ACCOUNTING AND AUDITING SUPPLEMENT NO

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3 Chapter 1 ACCOUNTING AND AUDITING SUPPLEMENT NO INTRODUCTION This update includes the more significant accounting and auditing developments from October 2015 through December Included in this update are standard setting and project activities of the Auditing Standards Board (ASB), Accounting and Review Services Committee, Assurance Services Executive Committee, Professional Ethics Executive Committee, FASB, PCAOB, and the SEC. These developments, although believed to be complete at the date at which they were prepared for this course material, may not cover all areas within accounting and auditing relevant to all users of this material. This update may refer you to other sources of information, in which case you are strongly encouraged to review that information if relevant to your needs. After completing this course, you should be able to identify some of the more significant accounting and auditing developments from October through December Copyright AICPA Unauthorized Copying Prohibited 1-1

4 Part I Audit and Accounting Final and Proposed Standards FINAL STANDARDS AND INTERPRETATIONS AICPA Auditing Standards Board Auditing Standards SAS No. 130, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements Issue Date Statement on Auditing Standards (SAS) No. 130, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements (AICPA, Professional Standards, AU-C sec. 940) was issued October Effective Date SAS No. 130 is effective for integrated audits for periods ending on or after December 15, Background SAS No. 130 was issued as a result of the ASB s Attestation Clarity Project. The ASB concluded that, because engagements performed under AT section 501, An Examination of an Entity s Internal Control Over Financial Reporting That Is Integrated With an Audit of Its Financial Statements (AICPA, Professional Standards), as well as related Attestation Interpretation No. 1, Reporting Under Section 112 of the Federal Deposit Insurance Corporation Improvement Act (AICPA, Professional Standards, AT sec. 9501), are required to be integrated with an audit of financial statements, it is appropriate to move the content of AT section 501 from the attestation standards into generally accepted auditing standards (GAAS). AT section 501 and the related attestation interpretation will be withdrawn when SAS No. 130 becomes effective. ASB s intention in developing this standard was to adhere as closely as possible to AT section 501 and PCAOB Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements. In order to integrate the SAS into GAAS, SAS No. 130 also amends various sections in SAS No. 122, Statements on Auditing Standards: Clarification and Recodification. Changes in SAS No. 130 include the following: The auditor will be required to examine and report directly on the effectiveness of internal control over financial reporting. There is no longer an option to examine and report on management s assertion about the effectiveness of internal control over financial reporting. The term significant account or disclosure used in AT section 501 has been changed to significant class of transactions, account balance, or disclosure. This change aligns with terminology used in existing GAAS and clarify that the risk factors the auditor is required to evaluate in the identification of significant classes of transactions, account balances, and disclosures and their relevant assertions 1-2 Copyright AICPA Unauthorized Copying Prohibited

5 are the same in the audit of internal control over financial reporting as in the audit of the financial statements. The SAS allows, as does AT section 501, the auditor to use the work of internal auditors and others in obtaining evidence about the effectiveness of internal control over financial reporting. Note: AU-C section 610, Using the Work of Internal Auditors (AICPA, Professional Standards), does not discuss others. The SAS requires the auditor planning to use the work of others in the audit of internal control over financial reporting to adapt and apply, as necessary, the requirements of AU-C section 610, including the need for others to apply a systematic and disciplined approach. Scope This section establishes requirements and provides guidance that applies only when an auditor is engaged to perform an audit of internal control over financial reporting (ICFR) that is integrated with an audit of financial statements (integrated audit). The objectives of the auditor in an audit of ICFR are to obtain reasonable assurance about whether material weaknesses exist as of the date specified in management s assessment about the effectiveness of ICFR (as of date) and express an opinion on the effectiveness of ICFR in a written report, and communicate with management and those charged with governance as required by this section, based on the auditor s findings. Definitions In SAS No. 130 the following terms have the meanings attributed as follows. Audit of ICFR. An audit of the design and operating effectiveness of an entity s ICFR. Control objective. The aim or purpose of specified controls. Control objectives address the risks that the controls are intended to mitigate. In the context of ICFR, a control objective generally relates to a relevant assertion for a significant class of transactions, account balance, or disclosure and addresses the risk that the controls in a specific area will not provide reasonable assurance that a misstatement or omission in that relevant assertion is prevented, or detected and corrected, on a timely basis. Criteria. The benchmarks used to measure or evaluate the subject matter. Detective control. A control that has the objective of detecting and correcting errors or fraud that have already occurred that could result in a misstatement of the financial statements. Internal control over financial reporting (ICFR). A process effected by those charged with governance, management, and other personnel, designed to provide reasonable assurance regarding the preparation of reliable financial statements in accordance with the applicable financial reporting framework and includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the applicable financial reporting framework, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and those charged with governance; and provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the entity s assets that could have a material effect on the financial statements. Copyright AICPA Unauthorized Copying Prohibited 1-3

6 ICFR has inherent limitations. ICFR is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. ICFR also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented, or detected and corrected, on a timely basis by ICFR. Management s assessment about ICFR. Management s conclusion about the effectiveness of the entity s ICFR, based on suitable and available criteria. Management s assessment is included in management s report on ICFR. Preventive control. A control that has the objective of preventing errors or fraud that could result in a misstatement of the financial statements. Requirements Note: the requirements in SAS No. 130 are rather extensive. The following is a list of requirements in SAS No Following the list are selected requirements in more detail of this SAS: Preconditions for the Audit of ICFR Requesting a Written Assessment Integrating the Audit of ICFR With the Financial Statement Audit Planning the Audit of ICFR Role of Risk Assessment Addressing the Risk of Fraud Using the Work of Internal Auditors or Others Materiality Using a Top-Down Approach Entity-Level Controls Evaluating the Components of ICFR Period-End Financial Reporting Process Identifying Significant Classes of Transactions, Account Balances, and Disclosures, and Their Relative Assertions Understanding Likely Sources of Misstatement Selecting Controls to Test Testing Controls Evaluating Design Effectiveness Testing Operating Effectiveness Relationship of Risk to the Evidence to Be Obtained Timing and Extent of Tests of Controls Rollforward Procedures Special Considerations for Subsequent Years Audits Identifying Deficiencies in ICFR Determination of Whether Material Weaknesses Exist as of the Date Specified in Management s Assessment About ICFR Determination of Whether Significant Deficiencies Exist During the Integrated Audit Subsequent Events Concluding Procedures Forming an Opinion Obtaining Written Representations Communicating ICFR-Related Matters Reporting on ICFR Report Date Report Modifications 1-4 Copyright AICPA Unauthorized Copying Prohibited

7 Adverse Opinions Elements of Management s Report Are Incomplete or Improperly Presented Scope Limitations Making Reference to a Component Auditor and Assuming Responsibility for the Work of a Component Auditor Additional Information Special Topics Entities With Multiple Components Special Situations Use of Service Organizations Benchmarking of Automated Controls Selected Requirements in SAS No. 130 Preconditions for the Audit of ICFR 1 AU-C section 210, Terms of Engagement, requires the auditor to establish whether the preconditions for an audit are present. In an audit of ICFR, the auditor should obtain the agreement of management that it acknowledges and understands its responsibility for o designing, implementing, and maintaining effective ICFR. o evaluating the effectiveness of the entity s ICFR using suitable and available criteria. o providing management s assessment about ICFR in a report that accompanies the auditor s report. o supporting its assessment about the effectiveness of the entity s ICFR with sufficient evaluations and documentation. o providing the auditor with access to all information of which management is aware that is relevant to management s assessment of ICFR, such as records, documentation, and other matters; additional information that the auditor may request from management for the purpose of the audit of ICFR; and unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence. determine that the as of date corresponds to the balance sheet date (or period ending date) of the period covered by the financial statements. The auditor should evaluate the effectiveness of the entity s ICFR using the same suitable and available criteria used by management for its assessment. Requesting a Written Assessment 2 The auditor should request from management a written assessment about the effectiveness of the entity s ICFR. Management s refusal to provide a written assessment represents a scope limitation, and the auditor should apply the requirements in paragraphs Par Par Paragraphs cover situations in which an auditor encounters a scope limitation and the requirements for responding to those limitations including withdrawing from the integrated audit engagement or disclaiming an opinion on ICFR and considering. the implications on the financial statement audit. Copyright AICPA Unauthorized Copying Prohibited 1-5

8 Integrating the Audit of ICFR With the Financial Statement Audit 4 The objectives of an audit of ICFR and an audit of financial statements are not the same; therefore, the auditor should plan and perform the integrated audit to achieve their respective objectives simultaneously. The auditor should design tests of controls to obtain sufficient appropriate audit evidence to support the auditor s opinion on ICFR as of the date specified in management s assessment about ICFR and to obtain sufficient appropriate audit evidence to support the auditor s control risk assessments for purposes of the audit of financial statements. If the auditor is engaged to audit the effectiveness of an entity s ICFR for a period of time, the requirements and guidance in this section should be modified accordingly, and the auditor should integrate the audit of ICFR with an audit of financial statements covering the same period of time. The auditor should consider the effect of the results of the financial statement auditing procedures on the auditor s risk assessments and the testing necessary to conclude on the operating effectiveness of a control. If, during the audit of ICFR, the auditor identifies a deficiency in ICFR, the auditor should determine the effect of the deficiency, if any, on the nature, timing, and extent of substantive procedures to be performed to reduce audit risk in the audit of the financial statements to an acceptably low level. When concluding on the effectiveness of controls for the purpose of the financial statement audit, the auditor should evaluate the results of any additional tests of controls performed by the auditor to achieve the objective related to expressing an opinion on the entity s ICFR. Reporting on ICFR 5 The auditor s report on the audit of ICFR should be in writing and should include the following elements: a. A title that includes the word independent to clearly indicate that it is the report of an independent auditor b. An addressee as required by the circumstances of the engagement c. An introductory paragraph that includes the following: i. Identification of the entity whose ICFR has been audited ii. A statement that the entity s ICFR has been audited iii. Identification of the as of date iv. Identification of the criteria against which ICFR is measured d. A section with the heading Management s Responsibility for Internal Control Over Financial Reporting that includes the following: i. A statement that management is responsible for designing, implementing, and maintaining effective ICFR ii. A statement that management is responsible for its assessment about the effectiveness of ICFR iii. A reference to management s report on ICFR 4 Para Para Copyright AICPA Unauthorized Copying Prohibited

9 e. A section with the heading Auditor s Responsibility that includes the following: i. A statement that the auditor s responsibility is to express an opinion on the entity s ICFR based on the audit ii. A statement that the audit was conducted in accordance with auditing standards generally accepted in the United States of America iii. A statement that such standards require that the auditor plan and perform the audit to obtain reasonable assurance about whether effective ICFR was maintained in all material respects iv. A description of the audit by stating that (1) an audit of ICFR involves performing procedures to obtain audit evidence about whether a material weakness exists (2) the procedures selected depend on the auditor s judgment, including the assessment of the risks that a material weakness exists (3) an audit includes obtaining an understanding of ICFR and testing and evaluating the design and operating effectiveness of ICFR based on the assessed risk v. A statement about whether the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the audit opinion f. A section with the heading Definition and Inherent Limitations of Internal Control Over Financial Reporting or other appropriate heading that includes the following: i. A definition of ICFR (the auditor should use the same description of the entity s ICFR as management uses in its report) ii. A paragraph stating that because of inherent limitations, ICFR may not prevent, or detect and correct, misstatements and that projections of any assessment of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate g. A section with the heading Opinion that includes the auditor s opinion on whether the entity maintained, in all material respects, effective ICFR as of the specified date, based on the criteria h. The manual or printed signature of the auditor s firm i. The city and state where the auditor practices j. The date of the auditor s report. If the auditor issues a separate report on ICFR, the auditor should add the following paragraph, in an other-matter paragraph with an appropriate heading, in accordance with AU-C section 706, Emphasis-of- Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor s Report, to the auditor s report on the financial statements: We also have audited, in accordance with auditing standards generally accepted in the United States of America, [entity name] s internal control over financial reporting as of December 31, 20X8, based on [identify criteria] and our report dated [date of report, which should be the same as the date of the report on the financial statements] expressed [include nature of opinion]. Copyright AICPA Unauthorized Copying Prohibited 1-7

10 The auditor also should add the following other-matter paragraph to the report on ICFR: We also have audited, in accordance with auditing standards generally accepted in the United States of America, the [identify financial statements] of [entity name] and our report dated [date of report, which should be the same as the date of the report on ICFR] expressed [include nature of opinion]. Report Date The auditor should date the report on ICFR no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence to support the auditor s opinion, including evidence that the audit documentation has been reviewed. Because the audit of ICFR is integrated with the audit of the financial statements, when issuing separate reports on the entity s financial statements and on ICFR, the dates of the reports should be the same. Report Modifications The auditor should modify the report on ICFR if any of the following conditions exist: a. One or more material weaknesses exist. b. Elements of management s report are incomplete or improperly presented. c. There is a limitation on the scope of the engagement. d. The auditor decides to refer to the report of a component auditor as the basis, in part, for the auditor s own opinion. e. There is other information contained in management s report. Adverse Opinions If there are deficiencies that, individually or in combination, result in one or more material weaknesses as of the date specified in management s assessment about ICFR, the auditor should express an adverse opinion on the entity s ICFR, unless there is a limitation on the scope of the engagement. When ICFR is not effective because one or more material weaknesses exist, the auditor s report should include a. the definition of a material weakness and b. a statement that one or more material weaknesses have been identified and an identification of the material weaknesses described in management s assessment about ICFR. If one or more material weaknesses have not been included in management s report accompanying the auditor s report, the auditor s report should be modified to state that one or more material weaknesses have been identified but not included in management s report. Additionally, the auditor s report should include a description of each material weakness not included in management s report. The auditor s description should include specific information about the nature of each material weakness and its actual and potential effect on the presentation of the entity s financial statements issued during the existence of the weakness. In this case, the auditor also should communicate, in writing, to those charged with governance that one or more material weaknesses were not disclosed or identified as a material weakness in management s report. If one or more material weaknesses have been included in management s report but the auditor concludes that the disclosure of such material weaknesses is not fairly presented in all material respects, the auditor s report should describe this conclusion as well as the information necessary to fairly describe each material weakness. 1-8 Copyright AICPA Unauthorized Copying Prohibited

11 The auditor should determine the effect an adverse opinion on ICFR has on the auditor s opinion on the financial statements. Additionally, the auditor should disclose, in an other-matter paragraph or as part of the paragraph that identifies the material weakness, whether the auditor s opinion on the financial statements was affected by the material weakness. Included in SAS No. 70 are the following amendments and illustrative reports: Appendix Amendments to Various Sections in Statement on Auditing Standards No. 122, Statements on Auditing Standards: Clarification and Recodification Exhibit A Illustrative Reports Exhibit B Illustrative Written Communication of Significant Deficiencies and Material Weaknesses Exhibit C Illustrative Management Report Exhibit D Reporting Under Section 112 of the Federal Deposit Insurance Corporation Improvement Act KNOWLEDGE CHECK 1. Changes in SAS No. 130, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements a. Include that the auditor will be required to examine and report directly on the effectiveness of internal control over financial reporting. b. Retain the option to examine and report on management s assertion about the effectiveness of internal control over financial reporting. c. Do not allow the auditor to use the work of internal auditors to obtain evidence about the effectiveness of internal control over financial reporting. d. Retain the term significant account or disclosure used in AT section 501. Auditing Interpretations No updates for this period Attestation Standards No updates for this period Accounting and Review Services Committee No updates for this period Professional Ethics Executive Committee No updates for this period Copyright AICPA Unauthorized Copying Prohibited 1-9

12 FASB Accounting Standards Updates ASU No , Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes Issue Date Accounting Standards Update (ASU) No was issued November Why Issued This ASU is part of FASB s simplification initiative. Stakeholders told FASB that the requirement to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position results in little or no benefit to users of financial statements because the classification does not generally align with the time period in which the recognized deferred tax amounts are expected to be recovered or settled. Entities also incur costs in separating deferred income tax liabilities and assets into a current and noncurrent amount. Who Is Affected? The amendments in this ASU apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this ASU. Main Provisions The amendments in this ASU require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. Difference from Current GAAP GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. Effective Date and the Transition Requirements Public Business Entities Effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. All Other Entities Effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period. The amendments in this ASU may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Disclosures If an entity applies the guidance prospectively, the entity should disclose in the first interim and first annual period of change, the nature of and reason for the change in accounting principle and a statement that prior periods were not retrospectively adjusted Copyright AICPA Unauthorized Copying Prohibited

13 If an entity applies the guidance retrospectively, the entity should disclose in the first interim and first annual period of change the nature of and reason for the change in accounting principle and quantitative information about the effects of the accounting change on prior periods. KNOWLEDGE CHECK 2. Which is true of ASU No , Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes, which was issued November 2, 2015 and is part of the FASB s simplification initiative? a. The ASU requires an entity to separate deferred income tax liabilities and assets into a current and noncurrent amount. b. The ASU requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. c. The ASU changes the current requirement that deferred tax liabilities and assets of a taxpaying component of an entity be offset and presented as a single amount. d. The ASU must be applied retrospectively to all deferred tax liabilities and assets. PCAOB Improving Transparency Through Disclosure of Engagement Partner and Certain Other Participants in Audits On December 15, 2015, the PCAOB adopted new rules 6 to provide investors with more information about who is participating in company audits. The new rules and related amendments apply to the PCAOB auditing standards and are designed to provide investors and other financial statement users with information about accounting firms and which engagement partners in that accounting firm participated in each audit of issuers. The disclosures required by the new rules and amendments are designed to improve transparency. Under the final rules, the accounting firm will be required to file Form AP Auditor Reporting of Certain Audit Participants, for each issuer audit. Form AP is a new form that requires the auditing firm, for each issuer audited, to disclose the following: The name of the engagement partner. Information about other accounting firms that participated in the audit whose work would constitute at least 5 percent of the total audit hours including o name; o location; and o extent of participation. 6 Public Company Accounting Oversight Board (2015). Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form and Related Amendments to Auditing Standards. [PCAOB release No ]. Retrieved from pcaobus.org/rules/rulemaking/docket029/release pdf Copyright AICPA Unauthorized Copying Prohibited 1-11

14 the number and aggregate extent of participation of all other accounting firms whose individual participation was less than 5 percent of total audit hours. Form AP will be accessible in a searchable database on the PCAOB s website (pcaobus.org). Final rules Under the final rules investors and financial statement users will have access to the names of engagement partners on all issuer audits. This will allow all interested parties to accumulate information about the engagement partner. Disclosures required on Form AP about other accounting firms that participate in issuer audits will also benefit investors and other financial statement users. Public companies operate in multiple locations including internationally. Currently the firm signing the auditor s report may be performing only a portion of that audit. The rest of the audit may be performed by other accounting firms located in other jurisdictions. The final rules require disclosure of other accounting firms participating in the audits whose work constitutes at least 5 percent of total audit hours. If there are firms involved in the audit who individually perform less than 5 percent of the audit, the final rules require that the total number of these firms in the aggregate and the total percentage of the audit they performed be disclosed. Example: Three accounting firms, A, B, and C, participate in the audit of International Company, Inc. Firm A did one percent of the audit, firm B did two percent, and firm C did one percent. The accounting firm would be required to disclose the fact that three other firms did 4 percent of the audit. The object of these rules is to provide investors and other users of financial statements with additional information on firms actually participating in the audit. Form AP Form AP is designed to help those who use financial statements understand how much of the audit was performed by the firm signing the auditor s report and how much was performed by other accounting firms, allowing investors to research publicly available information about the firms identified. The investors will also have a better idea of how the audit was conducted and if firms in other jurisdictions, such as foreign branches of the entity, were involved. Transparency by this required public disclosure will increase accountability in the audit process, and increase accountability at the firm level. Note that the final rules do not require disclosure of the engagement partner in the auditor s report. Instead the requirement for the disclosure of the engagement partner is on Form AP. Accounting firms are not precluded from including the name of the engagement partner in the auditor s report. The final rules allow the firm to do so voluntarily. Effective Date Form AP will be required for audit reports issued on or after the date three months after SEC approval of the final rules, or January 31, The disclosure of other accounting firms will be required for all reports issued on or after June 30, Result of the PCAOB Actions The PCAOB board s actions resulted in two new rules, Rule 3210 and Rule 3211, which are amendments to Section 3 of the Rules of the Board, Auditing and Related Professional Practice Standards and Form AP Copyright AICPA Unauthorized Copying Prohibited

15 Note: These are disclosure requirements. They do not change the performance obligations of the auditor in conducting the audit. There are also amendments to AS 3101 (AU section 508) Reports on Audited Financial Statements and AS 1205 (AU section 543) Part of the Audit Performed by Other Independent Auditors. Form AP Filing Date Form AP must be filed 35 days after the date the auditor s report is first included in a document filed with the SEC. For initial public offerings the filing deadline will be 10 days after the auditor s report is first included in a document filed with the SEC. KNOWLEDGE CHECK 3. Which is true of the new rules adopted by the PCAOB which require more information about who is participating in company audits? a. The final rules are intended to provide only the SEC with information about other accounting firms that participate in issuer audits. b. Under the final rules, audit participants in foreign countries need not be identified. c. The object of the final rules is to provide investors and other users of financial statements with additional information on firms actually participating in the audit. d. Under the final rules the investor s ability to determine how the audit was conducted does not change. SEC No updates for this period. PROPOSED STANDARDS AND INTERPRETATIONS AICPA Auditing Standards Board Proposed Auditing Standards No updates for this period. Proposed Attestation Standards No updates for this period. Copyright AICPA Unauthorized Copying Prohibited 1-13

16 Accounting and Review Services Committee No updates for this period. Professional Ethics Executive Committee No updates for this period. FASB Exposure Drafts Proposed ASUs Proposed Accounting Standards Update Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance Proposed ASU Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistances was issued November 12, The comment deadline is February 10, Why Issued Currently, diversity exists in the recognition, measurement, and disclosure of government assistance arrangements because no explicit generally accepted accounting principles (GAAP) exist for government assistance received by business entities. The FASB is issuing this proposed ASU to increase transparency about government assistance arrangements including the following: Types of arrangements. Accounting for government assistance. Effect on an entity s financial statements. Requiring disclosures about government assistance in the notes to financial statements could improve the information that is provided to users when analyzing an entity s financial results and prospects for future cash flows. Who Is Affected? The proposed amendments apply to an entity or entities, other than not-for-profit entities (NFPs) within the scope of FASB ASC 958, Not-for-Profit Entities, that have entered into a legally enforceable agreement with a government to receive value. Under these agreements, the government determines whether an entity will receive assistance and how much assistance an entity will receive even if the entity meets the applicable eligibility requirements. The scope of the proposed amendments does not apply to transactions in which the government is legally required to provide a nondiscretionary level of assistance to an entity simply because the entity meets applicable eligibility requirements that are broadly available without specific agreement between the entity and the government or solely a customer Copyright AICPA Unauthorized Copying Prohibited

17 Main Provisions If this ASU is adopted, the amendments will result in entities providing information on existing government assistance agreements for annual reporting periods that would enable a user to better assess all of the following: The nature of the assistance, related accounting policies used to account for government assistance, and the effect of government assistance on an entity s financial statements Significant terms and conditions of the legally enforceable agreement. Disclosures If this ASU is adopted, the amendments will require the following disclosures about material existing government assistance agreements for annual reporting periods: Information about the nature of the assistance, including a general description of the significant categories and the related accounting policies adopted or the method applied to account for government assistance. Which line items on the balance sheet and income statement are affected by government assistance and the amounts applicable to each line item. Significant terms and conditions of the agreement, including commitments and contingencies. Unless impracticable, the amount of government assistance received but not recognized directly in the financial statements. The amount of government assistance received but not recognized includes value that was received by an entity for which no amount has been recorded directly in any financial statement line item (for example, a benefit of a loan guarantee, a benefit of a below-market rate loan, or a benefit from tax or other expenses that have been abated). Difference From Current GAAP Current GAAP has no explicit guidance on the accounting for, or the disclosure of, government assistance received by business entities. The amendments in this proposed ASU, if adopted, will improve financial reporting by providing disclosure requirements to increase transparency about government assistance arrangements, including the types of arrangements; the accounting for government assistance; and their effect on an entity s financial statement Effective Date If this proposed ASU is adopted, in the first set of financial statements following the effective date, the amendments in this proposed ASU would be applied to all agreements existing at the effective date and entered into after the effective date. Retrospective application would be permitted. The effective date will be determined after FASB considers stakeholder feedback on the amendments in this proposed ASU. Proposed ASU Business Combinations (Topic 805): Clarifying the Definition of a Business Proposed ASU Business Combinations (Topic 805): Clarifying the Definition of a Business was issued November 23, The comment deadline is January 22, Copyright AICPA Unauthorized Copying Prohibited 1-15

18 Why Issued This proposed ASU was released to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Stakeholders have said that the definition of a business in FASB ASC 805, Business Combinations, is applied too broadly, thereby resulting in many transactions that qualify as businesses that to them are more akin to asset acquisitions. They have also said that analyzing transactions under the current definition can be difficult and costly. Note that those concerns about the definition of a business were among the primary issues raised in connection with the Post-Implementation Review Report on FASB Statement No. 141 (revised 2007), Business Combinations (Statement 141(R)), now codified in FASB ASC 805. The guidance in this proposed ASU should address these concerns. Current Implementation Guidance Under the current implementation guidance, there are three elements of a business: 1. Inputs 2. Processes 3. Outputs A set of assets and activities (collectively referred to as a set ) that is a business usually will have outputs, although outputs are not required to be present. All of the inputs and processes that a seller uses in operating a set are not required if market participants are capable of acquiring the set and continuing to produce outputs, for example, by integrating the acquired set with its own inputs and processes. FASB ASC does not specify the minimum inputs and processes required for a set to meet the definition of a business. This lack of clarity has led to broad interpretations of the definition of a business. Stakeholders Feedback Some stakeholders have said that a set may qualify as a business even if no processes are included in the transaction when revenue-generating activities continue after an acquisition. Example: In the real estate industry, a market participant often is capable of acquiring inputs (a building with leases) and combining them with its own processes to continue generating outputs (lease income). The definition of outputs currently refers to the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. Many transactions can provide a return in some form (for example, the acquisition of a new machine could be expected to lower costs). Thus, the definition of outputs also can contribute to broad interpretations of the definition of a business. In addition to concerns about the broad application of the definition of a business, the scope of FASB ASC , Other Income Gains and Losses from the Derecognition of Nonfinancial Assets (created as part of the amendments in ASU No , Revenue from Contracts with Customers [Topic 606]), excludes a set of activities and assets that is a business unless that business is deemed to be an in substance nonfinancial asset. Stakeholders also indicated that in certain cases it may be unclear when a set of activities and assets that meets the definition of a business is an in substance nonfinancial asset Copyright AICPA Unauthorized Copying Prohibited

19 The scope of FASB ASC is particularly important to certain industries, such as the real estate industry. Until the amendments in ASU are effective, the derecognition of real estate should be accounted for consistently, regardless of whether that real estate is an asset or a business. The amendments in ASU remove the existing industry- or transaction-specific real estate guidance. Instead, an entity would derecognize real estate that is not a business (or that is a business, but is an in substance nonfinancial asset) in sales transactions with noncustomers in accordance with FASB ASC and apply the recognition and measurement guidance in FASB ASC 606. Sales of real estate that are not within the scope of FASB ASC 606 or should apply the deconsolidation guidance in FASB ASC Future Activities In future phases of this project, FASB will discuss clarifying the guidance for partial sales or transfers of assets in the scope of FASB ASC and the corresponding accounting for the retained interests. In this phase of the project, FASB anticipates clarifying the reference to in substance nonfinancial assets in FASB ASC consider whether there are differences in the acquisition and derecognition guidance for assets and businesses that could be aligned. Main Provisions The proposed amendments require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together contribute to the ability to create outputs and would remove the evaluation of whether a market participant could replace any missing elements. provide a framework to assist entities in evaluating whether both an input and a substantive process are present. include a screen that would reduce the number of transactions that need to be evaluated under that framework. When applying that screen, a set would not be a business when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets. narrow the definition of outputs 7 so that the term is consistent with how outputs are described in FASB ASC 606. Difference from Current GAAP The amendments in this proposed ASU, if adopted, would provide a more robust framework to determine when a set of assets and activities is a business. The current definition of a business is interpreted broadly and can be difficult to apply. Stakeholders have indicated that analyzing transactions can be inefficient and costly and that the definition does not permit the use of reasonable judgment. The proposed amendments provide more consistency in application of the guidance, reduce the costs of its application, and make the definition of a business more operable. Effective Date The proposed amendments, if adopted, will be applied prospectively to any transaction that occurs on or after the effective date. 7 The definition of output in the proposed ASU is The result of inputs and processes applied to those inputs that provide goods or services to customers, other revenues, or investment income, such as dividends or interest. Copyright AICPA Unauthorized Copying Prohibited 1-17

20 No disclosures would be required at transition. FASB will determine the effective date and whether the proposed amendments may be applied before the effective date after it considers stakeholder feedback on the proposed amendments. Proposed ASU Fair Value Measurement (Topic 820): Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measurement Proposed ASU Fair Value Measurement (Topic 820): Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measurement was issued December 3, The comment deadline is February 29, Why Issued The amendments in this proposed ASU are part of the disclosure framework project. The objective and primary focus of the disclosure framework project are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by generally accepted accounting principles (GAAP) that is most important to users of each entity s financial statements. Achieving the objective of improving the effectiveness of the notes to financial statements includes the following: The development of a framework that promotes consistent decisions by FASB about disclosure requirements The appropriate exercise of discretion by reporting entities. Background In March 2014, FASB issued proposed FASB Concepts Statement Conceptual Framework for Financial Reporting Chapter 8: Notes to Financial Statements. The proposed concepts statement is intended to identify a broad range of possible information for FASB to consider when deciding on the disclosure requirements for a particular topic. FASB will then identify a more narrow set of disclosures about that topic to be required on the basis of an evaluation of whether the benefits of entities providing the information justify the costs. The finalized concepts statement will be used by FASB as a basis for establishing disclosure requirements in future accounting standards as well as for evaluating existing disclosure requirements. FASB decided to test the guidance in the proposed concepts statement and improve the effectiveness of disclosure requirements in a number of topics including fair value measurements by using those proposed concepts. The amendments in this proposed ASU are the result of FASB s consideration of the concepts in the proposed concepts statement as they relate to fair value measurement disclosures. The amendments in proposed ASU Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material issued in September 2015 have been considered by FASB in developing the amendments in this proposed ASU. The aforementioned proposed ASU is intended to promote the use of discretion by reporting entities when evaluating disclosure requirements set forth by FASB. This would result in an entity providing material information while providing an option to generally exclude immaterial information. It would also clarify that reporting entities may consider materiality when assessing disclosure requirements for both quantitative and qualitative information Copyright AICPA Unauthorized Copying Prohibited

21 The amendments in this proposed ASU Fair Value Measurement (Topic 820): Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measure do the following: State that an entity shall provide required disclosures if they are material. Eliminate phrases like an entity shall disclose at a minimum, which make it difficult to justify omitting immaterial disclosures. Refer readers to FASB ASC 235, Notes to Financial Statements (as will be amended by the guidance in the proposed ASU on that FASB ASC topic), for discussion of the appropriate exercise of discretion. In regards to cost, FASB does not anticipate that entities will incur significant costs as a result of the amendments in this proposed ASU. there could be additional costs and efforts to comply with some of the proposed amendments, but those costs may be offset by other amendments. an entity s decision to omit immaterial disclosure (if it had not done so previously) may reduce the entity s total cost in complying with all of the disclosure requirements, although in certain cases there may be costs incurred to assess whether a disclosure is material. Who Would Be Affected? The amendments in this proposed ASU apply to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements. Certain of the disclosures required by the amendments in this proposed ASU will not be required for private companies. FASB is seeking input on the application of the proposed amendments to private companies, employee benefit plans, and not-for-profit entities. Main Provisions The amendments in this proposed ASU modify the disclosure requirements on fair value measurements. The following disclosure requirements will be removed from FASB ASC 820, Fair Value Measurement, either because they are not consistent with the concepts in the proposed concepts statement or because they are no longer deemed to provide useful information: The amount of and reasons for transfers between levels 1 and 2 of the fair value hierarchy The policy for timing of transfers between levels The valuation policies and procedures for level 3 fair value measurements For private companies, the change in unrealized gains and losses for the period included in earnings (or changes in net assets) on recurring level 3 fair value measurements held at the end of the reporting period The disclosure requirements in FASB ASC 820 are modified as follows to align with the concepts in the proposed concepts statement: Private companies are no longer required to reconcile the opening balances to the closing balances of recurring level 3 fair value measurements. However, private companies are required to disclose transfers into and out of level 3 of the fair value hierarchy and purchases and issues of level 3 assets and liabilities. Investments in certain entities that calculate net asset value require disclosure of the timing of liquidation of an investee s assets and the date when restrictions from redemption will lapse only if the investee has communicated the timing to the entity or announced the timing publicly. Copyright AICPA Unauthorized Copying Prohibited 1-19