MODULE 1

14. The FASB issued ASU 2016-02 Primarily to

a. Overhaul lessor accounting.

b. Clarify the recognition of leased assets and liabilities on the balance sheet.

c. Improve the cash flow presentation of leased assets.

d. Reduce the amount of lease disclosures

15. ASU 2016-02 was issued in conjunction with:

a. IFRS 16, Leases

b. ASC Topic 606, Revenue from Contracts with Customers

c. ASC Topic 840, Leases

d. The Sarbanes-Oxley Act

16. A/an ________ is defined as a contract, or part of a contract, that conveys the rightto control the use of identified property, plant, or equipment for a period of time inexchange for consideration.

a. Component

b. Lease

c. Indirect cost

d. Right-of-use asset

17. Which type(s) of lease disclosures does FASB’s Topic 842 require?

a. Qualitative disclosures only

b. Quantitative disclosures only

c. Both qualitative and quantitative disclosures

d. None; Topic 842 does not require lease disclosures.

18. When starting a lease accounting project, a company’s first step should be to:

a. Perform a situational assessment

b. Understand the new lease accounting standard

c. Staff the lease project team

d. Review its current leasing program

19. For public businesses, the new lease accounting standard is effective for fiscalyears beginning after:





20. Which strategy for estimating the budget for a lease accounting project is calledthe “top-down� strategy?

a. Using a similar project as benchmark for what lease accounting might cost

b. Budgeting the individual components of the lease accounting projectseparately

c. Conducting a financial impact analysis

d. Estimating the cost of the project as a percentage of the value of the company’sleasing portfolio

¶10,301


21. Which of the following identifies the second step in the ASC Topic 606 newrevenue recognition model?

a. Identify the contract with the customer.

b. Identify performance obligations.

c. Identify payment terms.

d. Identify the discount rate.

22. After an entity has identified performance obligations, the entity should do whichof the following as it relates to the ASC Topic 606 new revenue recognition model?

a. Determine the transaction price.

b. Identify the promised goods or services

c. Assess the probability of collection.

d. Determine whether the contract has commercial substance.

23. Which of the following identifies the last step in the new revenue recognitionmodel under Topic 606?

a. Identify payment terms.

b. Recognize revenue when (or as) an entity satisfies a performance obligation.

c. Allocate the transaction price to the performance obligations.

d. Collect cash from the customer.

24. Which of the following identifies a required disclosure for private companies withrespect to revenue recognition under Topic 606?

a. Revenue recognized that was included in the contract liability at the beginningof the period

b. A discussion of how probable the amount of variable consideration was deter-mined to be

c. Revenue recognized related to performance obligations satisfied in the priorperiod

d. Explanation of changes in contract balances due to changes in estimates ofvariable consideration

25. Which of the following identifies a transition consideration as it relates to businesspractices?

a. Performance metrics in compensation and bonus plans

b. Effect on non-GAAP measures

c. Changes to contracts with customers

d. Internal controls over financial reporting

26. Which of the following is not one of the basic concepts that apply to all financialapplications?

a. Materiality

b. Misstatement

c. Measurement

d. Modification

¶10,301


27. Which of the following entities are within the scope of the new guidance in ASU2016-13, Financial Instruments—Credit Losses (Topic 326)?

a. Public business entities that are SEC filers

b. Public business entities that are not SEC filers

c. Organizations that hold financial assets in leases that are not accounted for atfair value with changes in fair value reported in net income

d. All of the above

28. Which of the following ASUs were released by the FASB in response to stake-holder concerns relating to the Tax Cuts and Jobs Act?

a. ASU 2018-02

b. ASU 2016-14

c. ASU 2016-13

d. ASU 2014-09

29. Which of the following statements with respect to ASU 2017-12, Derivatives andHedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, iscorrect?

a. It requires separate measurement and reporting of hedge ineffectiveness

b. It addresses financial statement users’ concerns about the way hedging activi-ties are reported

c. It allows fewer risk components to qualify for hedge accounting

d. It makes the application of the hedge accounting standard more complex

30. Which of the following statements is correct regarding the new auditor’s reportingmodel requirements?

a. The PCAOB has not yet issued a standard outlining the requirements.

b. They relieve auditors from communicating critical audit matters.

c. They represent the biggest overhaul of the auditor’s report in more than 70years.

d. They are optional for certain classes of auditors.

31. The FASB primarily conducts outreach with its stakeholders, such as preparers,auditors, and regulators, after it issues a standard, in order to:

a. Identify entities who are inappropriately applying the standard

b. Identify which stakeholders adopted the standard most quickly.

c. Learn about implementation issues so it can address them effectively.

d. Reward stakeholders who have no implementation concerns.

32. Which of the following statements regarding ASU 2016-14, Not-for-Profit Entities(Topic 958): Presentation of Financial Statements of Not-for-Profit Entities is correct?

a. It simplifies the net asset classification scheme to two classes

b. It revises the net asset classification scheme to three classes

c. It requires not-for-profit entities to use the direct method of reporting operatingcash flows

d. It requires not-for-profit entities to use the indirect method of reporting operat-ing cash flows

¶10,301


33. Which of the following statements is correct regarding materiality?a. The concept of materiality applies to some financial statement engagements

but not others.b. There is no authoritative formula for determining what is material in a financial

statement engagement.c. All standard-setting organizations have adopted the same definition of

materiality.d. Materiality is irrelevant according to GAAP.

34. The FASB’s _________ makes it easy for stakeholders to submit questions.a. Technical inquiry serviceb. Training sessionsc. Transition Resource Groups (TRGs)d. Accounting Standards Updates (ASUs)

35. Which of the following is enabling the accounting profession to provide unprece-dented levels of insight and assurance?

a. Benchmarkingb. Standards implementationc. Emerging technologyd. Effective disclosures

36. The FASB’s main objective in developing ASU 2016-01 was to:a. Enhance the reporting model for financial instruments to give financial state-

ment users more useful information to make decisionsb. Improve financial reporting by requiring timelier recording of credit losses on

loans and other financial instrumentsc. Require an economic forecast be created over the entire contractual life of

long-dated financial assetsd. Introduce new disclosure requirements for financial instruments

37. The amendments in ASU 2016-13 were updated to reflect the change from a(n)_______ credit loss methodology to an a(n) _______ credit loss methodology.

a. incurred; impairedb. expected; probablec. expected; incurredd. incurred; expected

38. The amendments prescribed by ASU 2016-01 affects:a. Public entities that hold financial assetsb. Nonprofit organizationsc. Private entities that owe financial liabilitiesd. All of the above

39. Which of the following ASUs require the measurement of all expected creditlosses for financial assets held at the reporting date based on historical experience,current conditions, and reasonable and supportable forecasts?

a. ASU 2016-01b. ASU 2016-13c. ASU 2016-14d. ASU 2018-02

¶10,301


40. For purposes of ASU 2016-13, all of the following are considered financingreceivables, except:

a. A financing arrangement that represents a contractual right to receive moneyeither on demand or on fixed or determinable dates

b. A financing arrangement that is recognized as an asset in the balance sheet.

c. A financing arrangement that is not recognized as an asset in the balancesheet.

d. A receivable relating to a lessor’s rights to payments from a leveraged leaserecognized as an asset.

41. The current expected credit loss (CECL) model applies to each of the followingtransactions, except?

a. Available-for-sale debt securities

b. Credit losses for purchased financial assets

c. Trading securities

d. Held-to-maturity securities

42. Which of the following statements is correct regarding the new CECL model?

a. Its application is expected to have minor impacts on an entity.

b. It will only affect an entity’s information systems business unit.

c. It will significantly affect an entity’s impairment estimates and financial andregulatory capital ratios.

d. It will not affect an entity’s loans.

43. According to ASU 2016-01, public business entities are no longer required to:

a. Measure equity investments at fair value with changes in fair value recognizedin net income

b. Disclose the methods and significant assumptions used to estimate the fairvalue that is required to be disclosed for financial instruments measured atamortized cost on the balance sheet

c. Use the exit price notion when measuring the fair value of financial instru-ments for disclosure purposes

d. Provide separate presentation of financial assets and financial liabilities bymeasurement category and form of financial asset

44. Early application of the amendments in ASU 2016-13 is permitted for fiscal yearsbeginning after:





45. Each of the following identifies a characteristic of an SEC filer, except?

a. An entity that is required to file its financial statements with the SEC

b. An entity that voluntarily files financial statements with the SEC

c. An entity subject to Section 12(i) of the Securities Exchange Act that isrequired to file its financial statements with the appropriate agency under thatsection

d. An entity that is not otherwise a SEC filer but whose financial statements areincluded in a submission by another SEC filer

¶10,301


¶10,302 FINAL EXAM QUESTIONS: MODULE 2

1. Which of the following historical acts mandated the use of Regulation S-K?

a. Securities Act of 1933

b. Securities Exchange Act of 1934

c. Investment Company Act of 1940

d. Investment Advisers Act of 1940

2. Regulation S-K applies to each of the following, except:

a. Annual or other reports

b. Going-private transaction statements

c. Tender offers

d. Agreed upon procedures engagements

3. Which of the following identifies the broad form used to notify investors in U.S.public companies of specified events that may be important to shareholders or the SEC?

a. Form S-1

b. Form 8-K

c. Form 10-Q

d. Form 10-K

4. Information and overall principles/requirements with respect to non-GAAP mea-sures are outlined in which subpart of Regulation S-K?

a. General

b. Business

c. Financial information

d. Management and certain security holders

5. Information related to a description of a company’s securities is outlined in Subpart____ of Regulation S-K.

a. 100

b. 200

c. 300

d. 400

6. Based on Regulation S-K Item 302 related to supplementary financial information,which of the following disclosures of selected quarterly data should be made for the twomost recent fiscal years?

a. Income from continuing operations

b. Total assets

c. Gross profit

d. Cash dividends declared per common share

¶10,302


7. Liquidity, capital resources, results of operations, off-balance sheet arrangements,and a tabular disclosure of contractual obligations should be discussed in:

a. Management’s discussion and analysis

b. Prospectus summary

c. Risk factors of Form 8-K

d. Form S-12

8. Which of the following items within Regulation S-K outlines the reporting require-ments with respect to executive compensation?

a. Item 401

b. Item 402

c. Item 501

d. Item 502

9. Which of the following subparts of Regulation S-K would a company primarily referto when preparing its registration statement and prospectus summary?

a. Subpart 400

b. Subpart 500

c. Subpart 900

d. Subpart 1200

10. In October 2017, the SEC voted to propose amendments to modernize andsimplify disclosure requirements for public companies, investment advisers, and invest-ment companies and to implement a mandate under which of the following acts?

a. Fixing America’s Surface Transportation Act

b. Tax Cuts and Job Act

c. Job Creation and Worker Assistance Act

d. Economic Growth and Tax Relief Reconciliation Act

11. Which entity has oversight over the Public Company Accounting Oversight Board(PCAOB)?

a. U.S. Securities and Exchange Commission (SEC)

b. Financial Accounting Standards Board (FASB)

c. American Institute of Certified Public Accountants (AICPA)

d. International Auditing and Assurance Standards Board (IAASB)

12. Under the new PCAOB auditor reporting model, where should the Basis ofOpinion section be placed?

a. Before the Opinion section

b. After the Opinion section

c. At the end of the auditor’s report

d. At the very beginning of the auditor’s report

13. The new auditor reporting model requires that an explicit reference to auditorindependence be included in the ______ section.

a. Opinion

b. Basis of Opinion

c. Disclaimer of Opinion

d. Other Information

¶10,302


14. International Standards on Auditing (ISAs) are issued by the:

a. IASB

b. IAASB

c. PCAOB

d. FASB

15. Released in January 2015, the new and revised ISAs relating to reporting onaudited financial statements are effective for audits of financial statements for periodsending on or after:


b. January 1, 2015



16. The Accounting Standards Board (ASB) based its proposed revisions to the U.S.standards on auditor reporting on which of the following types of auditing standards?

a. PCAOB

b. AICPA

c. ISA

d. GASB

17. The effective date for all elements of the PCAOB auditor’s report (except CAMs)is for audits for fiscal years ending on or after:





18. Which of the following identifies one of the significant changes from the proposedSAS Forming an Opinion and Reporting on Financial Statements?

a. The Basis for Opinion section has been removed.

b. The Opinion section must be placed at the end of the auditor report.

c. The requirement to identify the parties responsible for overseeing the financialreporting process has been removed.

d. The descriptions of the auditor’s responsibilities and the key features of anaudit have been expanded.

19. Which of the following ISAs includes a significant change related to communicat-ing key audit matters (KAMs) in the auditor’s report?

a. ISA 260 (Revised)

b. ISA 570 (Revised)

c. ISA 700 (Revised)

d. ISA 705 (Revised)

¶10,302


20. How do the proposed amendments to AU-C section 570 (SAS 132) change theauditor reporting requirements on going concern?

a. They change the underlying auditor performance requirements relating togoing concern.

b. They make the new requirements consistent with the corresponding require-ments in ISA 570 (Revised).

c. They prohibit the auditor from concluding that substantial doubt remainsabout an entity’s ability to continue as a going concern.

d. They provide a new definition of going concern.

21. Most of the amendments in SSARS 24 are effective for compilations and reviews offinancial statements for periods ending on or after:

a. May 1, 2017

b. May 1, 2018

c. June 15, 2018

d. June 15, 2019

22. Which of the following standards provide guidance on the compilation of proforma financial information?

a. SSARS 21

b. SSARS 22

c. SSARS 23

d. SSARS 24

23. Which of the following organizations is responsible for issuing Statements onStandards for Accounting and Review Services (SSARS)?

a. Council of the AICPA

b. Financial Accounting Standards Board (FASB)

c. Financial Accounting Foundation

d. AICPA’s Accounting and Review Services Committee (ARSC)

24. According to SSARS 21, a note such as the following must appear on each page ofthe financial statement for which type of engagement? “These financial statements havenot been compiled, reviewed or audited, and no CPA expresses an opinion or aconclusion or provides any assurance on them.�

a. Compilation

b. Preparation

c. Review

d. All types of engagements

25. Which of the following type of engagement requires an independencedetermination?

a. Compilation

b. Preparation

c. Agreed upon procedures

d. Consulting

¶10,302


26. Which of the following statements regarding the requirements of SSARS 24 isincorrect?

a. It includes a new section addressing special considerations for internationalreporting issues.

b. It revises AR-C Section 60, General Principles for Engagements Performed inAccordance With Statements on Standards for Accounting and Review Services.

c. It revises AR-C section 90, Review of Financial Statements.

d. It contains no guidance on the requirements for going concern.

27. When determining whether the financial reporting framework selected by man-agement to prepare the financial statements is acceptable based on the requirements ofSSARS 24, an accountant should consider:

a. The intended users of the financial information

b. Whether the framework chosen is a fair presentation

c. The steps management has taken to determine that the framework isacceptable

d. All of the above

28. Which of the following parts of SSARS 24 are effective upon issuance?

a. Amendments to AR-C Section 90, paragraph .39

b. Amendments to AR-C Section 80

c. Amendments to AR-C Section 70

d. Amendments to AR-C Section 60

29. SSARS 22 is effective on or after:

a. May 1, 2017

b. May 1, 2018

c. June 15, 2018

d. June 15, 2019

30. Which of the following statements is correct regarding the financial reportingframework?

a. The accountant should always select the framework for management.

b. Management should always select the framework.

c. SSARS 24 does not define the term financial reporting framework.

d. The framework is not taken into consideration when an accountant accepts anengagement.

¶10,302

163

¶10,400 Answer Sheets¶10,401 Top Accounting and Auditing Issues for 2019CPE Course: MODULE 1

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Module 1: Answer SheetPlease answer the questions by indicating the appropriate letter next to the correspond-ing number.

1. 10. 19. 28. 37.

2. 11. 20. 29. 38.

3. 12. 21. 30. 39.

4. 13. 22. 31. 40.

5. 14. 23. 32. 41.

6. 15. 24. 33. 42.

7. 16. 25. 34. 43.

8. 17. 26. 35. 44.

9. 18. 27. 36. 45.

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Module 2: Answer SheetPlease answer the questions by indicating the appropriate letter next to the correspond-ing number.

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2. 12. 22.

3. 13. 23.

4. 14. 24.

5. 15. 25.

6. 16. 26.

7. 17. 27.

8. 18. 28.

9. 19. 29.

10. 20. 30.

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¶10,500 Top Accounting and AuditingIssues for 2019 CPE Course: Evaluation Form

(10024493-0006)

Please take a few moments to fill out and submit this evaluation to Wolters Kluwer sothat we can better provide you with the type of self-study programs you want and need.Thank you.

About This Program

1. Please circle the number that best reflects the extent of your agreement with thefollowing statements:

Strongly StronglyAgree Disagree

a. The Course objectives were met. 5 4 3 2 1

b. This Course was comprehensive and 5 4 3 2 1organized.

c. The content was current and technically 5 4 3 2 1accurate.

d. This Course content was relevant and 5 4 3 2 1contributed to achievement of the learningobjectives.

e. The prerequisite requirements were 5 4 3 2 1appropriate.

f. This Course was a valuable learning 5 4 3 2 1experience.

g. The Course completion time was 5 4 3 2 1appropriate.

2. What do you consider to be the strong points of this Course?

3. What improvements can we make to this Course?

THANK YOU FOR TAKING THE TIME TO COMPLETE THIS SURVEY!

2700 Lake Cook RoadRiverwoods, IL 60015800 344 3734 CCHCPELink.com

CCH® CPELINKMeeting your continuing professional education requirements every year is time consuming enough without spending extra time hunting for relevant courses and keeping track of what you need to take. CCH® CPELink gives you your required CPE to maintain your license without giving you a headache. Hundreds of courses over a broad range of topics make it easy to find CPE relevant to your professional development, while the Compliance Manager makes it easy to actively monitor your CPE deadlines and mandatory subject requirements so you don’t have to. Take a look at our offerings and feel good about the time you put into your CPE.

n Webinars. We offer more than 300 live, online interactive sessions every year, hosted by some of the industry’s leading experts.

n Self-Study. Learn at your own pace with our online self-study courses. More than 500 courses cover everything from tax and accounting basics to niche topics to help you in your specified field.

n Print CPE. This convenient self-study learning is a great way to earn the required CPE credit you need. Download the complimentary course content PDF from CCHCPELink.com/printcpe. When you’re ready, return to the website to take the test and earn your CPE.

n Compliance Manager. Never miss another CPE deadline! The Compliance Manager includes CPE tracking and compliance monitoring for CPAs in every state (including Puerto Rico) plus many other regulators. Let the Compliance Manager track your CPE so you don’t have to.

n Subscription packages. Take care of all your CPE needs and save money doing it. View unlimited webinars, save on self-study and webinar hours, or get unlimited CPE for your whole firm. Visit CCHCPELink.com for details.


