Issue 9 June 2015 Audit Committee Bulletin This bulletin reflects some of the issues that audit committee chairs of leading European companies are currently discussing with their advisors in EY.
Foreword Jean-Yves Jegourel EY s Assurance Leader for Europe, Middle East, India and Africa Dear readers, Increasing demands for transparency and the requirements of ever-changing standards are continuing to have an impact on the work of audit committees. In Issue 9 of EY s Audit Committee Bulletin we examine these and other issues that committee chairs and members tell us are particularly affecting their work. We hope they strike a chord with you and stimulate further discussion. In this issue: The new converged standards on revenue recognition will override nearly all existing requirements under IFRS and US GAAP. On page 3, we explore IFRS 15 Revenue from Contracts with Customers and discuss some of the significant judgments required. It s all about the Base Erosion and Profit Shifting (BEPS) project. On page 5, we investigate how the BEPS project has the potential to reshape country tax laws and discuss how audit committees can respond. Companies report they are spending more time managing tax controversy than they do on tax planning or tax financial reporting. In response to the growing uncertainty associated with this new era, on page 6, we look at how they are trying to manage their tax risks more effectively. We include highlights from the recent meeting of the European Audit Committee Leadership Network on page 7. Members covered the role of the International Auditing and Assurance Standards Board, the proposed standards on enhanced auditor reporting and how auditors should review other information. The articles in this issue are summaries of more detailed material. If you would like to explore any of the topics further, please get in touch with your EY contact. 2
IFRS 15: a transformational new standard The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have issued new revenue recognition standards that will supersede nearly all existing revenue recognition requirements under IFRS and US GAAP. Under IFRS, the new standard is IFRS 15 Revenue from Contracts with Customers. The standard s core principle is that an entity will recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Estimating the standalone selling price if it is not otherwise observable, or if the goods and services are offered as incentives for the customer to purchase more from the seller IFRS 15 also requires extensive disclosures that are intended to provide more useful information to users. These disclosures relate to the way in which contract assets, liabilities and revenue are presented, as well as the judgments and estimates made in applying the standard. We recommend the five-phase model for implementing accounting change: Applying a comprehensive methodology for implementing the accounting change will help your entity adopt the standard in an organized and efficient manner, as well as reduce risk and the possibility of costly errors and delays. Consistent with current IFRS, IFRS 15 uses broad principles, rather than specific requirements and will require entities to make many estimates and use significant judgments. Areas requiring significant judgment include: Diagnostic Design and planning Solution development Implementation Postimplementation Evaluating whether an arrangement meets the criteria to be accounted for as a contract under the model in IFRS 15 Evaluating an arrangement to determine whether to account for the promised goods and services as one or more performance obligations Estimating the value of variable consideration at contract inception and then updating those estimates when more information is known Objective Identify accounting, reporting and tax differences and their consequences on business processes and IT systems Set up project infrastucture and management, including road map and change management strategy Identify solutions, prepare an implementation plan and develop solutions across workstreams Approve and roll out solutions across workstreams Address deferred items and transition to operational model 3
How EY can help With experience in the implementation of IFRS 15, EY may be able to support your entity s management transition to the new standard* by: Assisting in the evaluation of peers, competitors and industry disclosures and of the expected impact of the new standard on financial reporting Identifying shortfalls or gaps in the information necessary to adopt the standard Designing and delivering training sessions Developing a consistent methodology around judgmental areas Developing processes for identifying performance obligations, estimating variable consideration, measuring progress and costs incurred and assessing the impact on the financial statements Communicating the effect of adoption to stakeholders Updating accounting manuals and accounting policies Questions for audit committees How is management preliminarily assessing the standard s impact on the organization and when is such an assessment expected to be complete? How does management s preliminary assessment compare against competitors? What is the anticipated effect on the organization s business, process and financial reporting? What process has the organization implemented to monitor and consider interpretations by the IASB and FASB, as well as the To find out more, visit ey.com/ifrs. activities of the IASB/FASB Joint Transition Resource Group for Revenue Recognition (TRG) 1 and other implementation groups? How, and to what extent, will accounting processes and controls be affected or need to be changed? What are the organization s plans for communicating with stakeholders? What is the planned transition method? What is the expected timing of implementation? Does the entity have sufficient resources for an effective implementation? *Note: Certain services for an audit client and its affiliates may be more limited in order to comply with applicable independence standards. Please reach out to your EY contact for further information. 1. See further information at: www.ifrs.org/about-us/iasb/advisory-bodies/ Joint-Revenue-Transition-Resource-Group/Pages/Meetings.aspx. 4
Global focus on tax base erosion and profit shifting Now is the time for companies to review their business models and structures against a growing number of Organisation for Economic Co-operation and Development (OECD) recommendations. This will help to identify possible pressure points, prepare for the possibility of country-by-country reporting, manage tax controversy and engage with the OECD and country policy-makers on international tax issues. The Base Erosion and Profit Shifting (BEPS) project, driven by the OECD and strongly supported by G20 leaders, is intended to better coordinate how countries address tax strategies perceived as eroding their tax bases. The initiative mainly focuses on: Reporting and transparency Transfer pricing Deductibility of financial costs Entitlement to tax treaty benefits Tax treatment of companies operating in the digital economy Preferential tax regimes Even though the OECD is not a governmental body, it is influential in setting global tax policy. Moreover, the BEPS project involves all G20 countries, including China and India, which are not OECD members. In September 2014, the OECD released several deliverables including guidelines on transfer pricing for intangibles, recommendations on hybrid mismatch arrangements and a template for country-by-country reporting of income, profit and economic activity. It is currently working on a range of other deliverables for later in 2015, including issues such as the treatment of interest expense, allocation of risk and capital, and controlled foreign corporation rules. Some countries, however, have already started implementing anti-beps policies through both legislation and enforcement activity, without waiting for the OECD s final recommendations. Tax laws enacted in the recent past in France and Mexico have included several BEPS-related changes. The US Treasury has also taken a lead role and strongly supports many of the OECD s BEPS action items. The BEPS project is expected to play a role in reshaping country tax laws in the future and, thereby, reduce opportunities to shift profits to lower-taxed jurisdictions. The likely long-term effect of this on multinational companies will be more aggressive tax enforcement, heightened tax scrutiny, greater transparency requirements, increased compliance costs and, potentially, more taxes paid. As a significant number of OECD recommendations are in place, and as countries have begun assessing how to develop their local implementation, now is the right time for companies to review their business models and structures against OECD recommendations in order to identify possible pressure points. To understand trends and anticipate changes, companies need to track BEPS-related developments carefully, both at the OECD level and within the countries where the company has current or future operations or investment. Steps companies can take to respond to BEPSrelated developments Prepare for the possibility of country-by-country reporting of financial and operating profiles Proactively manage global tax controversy Consider advance pricing agreements (APAs) and other early engagement with tax authorities to gain greater advance certainty on the tax treatment of significant transactions Consider proactively communicating information regarding your company s total tax and economic contribution with key stakeholders Consider engaging with the OECD and country policy-makers on international tax issues Share with management and board any relevant information that emerges from discussions with policy-makers Questions for audit committees Has management conducted a strategic review of the implications of potential cross-border tax changes for the company s business models and structures? Has management shared this evaluation with the board? Has the board evaluated how the company can position itself for the evolving global tax landscape? Is the company ready for heightened scrutiny and tax audit risk, which can place increased pressure on cash tax and effective tax rate positions? Is the company prepared for the potentially substantial increase in global reporting requirements and the commensurate increase in compliance costs? Find out more by reading the full article on tax base erosion and profit sharing. 5
Managing tax controversy Tax disputes can affect a company financially, diminishing shareholder value and damaging reputation. Companies now report spending more time managing controversy than they do on tax planning or tax financial reporting. Implementing more global, strategic approaches to managing tax risk and controversy can help them assess tax controversy risks more accurately and prioritize which disputes and disagreements to tackle first. New legislation, demands for greater transparency and the increasing search for revenue by governments around the world have made tax more relevant than ever in boardrooms. Tax disputes are becoming more common, partly because tax administrators are focusing more on cross-border transactions. According to EY s 2014 Tax risk and controversy survey, 2 68% of the largest companies that responded say tax audits have become more frequent and aggressive in the last two years. And only 27% (as opposed to 56% in 2011) of companies believe tax authorities are trying to forge a more open relationship with them. High levels of fiscal deficits, and the perceived inability of the international tax architecture to keep pace with global business models, are two of the reasons behind the increase in tax controversy. Some 74% of the survey respondents report that tax authorities in some countries have begun focusing on areas that are the target of the OECD s BEPS project. In effect, however, many tax authorities are already judging transactions against recommendations that are yet to be finalized by the OECD. As many as 61% of companies said they expect higher levels of double taxation in the next three years, fueling further tax controversies. Companies also believe that elements of the OECD s BEPS project, including the proposal for a country by-country reporting template that details revenue, taxes paid and economic activity, will also create more disputes as countries argue over who has the right to tax. Many companies say that managing tax risk and controversy will become more important for them in the next two years and that they will need to hire additional resources to comply with new transparency and reporting regulations. In an effort to manage tax controversy risk effectively, companies are: Redeploying existing resources Developing dedicated tax controversy management roles Updating policies, internal controls and processes Using technology to identify and track uncertain tax positions, disputes and ongoing litigation Increasing overall levels of tax corporate governance Implementing new processes to monitor local changes and potential effects on their business These strategies can help companies asses their tax controversy risks accurately, prioritize disputes and disagreements, and even help mitigate potential controversies before they occur. Companies can also devote more time and investment to risk assessment and data analytics in order to identify potential issues early. Doing so can be challenging and expensive, but ignoring the issue could be worse in terms of cost, brand reputation and corporate flexibility in the long run. Questions for audit committees Does the company have a strong global vision and strategy for how tax risk and tax controversy should be managed? Has the strategy been communicated to the board? Are current tax processes and controls fit for purpose in such a rapidly shifting tax environment? Does the board have appropriate awareness of open disputes and litigation? Does the tax function have regular and clear input into major transactions and business plans? Are there any areas of major disagreement between the company and a taxing authority? Is the board satisfied with the way disputes are being handled? Have any potential additional tax liabilities been adequately provided for? 2. See further information at www.ey.com/taxriskseries. 6
Dialogue with the IAASB On 18 19 November 2014, members of the European Audit Committee Leadership Network (EACLN) met in Paris. In one session, they were joined by Professor Arnold Schilder, Chairman of the International Auditing and Assurance Standards Board (IAASB), and Dan Montgomery, recently retired Deputy Chair of the IAASB and retired EY US senior partner. Participants discussed the role of the IAASB and aspects of its activities that are of interest to audit committees, including proposed standards on enhanced auditor reporting and how auditors should review other information beyond the financial statement. (In January 2015, the IAASB issued final standards on enhanced auditor reporting). The IAASB and its role The IAASB is a private organization that serves as the chief global standards setter for audit and assurance. The due process the IAASB uses to develop standards involves input from a range of stakeholders, including user groups, regulators, financial executives and the IAASB s Consultative Advisory Group. The IAASB s oversight body, the Public Interest Oversight Board, works to ensure that this process is open, inclusive and independent. The IAASB s International Standards on Auditing (ISAs) have been adopted by over 100 countries. Though the European Union (EU) has not formally adopted ISAs, they are referenced by EU legislation and most European countries have adopted them. The United States has not adopted ISAs for listed companies, but the Public Company Accounting Oversight Board has an ongoing dialogue with the IAASB, and the Auditing Standards Board of the American Institute of CPAs, which sets standards for audits of private entities in the US, has converged its standards with ISAs. Auditor responsibility for information beyond the financial statements The IAASB issued two exposure drafts on revising the ISA for the auditor s responsibilities relating to other information, 3 a term that refers to the financial or non-financial information communicated to investors included in an entity s annual report. At the time of the meeting in Paris, the IAASB was reviewing comments on the second exposure draft. The standard was approved by the IAASB in December 2014, and released in April 2015. This standard as well as the suite of auditor reporting standards, are effective for audits of financial statements for periods ending on or after 15 December 2016. In the revised standard, other information is limited to the annual report, and the auditor s basic responsibilities vis-à-vis other information includes the following: To consider whether there is a material inconsistency between the other information and the financial statements 3. The exposure draft goes into considerably more detail. See International Auditing and Assurance Standards Board, The Auditor s Responsibilities Relating to Other Information: Proposed Consequential and Conforming Amendments to Other ISAs, pp 16 19. To consider whether there is a material inconsistency between the other information and the auditor s knowledge obtained in the audit To work with management and, if necessary, those charged with governance to resolve potential material inconsistencies and to report on the results in a separate section of the auditor s report EACLN members urged the IAASB to consider information beyond the annual report, including press releases, interim reports and management presentations. Given the importance of this information to investors, participants commented that some level of assurance by the auditor would be valuable. However, members noted that the IAASB will need to evaluate this possibility in cooperation with regulators. Meeting participants also acknowledged that there are many elements of other information that auditors are simply not in a position to evaluate. Some noted that companies can decide individually to ask the external auditor to review non-gaap information. Enhancing auditor reporting Audit committee chairs at the meeting endorsed the objectives of the recently approved standards on auditor reporting, including the provisions for communicating key audit matters. Those who have already experienced some form of enhanced auditor reporting said that it has strengthened the relationship between the auditor and the audit committee. 7
Members said that changes to auditor reporting should be made holistically in relation to management and audit committee reporting. Auditor reporting, members of the EACLN agreed, could provide more information. Having the auditor flag risks and disclose risks of most significance would equip the investor with useful future information about the company. However, some members were wary of pushing the auditor too far toward discussing company risks. They expressed the view that major risks should be disclosed by the management, not the auditor, and some members commented that expanded reporting would create the risk of yet more boilerplate. Integrated reporting and data analytics Building on the consultation of the International Integrated Reporting Council, the IAASB will assess whether new auditing standards in the area of integrated reporting are necessary, or if existing standards can suffice. The IAASB will also study the use of data analytics by audit firms and their clients to determine whether existing standards on topics such as audit evidence and sampling are blocking innovation. The IAASB s project on enhancing the auditor s report was one of many similar initiatives stemming from reform efforts spawned by the financial crisis. The EU s recently adopted audit reform legislation includes provisions on the auditor s report, and in the UK, the Financial Reporting Council issued revised standards in June 2013. Investors in the UK have responded favorably to the first wave of expanded reporting. In the US, the Public Company Accounting Oversight Board is considering the introduction of critical audit matters as well as other changes to the auditor s report. The PCAOB s definition of critical audit matters differs from the IAASB s definition of key audit matters, but in some other respects the proposals are similar. Both the EU and UK approaches are broadly consistent with the IAASB s, although they are not identical. 5 Read more about the discussion on dialogue with the IAASB in ViewPoints. 4 4. European Audit Committee Leadership Network, Dialogue with the IAASB, ViewPoints (Waltham, MA: Tapestry Networks, 2014). 5. For a detailed comparison of the four approaches, see Enhancing the Auditor s Report, Overview. 8
Recent EY publications of interest to audit committees 9
EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Assurance Services Our assurance services help our clients meet their reporting requirements by providing an objective and independent examination of the financial statements that are provided to investors and other stakeholders. Throughout the audit process, our teams provide timely and constructive challenge to management on accounting and reporting matters and a robust and clear perspective to audit committees charged with oversight. The quality of our audits starts with our 60,000 assurance professionals, who have the breadth of experience and ongoing professional development that come from auditing many of the world s leading companies. For every client, we assemble the right multidisciplinary team with the sector knowledge and subject-matter knowledge to address your specific issues. All teams use our Global Audit Methodology and latest audit tools to deliver consistent audits worldwide. 2015 EYGM Limited. All Rights Reserved. EYG no. AU3241 GA 0085.01529 ED None In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com