One of the most difficult challenges for some auditors as 2019 comes to an end is maintaining their independence amid the frustration and confusion of their clients over the implementation of FASB’s new revenue recognition standard.
CPAs who see their clients struggling want to help, but if they are going to continue auditing a financial statement, they cannot also perform management responsibilities related to preparing that financial statement.
The revenue recognition standard takes effect this year for private companies that are reporting under GAAP, so time is running out for implementation of the five-step process for recognizing revenue. Practitioners say there is consternation and even panic among those who are responsible for financial reporting at some companies.
“When you hand them a standard that’s 600 or 700 pages long, it’s a heavy lift for people who, in their perspective, they’re running their businesses fine today,” said Julie Killian, CPA, a shareholder who heads the assurance practice at Clayton & McKervey in Southfield, Mich.
Practitioners can help their frustrated clients but must provide that assistance without compromising their independence.
The “General Requirements for Performing Nonattest Services” interpretation (ET §1.295.040) in the AICPA Code of Professional Conduct explains that when a member performs nonattest services for an attest client, the attest client and its management must agree, among other things, to assume all management responsibilities.
These management responsibilities, as described in the “Management Responsibilities” interpretation (ET §1.295.030), include accepting responsibility for the preparation and fair presentation of the attest client’s financial statements. But this can be difficult for small and even medium-size businesses as they attempt to implement the complicated revenue recognition standard.
Of course, when these businesses have trouble with accounting issues, they turn to experts at their accounting firms for help. If the accounting firms are performing the audit, though, they have to be careful to maintain their independence and not usurp management’s responsibility for preparing the financial statements.
“We’ve developed a process when they do need our help to walk that line to make sure we maintain independence,” Killian said.
Advisory services are permitted
Although auditors are not permitted to assume responsibility for the financial statements of an attest client, they can provide some assistance. The “Advisory Services” interpretation (ET §1.295.105) explains in paragraph .02 that if a member’s services are only advisory in nature, independence would not be impaired.
As an example, a member is permitted to provide advice, research materials, and recommendations to help management perform its functions and make decisions. A member is even allowed to prepare the financial statements that the member audits, as long as all the safeguards in the “General Requirements for Performing Nonattest Services” interpretation are followed. These include:
- The client’s management taking responsibility for the preparation and fair presentation; and
- The member being satisfied that the preparation is overseen by an individual with the client who possesses suitable skill, knowledge, and/or experience to oversee the preparation service.
Nonetheless, to avoid any possible perception of independence being impaired, some CPAs are choosing to suggest that clients should have one firm help them prepare the financial statement and another audit the financial statement.
“We’ve done some of that because we’ve built ourselves up more in the last three or four years as advisers to clients and kind of like acting CFOs,” said Scot Loyd, CPA, CGMA, a partner at Swindoll, Janzen, Hawk & Loyd LLC in Hutchinson, Kan.
Nonetheless, Loyd said, the dual CPA firm approach doesn’t work for many businesses, especially smaller businesses in rural areas.
“There’s not a lot of CPAs out here,” he said. “There’s not a lot of people where one could do the financial statement and another could do the audit. They don’t have the money to pay for two different firms being involved.”
Killian is advising some of those clients to switch over to the Financial Reporting Framework for Small- and Medium-Sized Entities, known as the FRF for SMEs, or to IFRS for SMEs. One wave of her clients converted shortly after the FRF for SMEs was introduced in 2013, primarily to avoid complicated GAAP accounting related to variable-interest entities and fair value on acquisitions.
A second wave is converting to FRF for SMEs or IFRS for SMEs to avoid the revenue recognition implementation. In all, about 30% of the client base for Clayton & McKervey has switched. But for the 70% who aren’t switching, Killian has used numerous tactics to prepare them to implement the revenue recognition standard.
Educating clients
It started with an attempt to educate clients about what was coming.
Clayton & McKervey delivered step-by-step handouts to clients, educating them on how to go through each implementation step. But when few clients paid attention, the firm put together a checklist to walk them through the implementation process.
Under the “Independence Rule” (ET §1.200.001), members are permitted to explain the steps that need to be taken to achieve the five core principles in the revenue recognition standard, which consist of:
- Identifying contracts with customers.
- Identifying the performance obligations in the contract.
- Determining the transaction price.
- Allocating the transaction price to the performance obligations in the contract.
- Recognizing revenue when or as the entity satisfies a performance obligation.
For the member to remain independent, though, the attest client must accept responsibility for the work and must understand how those five steps for revenue recognition relate to their particular business.
Some firms have been developing checklists to help clients work through those five steps. Checklists can help clients break down the core principles into various questions that help management think through their unique processes and use their professional judgment to determine how the standard should be applied to their situation.
Clayton & McKervey built a checklist by combining steps described in checklists developed by the AICPA’s Center for Plain English Accounting, as well as software vendors CCH and PPC. Clayton & McKervey’s checklist walks clients through the standard step by step and includes drop-down menus that provide examples for clients who may have questions.
The checklist also has optional parts that are specific to clients in certain industries such as construction or retail. For example, for change orders it asks questions that help the client determine whether the change order creates a new performance obligation. Is the change order part of the existing contract? Is it a separate contract? The questions help management make the decision on its own.
“Ultimately, they’re the ones filling it out and getting it to that level of understanding,” Killian said. “So effectively we’re helping them understand the standard rather than taking their particular case and doing everything for them. We’re giving them a means for understanding the standard and where it’s going to apply to them.”
Helping clients understand the revenue recognition standard so they can apply it themselves is the key. In presentations to members, the AICPA Ethics Team is encouraging members who are assessing independence to consider:
- The responsibility of client personnel.
- The extent of the training provided to clients.
- The degree of involvement in assisting clients with implementation efforts.
If the auditor’s involvement is extensive, the member may need to consider their work as a separate service subject to nonattest services requirements, rather than as a routine activity.
Training for clients
One way that PKF Texas has addressed its clients’ challenges in general with the revenue recognition standard is by holding a two-day training for clients with a third-party trainer.
“We had our staff as well as our clients attend the training,” said Danielle Supkis Cheek, CPA, a director at PKF Texas. “And we had a great turnout where there was good marketing for us as well as learning for our clients that reduced the threats to independence by having them learn how to do it.”
Often, though, the smallest clients are the most challenging with respect to independence. For example, the independence challenges related to revenue recognition may be more challenging for review and compilation providers than they are for auditors of companies that are preparing full GAAP financial statements.
“Those clients, because they’re doing a lesser attest service, are used to less work associated with their engagement,” Cheek said. “And sometimes they are the less sophisticated clients. They are going to be really unprepared.”
For review clients that are accustomed to paying smaller fees, the CPA firm’s fee increase related to revenue recognition challenges can be huge on a percentage basis, Cheek said.
“You could be talking a double fee,” Cheek said. “That’s going to be a hard pill to swallow.”
Contracts may pose a challenge
Some smaller clients are finding that contracts are a challenge as they implement the revenue recognition standard. Small business often have less formal agreements with their customers, and those agreements often aren’t standardized.
“For our clients, a lot of the contracts aren’t cut and dry,” Killian said. “There are email agreements going back and forth, modifications, things like that which make it hard to accommodate in the software. There’s a lot of manual thinking and considering and documenting that’s got to go on.”
Although this can be challenging for clients with respect to implementation, it’s also an opportunity for them to go back and improve their processes. Cheek said PKF Texas has alerted clients to operational problems in their contracts that clients may be able to fix by working with their lawyers.
This type of advice is an example of how auditors provide value to clients. Advising effectively on the revenue recognition standard’s requirements for preparation of the financial statements also provides value while enabling management to take responsibility for the financial statements.
Doing this effectively, Cheek said, is a matter of presenting very technical matters in nontechnical terms.
“On the complicated matters, you just have to find a way to explain it so they can actually understand the decisions they’re making and the implications of those decisions,” she said. “A lot of times it’s presenting the pros and cons of everything and all the other alternatives that are out there.”
— Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA’s editorial director.
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