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Mike Ervin

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PCAOB Auditor Disclosure Requirements: A Summary of New Guidance

Audit Disclosure Requirements - Buffalo CPA Firm

The Public Company Accounting Oversight Board (PCAOB) recently issued and the Securities and Exchange Commission approved rules that will soon require audit firms to disclose engagement partner names as well as other firms that participated in the audit. These rules were created to increase transparency and accountability among audit firms and allow investors access to information on which individual partner was responsible for the audit work in a given year.

To help firms understand the implication of these rules, here is a summary of the new guidance below.

Disclosure Summary

Under the new rules, auditors will be required to file a new PCAOB Form AP, Auditor Reporting of Certain Audit Participants, for all public company audits. The following information must be disclosed on the form:

  • Name of the engagement partner and their “Partner ID” (a unique ten-digit identifier that will now need to be assigned by the firm to each partner who serves as engagement partner for issuer audits)
  • For other accounting firms participating in the audit for which the responsibility for the audit is not divided:

5 percent or greater participation: The name, city and state (or, if outside the United States, the city and country) of the headquarters’ office, and, when applicable, the Firm ID, and the percentage of total audit hours attributable to each other accounting firm;

Less than 5 percent participation: The number of other accounting firms that participated in the audit whose individual participation was less than 5 percent of total audit hours, and the aggregate percentage of total audit hours of such firms; and

  • For other accounting firms participating in the audit for which the responsibility for the audit is divided:

The name, and when applicable, the Firm ID; city and state (or if outside the United States, the city and country) of the office of the other accounting firm that issued the other auditor’s report; and the magnitude of the portion of the financial statements audited by the other accounting firm.

Effective Dates: Phased Approach

Firms will need to start naming engagement partners on the new Form AP, which is available now on the PCAOB website, starting with audits issued on or after Jan. 31, 2017. Other audit firms must be named on the form with the required additional information for public company audits issued on or after June 30, 2017. Form AP must be filed directly with the PCAOB no more than 35 days after the date the auditor’s report is first included in a document filed with the SEC.

Who is Affected?

This change impacts both the accounting firms providing the service and the companies retaining them. The additional filing provides additional transparency to stockholders and others involved with the company.

If you are interested in learning how this new filing will impact your company or to discuss your 10K filings, Freed Maxick wants to help. Contact us for more information.

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Ways That Financial Statements Can Reveal Corporate Fraud

At long last, the U.S. economy seems to be recovering from the effects of the recession. But at least one major financial risk remains — corporate fraud. The good news is: A fraud expert can help investors and companies minimize losses from fraudulent conduct by simply scrutinizing a business’s financial statements.

Fictitious finances

businessman_thief.jpgCorporate fraud often is concealed when a business intentionally misrepresents material information in its financial reports. These misrepresentations may result from overly aggressive estimates of figures, the misapplication of accounting principles and material omissions. For instance, financial statements may conceal expenses or liabilities or report fictitious revenues in order to make a business appear more profitable than it really is.

In order to cover fraud, a perpetrator often conceals or omits information that can damage or improperly change the bottom-line results appearing in financial statements. Such omissions might include:

  • Liabilities such as loan covenants or contingency liabilities.
  • Significant events that are likely to affect future statements, such as potential lawsuits, impending product obsolescence and new competition.
  • Accounting changes that materially affect financial statements and are subject to disclosure rules, such as methods of accounting for depreciation, revenue recognition or accruals.

Perpetrators also might engage in fraudulent manipulation, particularly in the areas of revenues, reserves, expenses and one-time charges. A falsified financial statement can improperly value sales transactions (by, for example, inflating the per unit price), recognize sales prematurely or report phantom sales that never occurred. On the other hand, expenses can be manipulated by simply delaying their recognition — whether to match expenses with their corresponding revenue or to avoid reporting a loss. Another scheme is to improperly capitalize expenses so they appear on the business’s balance sheet rather than on its income statement.

In many cases, fraudulent financial statements may show reserves that have been calculated using bad-faith estimates. For instance, a fraudster can justify a smaller amount of reserves simply by underestimating the percentage of uncollectible receivables. One-time charges, such as a charge for research and development costs for a specific product, or a write-off of goodwill, can further distort financial statement figures and help hide fraudulent activity.

Unusual trends and relationships

When fraud is suspected, a CPA can examine complex financial statements and uncover manipulation that might not be apparent to the untrained eye. A fraud expert typically begins by reviewing suspicious statements for unusual trends and relationships. Any leads are then followed by more intensive forensic accounting work. This may include analysis of journal entries, specific transactions, work papers and supporting documentation — going far beyond a standard annual audit.

Moreover, a CPA may employ several types of analyses. For instance, a vertical analysis compares the proportion of every financial statement item — or groups of items — to a total within a single year that can be measured against industry norms. A horizontal analysis compares current data with data from prior years in order to detect patterns and trends. And a financial ratio analysis can calculate ratios from the current year’s data and then compare those with previous years’ ratios for the business, comparable companies and the relevant industry. Of course, the expert must have tremendous experience in the subject industry and be able to recognize any noncompliance with Generally Accepted Accounting Principles.

Noncompliance is a huge red flag for financial statement fraud. The Association of Certified Fraud Examiners (ACFE) has identified several behavioral red flags, including executives who exhibit a cavalier attitude toward internal controls, live beyond their means, have excessive organizational pressure to perform, and are unwilling to share duties or information with colleagues.

fraudFraud costs

The ACFE has estimated that the median loss in financial statement fraud schemes is around $1 million. But there are other damages as well, such as the public relations damage that rogue executives who manipulate the numbers can cause. A qualified CPA can help limit your clients’ losses by finding critical omissions and manipulations.

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