Auditing Special Purpose Frameworks--Business Combinations, Consolidation

Continuing to lay a foundation for developing audit strategies and audit plans, this article presents more comparisons of significant requirements in U.S. GAAP and the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/PCFR/Pages/Financial-Reporting-Framework.aspx  

This article presents comparisons of these topics:

·      Stock-Based Compensation Plans

·      Consolidation and Subsidiaries

·      Business Combinations

·      Push-Down Accounting

Stock-Based Compensation Plans

U.S. GAAP:

This form of compensation may be accounted for as either a liability or equity amount, depending on management’s intentions, at fair values.   Fair value will be determined based on this hierarchy: 1) a fair value accounting method when it can be reasonably determined, 2) calculated-value method if it can be reasonably estimated or 3) intrinsic value method when neither of these methods can be used.

FRF for SMEs:

This framework requires only footnote disclosures for such plans.  The disclosures include:

·      The terms of awards under the plan.

·      Vesting requirements.

·      The maximum terms of options granted.

·      Separate disclosures for multiple plans.

Consolidation and Subsidiaries

U.S. GAAP:

An entity having a controlling financial interest (normally more than 50% ownership) in another entity is required to consolidate the subsidiary. When the entity cannot maintain significant influence over the operation of the subsidiary, such as in the case of external events like bankruptcy, the subsidiary would not be consolidated.  For investments in variable interest entities, investors that have the power to significantly influence the operations of such entities will usually be deemed “primary beneficiaries.”  In such circumstances, primary beneficiaries are required to consolidate variable interest entities. Either the equity method or cost method would be used otherwise.

FRF for SMEs:

Management can elect to consolidate more than 50%-owned subsidiaries or account for them using the equity method (if it exercises significant influence over the entity).  When significant influence is not exercised over the subsidiary, the cost method should be used to report the investment.  Equity and debt securities that are available for sale, however, should be recognized at market values with changes in such values included in periodic net income.  General disclosures include:

·        Consolidation policy.

·        When consolidated, the names of all subsidiaries, income from each and the percentage of ownership.

·        Descriptions of the periods for subsidiaries’ financial statements that don’t coincide with the parent’s reporting date, along with any significant events or transactions in the intervening periods.

·        When financial statements are not consolidated, method of accounting for its subsidiaries, descriptions, names, carrying amounts, income and percentage of ownership for each.

Business Combinations

U.S. GAAP:

The acquisition method of accounting is required.  The acquisition-date fair values of assets, liabilities, goodwill and non-controlling interests in an acquired entity are used for measurement in financial reporting.

FRF for SMEs:

This framework essentially requires the acquisition method of accounting using acquisition-date market values.  It permits, however, management to elect to account for an intangible asset either separately or as a part of goodwill. General disclosures similar to U.S. GAAP are required for material and immaterial business combinations. 

Push-Down (New Basis) Accounting

U.S. GAAP:

There is no requirement to permit new-basis accounting for acquired entities.

FRF for SMEs:

When an acquirer gains more than 50% control of an entity, the assets and liabilities of the acquired entity may be comprehensively revalued in its financial statements, assuming the new values are reasonably determinable.  This results in similar values being used in the acquired entity’s financial statements and the acquirer’s consolidated statements.  General disclosures include:

·        First applications:

o       Date push-down accounting was first applied and the date of the related purchase transaction.

o       Description of the situation resulting in push-down accounting and the amounts of changes to major classes of assets, liabilities and equity.

·        In addition for the following fiscal period:

o       Amount of the revaluation adjustment and the equity account in which it was recorded.

o       Amount of reclassified retained earnings and the equity account in which it was recorded.

The next article in this series will begin a step-by-step approach to performing small audits of special purpose frameworks, focusing primarily on the FRF for SMEs.  

Auditing Sprecial Purpose Frameworks--Pension Accounting, Revenue Recognition

The foundation for a cost-beneficial audit strategy is an auditor’s knowledge of the principles in a reporting entity’s applicable financial reporting framework, the framework selected and used in its financial reporting system. Clarified Audit Standards, first of all, require the auditor to evaluate the applicable framework to determine if it results in financial statement and footnote presentations of financial position, results of operations and cash flows that are appropriate and reasonable.

This article continues to lay such a framework by comparing significant principles in U.S. GAAP with the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs).  These topics are discussed below:

·      Retirement and Postemployment Benefits

·      Comprehensive Income

·      Revenue Recognition

Retirement and Postemployment Benefits

U.S. GAAP:

Accounting standards use a projected benefit obligation model that requires accounting for the aggregate of periodic pension costs and the overfunded and underfunded status of defined benefit and post-retirement benefits plans.  Defined contribution plans’ costs are accounted for as period expenses.

FRF for SMEs:

Management may elect to account for plans using a current contribution payable method or one of the accrued benefit obligation methods similar to U.S. GAAP.  General disclosures include:

·        Description of the plan and the period cost recognized.

·        Multi-employer plans description, period cost and any liability that would result from a probable withdrawal.

·        Description of deferred compensation plans, their participants and how payments are determined.

·        For defined benefit plans:

o       Description, plan participants and how benefits are determined.

o       Funded status information including benefit obligation, market value of plan assets and the under-funded or over-funded status at the reporting date.

o       Under the current contribution method, the current and following years contributions.

o       Expected rate of return on assets and the discount rate used to determine the benefit obligation.

o       Any current period termination benefits.

Comprehensive Income

U.S. GAAP:

Items of comprehensive income, such as the unrealized appreciation on available for sale securities and prior service costs for defined benefit pension plans, are reported in a separate statement of comprehensive income or a single statement combined with operating income.

FRF for SMEs:

This framework does not recognize items of comprehensive income.

Revenue Recognition

U.S. GAAP:

Revenue is recognized when it is earned or realized based on evidence of the arrangement, the occurrence of a point of sale or delivery, a fixed sales price and reasonable assurance of collectability.  Contracts for production or construction are accounted for currently under the percentage of completion or completed contract methods.  Future standards for recognizing revenue under the contract method will likely require revenue recognition as performance obligations are completed.

FRF for SMEs:

Revenue recognition is more principles-based and revenues will be recorded based on performance and reasonable assurance of collectability.  When the risks and rewards of ownership of goods are transferred to a customer, performance of a transaction is accomplished.  For services in long-term contracts, such as construction or production contracts, the percentage of completion or completed contract methods may be used.  The consideration received for the service will indicate accomplishment of stages of performance of a service.  General disclosures include:

·        Revenue recognition policy for all types of transactions in Note A.

·        Accounting policies for multi-deliverables.

·        Explanation of why the completed contract method is used instead of the percentage-of-completion method, if applicable.

·        Revenue and contingent assets from any contract-related claim.

·        Major categories of revenue disclosed on the statement of operations.

·        Any unrecorded claims if claims are not recorded until received or awarded.

My series of four live two-hour webcasts with CPE credit covering the AICPA’s FRF for SMEs can be accessed by clicking the applicable link on the left side of my home page, www.cpafirmsupport.com.

Auditing Special Purpose Frameworks--Leases and Income Taxes

As auditors prepare to audit special purpose frameworks, knowledge of underlying principles in commonly used frameworks is a prerequisite.  Previous articles presented a comparison of some of the basic principles in the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) with U.S. GAAP.  This article continues this comparison.  You may obtain the AICPA’s free Toolkits for the FRF for SMEs on its website. http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/pages/frf-smes-cpas.aspx

Accounting principles for these topics are discussed below:

·      Lease Accounting

·      Income Tax Accounting

Lease Accounting

U.S. GAAP:

Traditionally, a lessee treats leases as capital or operating leases depending on certain criteria.  Capital leased assets and capital lease obligations are recorded in financial statements.  Operating leases are disclosed.  A lessor treats leases as sales type, direct financing or operating leases.

FRF for SMEs:

Accounting approaches are generally similar to traditional U.S. GAAP.  A lessee either records capital leases or discloses operating leases. A lessor either records sales type or financing leases or discloses operating leases. General disclosures include:

·        Capital Leases—Lessees:

o       Cost of the leased asset, accumulated amortization and the amortization method used.

o       Interest rate, maturity date and the outstanding balance of the obligation.

o       Any security for the lease.

o       Interest expense related to lease obligations.

o       Aggregate payments in each of the five years after the reporting date.

·        Direct Financing and Sales-Type Leases—Lessors:

o       Net investment in each type of lease and implicit interest rates.

·        Operating Leases

o       Lessees—future minimum lease payments in total and for each of the five years after the reporting date.

o       Lessors—cost of assets held for leasing and the related accumulated amortization.

Income Tax Accounting

U.S. GAAP

A deferred income tax method is use to determine the effects of temporary differences between financial and tax reporting.  The standards require management to evaluate and disclose uncertain tax positions for all open tax years, for all taxing jurisdictions. Any estimated liabilities for unsustainable positions should be recorded in the financial statements.

FRF for SMEs:

Management may elect either an income taxes payable method or the deferred income taxes method.  Uncertain tax positions are not required to be evaluated or accrued.  General disclosures include:

·        The accounting policy—income taxes payable or deferred taxes method.

·        For the income taxes payable method:

o       Provision for income tax expense or benefit include in net income or loss before discontinued operations.

o       Explanation or reconciliation of the differences between statutory rates and the effective rate.

o       Unused loss or tax credit carryforwards.

o       Any allocation of expense or benefit to equity transactions.

·        For the deferred taxes method:

o       Current and deferred income tax expense or benefit included income or loss before discontinued operations.

o       Any allocation of expense or benefit to equity transactions.

o       Total amount of unused tax losses and credits and amounts of any temporary differences for which no deferred tax asset has been recognized.

o       Explanation or reconciliation of the differences between statutory rates and the effective rate.

o       Unused loss or tax credit carryforwards.

·        Pass-through entities will disclose they are not subject to income taxes.

A series of four live webcasts on the AICPA’s FRF for SMEs can be accessed by clicking the applicable link on the left side of my home page, www.cpafirmsupport.com.