BROKERS AND DEALERS
IN SECURITIES

mond Temple

By Howard Altman and Raymond TempleTo become more efficient, Wall Street has changed from a paper to an electronic marketplace. With an array of new diverse financial products, the financial services industry like so many other sectors of the economy, has become more specialized and complex. Consequently, the need for new guidance in accounting and auditing became obvious, because the last such guidance was codified in the 1985 Accounting and Auditing Guide on Brokers and Dealers in Securities.

To cope with all of the changes that have taken place in both the accounting profession and the securities industry, the Stockbrokerage and Investment Banking Committee of the AICPA (the committee) issued a new Audit and Accounting Guide--Brokers and Dealers in Securities (the guide) on April 1, 1997. The guide is intended to aid accountants in the preparation of financial statements and assist independent auditors in the audit of financial statements of broker-dealers. It includes illustrations of sample financial statements and related disclosures and descriptions of the many unique industry specific procedures.

Although lengthy, the guide provides an excellent overview of the securities industry, as well as the unique accounting, auditing, and regulatory considerations in the industry.

Consisting of seven chapters, 14 appendices, and a very useful glossary, the guide is organized as shown in Exhibit 1.

Financial Reporting

The guide incorporates the requirements of newly enacted pronouncements from the FASB and the AICPA. For example, SFAS No. 125, Accounting for Certain Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts that have a direct impact on the financial statements of broker-dealers, are integrated into the guide. The expectation-gap auditing standards of 1988 are dealt with in the chapter on auditing considerations as well as SAS No. 82, Consideration of Fraud in a Financial Statement Audit. In addition, significant industry related changes have been incorporated, including Rule 15c6-1, that decreases the allowable settlement period for regular-way trades from five business days after trade date to three. The guide requires two significant changes in financial reporting: 1) it does not allow combining of subordinated liabilities (those qualifying as capital in computing net capital requirements) with stockholders' equity in the statement of financial condition and 2) it requires that delayed delivery transactions be reported in the statement of financial condition on the settlement (delivery) date instead of the trade date.

The Securities Industry

The guide provides an overview of the operations of brokers and dealers by describing the various functions they perform, and touches on the financial markets, clearing organizations, depositories and business activities.

Broker-dealers perform various functions, including acting as agents to facilitate customer security transactions, and buying and selling for their own account with customers and other dealers. Many firms operate in both capacities and their range of activities is almost endless. For example, broker-dealers can provide such financial services as--

* underwriting, or participating in
the underwriting of, publicly offered
securities;

* assisting in the private placement of securities;

* providing investment research and advice;

* developing new financial products, including derivatives;

* providing a source of market liquidity (market makers and specialists) and creating a secondary market for many products;

* providing loans and financing, including equity and mortgage loans;

* providing the means for companies to hedge foreign currency, interest rate, and other risks;

* accommodating international investing, including U.S. investment in foreign markets and the investment activity of foreign investors in the U.S. markets;

* extending credit to customers who have bought securities on margin and to corporations that need financing for mergers, acquisitions, or leveraged buyouts;

* acting as a depository for securities owned by customers, disbursing dividends and interest received, and informing customers about calls, tenders, and other reorganization activities pertaining to their securities;

* serving in an advisory capacity for public and corporate finance activities (such as mergers and acquisitions and leveraged buyouts) and providing investment and management advisory services to individuals, corporations, and others (such as mutual funds); and

* providing many other financial services (such as credit cards, checking accounts, and insurance products).

The guide defines and explains the securities industry and practices in much more depth than did the 1985 guide. Among the new topics covered are business activities such as firm trading, riskless arbitrage, when-issued transactions, hedging, and soft-dollar arrangements.

Broker-Dealer Functions,
Books, and Records

Accounting for broker-dealers is unique in that two sets of books--the general ledger and the securities record (commonly referred to as the "stock record")--are maintained. The general ledger is used to record entries reflecting monetary balances and the securities record is used to account for securities positions. The guide discusses the accounting for the flow of a security transaction, whether manual or automated, through the standard departments and records within a broker-dealer. It also illustrates the basic journal entries to be recorded on both the general ledger and stock record.

There are two critical dates in all securities transactions: trade date and settlement date. On trade date, an agreement is entered into that establishes the negotiated elements of the transaction including the security description, quantity, price, and delivery terms. The date the securities must be delivered and payment received is referred to as the settlement date. Since generally accepted accounting principles require use of accrual accounting, the financial statements should be presented on a trade-date basis since the potential risks and benefits of each transaction become effective on that date.

Certain security transactions, due to their inherent nature and characteristics, require unique accounting treatment. For example, futures, swaps, and options contracts are recognized at their fair value rather than the amount expected to be received on the contractual settlement date. The basic accounting model for these instruments is discussed later.

Securities transactions can be negotiated to settle on a delayed-delivery basis that is, beyond the regular-way settlement period. The initial exposure draft to the guide issued in August 1994, proposed that delayed-delivery transactions be recorded on a settlement date basis. as opposed to the trade date basis, as was required by the 1985 guide. The change was suggested because delayed-delivery trades are executory contracts which may extend for significant periods of time and, consequently, may involve a greater risk of nonperformance. The committee notes that this change brings the accounting for such items into agreement with accounting for similar transactions, such as forward transactions. The committee also recognizes that there exists diversity in practice in accounting for delayed-delivery transactions but nevertheless believes that narrowing the diversity would be beneficial.

Consequently, the guide, as stated earlier, requires that delayed-delivery transactions be recorded on the settlement date with related gains or losses in value between the trade and settlement dates reported in the statement of operations.

Repurchase transactions ("repos") also require special accounting and financial statement presentation. A repo is a security sold with an agreement to repurchase the same security. A "reverse repo" is a purchase of a security with an agreement to resell the same security. Generally, the cash received or paid is recorded as a payable or receivable at the agreed-upon contract value. Offsetting repo positions in the statement of financial condition may be acceptable if the conditions of FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements--an Interpretation of APB Opinion No. 10 and a Modification of FASB Interpretation No. 39, are met.

The guide's discussion of commodity futures and options highlights the different settlement procedures for a futures contract--i.e., they may be settled by delivery--but virtually all commodity contracts, even those trading commodities such as grains, soybeans, coffee, etc., are not settled by delivery, but rather with an offsetting purchase or sale. Unlike the over-the-counter products, futures are regulated by the Commodity Futures Trading Commission (CFTC), are marked-to-market, and settled daily. The guide provides a checklist of records required by the CFTC. In addition, the guide provides an overview of the clearance and settlement process in municipal securities, international securities, and options on securities.

Regulatory Considerations

Since the securities industry is heavily regulated, the guide provides an overview of numerous regulatory considerations, primarily those of the SEC, including net capital requirements under Rule 15c3-1, customer protection rules under Rule 15c3-3, and reporting requirements under Rule 17a-5. In addition, the guide includes definitions and explanations of SEC Rule 17a-3 (Records to Be Made by Certain Exchange Members, Brokers, and Dealers), Rule 17a-4 (Records to Be Preserved by Certain Exchange Members, Brokers, and Dealers), and Federal Reserve System Regulation T (Maintenance of Margin). The 1985 guide provided limited guidance on regulatory considerations. The new guide now provides an interpretation of the rules and their purpose.

Broker-dealers are required to maintain minimum levels of liquid assets to support the volume and risk of the business in which they engage. These minimum levels and applicable calculations are defined in SEC Rule 15c3-1. The new guide incorporates many definitions and narrative explanations included in Rule 15c3-1 and includes an outline of the net capital calculation and the alternative method available under the rule.

One of the rules covered in detail is Rule 15c3-3, the customer protection rule. The objectives are to safeguard customer assets, obtain prompt possession or control of customers' securities, segregate firm and customer-related business, make daily determinations of security locations, enforce expeditious execution of trades, and prepare periodic deposit computations to protect customer assets in event of the liquidation of an insolvent broker-dealer. The deposit computation requires a broker-dealer to segregate cash or qualified securities in a reserve
bank account equal to the excess of
customer-related credits over customer-related debits.

The guide provides definitions of key terms under Rule 15c3-3. For example, a customer is defined as any person for whom or on whose behalf a broker-dealer has received, acquired, or holds funds or securities. Customers do not include other broker-dealers or registered municipal securities dealers. A key element of Rule 15c3-3 is the concept of possession or control that requires broker-dealers carrying accounts of customers to promptly obtain and thereafter maintain the physical possession or control of
all fully paid securities and excess-margin securities carried for the accounts of
customers.

Most broker-dealers are exempt from Rule 15c3-3 based upon the activities in which they engage, i.e., fully disclosed broker-dealers who introduce their customer transactions to another broker-dealer who clears and carries the trades.

Rule 17a-5 describes the requirement of the independent auditor to examine the adequacy of the broker-dealer's accounting system and control procedures for safeguarding securities. The guide includes a detailed description of the requirements and responsibility of the independent auditor in this regard.

Financial Statement
Presentation and Classification

Pursuant to the Securities Exchange Act of 1934, broker-dealers are generally required to file annual audited financial statements with the SEC. The financial statements are also filed with the various exchanges (or self-regulatory organizations) of which the broker-dealer is a member and with state agencies with which the broker-dealer is registered. These financial statements are prepared in accordance with generally accepted accounting principles and are subject to Rule 17a-5 that specifies form and content. In addition to the basic financial statements, broker-dealers must also include 1) a statement of changes in liabilities subordinated to claims of general creditors when liabilities are subordinated and treated as additions to net worth in the computation of net capital, 2) supplementary schedules of the computation of net capital under Rule 15c3-1, and where applicable, 3) the reserve requirement computation and information relating to position or control requirements under Rule 15c3-3. The statements and supplementary schedules need not be comparative, and the statement of financial condition is presented in an unclassified format. The guide includes an illustration of broker-dealer financial statements, footnotes, supplementary information, and a model Form X-17A-5 Part III facing page, including the oath or
affirmation page.

The guide also contains changes in the presentation of subordinated liabilities that qualify as capital in computing net capital under Rule 15c3-1. Under the guide, such liabilities cannot be combined with stockholder's equity in the statement of financial condition, whereas the combination of these amounts was acceptable under the 1985 guide. The change was made because the inclusion of subordinated liabilities with equity is misleading. This thinking is similar to other entities (such as banking institutions) that have regulatory capital but do not present their financial statements based upon regulatory requirements. In addition, as expressed by the committee, as business activities of financial service entities become more homogeneous, financial statement users will benefit if financial reporting anomalies about such entities are reduced or eliminated.

The guide incorporates the disclosure requirements of SFAS No. 105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk, and provides illustrative notes disclosing financial instruments with off-balance sheet risk, including futures, forward and foreign exchange contracts, options, to-be-announced securities, when-issued securities, and interest-rate swaps. The contractual or notional amounts related to these financial instruments are a required disclosure. In addition, SFAS No. 105 requires disclosure of concentration of credit risk. A broker-dealer may be engaged in various trading and brokerage activities whose counterparties include other customers, broker-dealers, banks, and financial institutions. To the extent the counterparties default, the broker-dealer may be exposed to risk. Disclosure regarding that potential risk and efforts to mitigate the risk is required.

The guide highlights two areas of increased disclosure for broker-dealers. One is risks and uncertainties as required by SOP 94-6, Disclosure of Certain Significant Risks and Uncertainties. The other is derivatives. The guide provides guidance on the disclosure of derivative activity by incorporating the requirement of SFAS No. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments.

Auditing Considerations

The 1985 guide's focus was based on SEC rule 17a-5 relating to prescribed audit objectives and the extent of auditing procedures. Thus, the 1985 guide provided substantive audit guidance on the financial statements of a broker-dealer. The chapter on auditing considerations in the new guide has been rewritten in the format of the expectation gap auditing standards Nos. 53 through 61. The new guide also incorporates the risk model of SAS No. 47, Audit Risk and Materiality in Conducting an Audit, including a focus on inherent risk, control risk, and detection risk in a broker-dealer environment. The guide points out that in planning an audit of a broker-dealer, the auditor should assess the effect of the regulatory environment, changes in that environment, and the expectations of the client, its customers, and regulators on both audit risk and materiality.

New Guidance. While the 1985 guide did not include guidance in general audit areas such as materiality and audit sampling, the new guide discusses both topics and provides specific guidance on determining materiality and audit sampling applications. In the latter case, the guide breaks new ground by providing specific audit sampling guidance on--

* customer balances,

* stock records,

* compliance,

* net capital computation,

* reserve requirements, and

* possession or control requirements.

Risk Components. The chapter incorporates the five broad categories of assertions from SAS No. 31, Evidential Matter, and reclassifies them in six separate risk components--four that can arise in the processing and recording of transactions that make up an account balance and two that can arise in the preparation of financial statements. Risk components at the account balance level are: completeness, validity, recording, and cutoff. Risk components at the financial statement level are: valuation and presentation.

The guide then blends the auditors' consideration of the five assertions, audit objectives, and substantive tests in a chart on Securities Broker-Dealers' Auditing Considerations, arranged by broad audit objectives. Exhibit 2 depicts an example from the chart; in this case, the audit of commission revenue.

The guide also addresses the auditors' responsibility for the detection of fraud in an audit of financial statements. Under SAS No. 82, the auditor is required to specifically assess the risk of material misstatement of the financial statements due to fraud and to consider that assessment in designing audit procedures to be performed.

In addition, the guide also reminds the auditor of its responsibility under SAS No. 54, Illegal Acts by Clients, to detect and report misstatements resulting from illegal acts that have a direct and material effect on the determination of financial statement amounts. Consequently, the auditors must design the audit to obtain reasonable assurance of detecting illegal acts that have a direct and material effect on the financial statements.

Since broker-dealers may be affected by many laws or regulations, the guide discusses the regulatory environment in areas such as fair practice, securities trading, underwriting, and customer transactions. Since most laws and regulations generally relate more to broker-dealer operations rather than financial and accounting matters, their financial statement effects are indirect. Although the new guide reminds auditors that a GAAS audit does not include audit procedures specifically designed to detect illegal acts that have an indirect effect on financial statements, SAS No. 54, Illegal Acts by Clients, however, provides guidance when the auditor does detect such an illegal act during the course of such normal audit procedures.

Internal Audit Function. Since the old guide was written, much more emphasis has been placed on the internal controls of a broker-dealer, and with that, the ever increasing importance of the internal audit function. External auditors have used, to some extent or another, the work of a client's internal audit for many years. Varying degrees of reliance and questions of independence have given rise to considerable debates between internal and independent auditors as to the appropriate level of acceptance of the work of internal auditors for use by the external auditor. The new guide reminds auditors that the work of the internal auditors may have an important bearing on the independent auditor's procedures and directs the auditor's attention to SAS No. 65, The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements.

Analytical Review. The new guide points out the usefulness of analytical procedures in view of the ease in obtaining information with which to compare a broker-dealer and the resultant identification of areas where greater or lesser audit effort is necessary. Examples cited in the guide where analytical procedures may be useful in the initial planning process include--

* enhancing knowledge of the broker-dealer's business,

* providing a basis for preliminary judgments about materiality,

* increasing awareness of inherent risk factors, and

* directing attention to accounts and
classes of transactions (or changes in them) that merit additional audit emphasis.

The guide provides additional examples of effective analytical procedures useful during an engagement, as well as specific wrap-up analysis applied to financial statement captions and account balances. The guide also includes many useful analytical procedures in the illustrative audit program, contained in the appendix to chapter five. Exhibit 2 includes an example of analytical procedures for the audit of commission revenue.

Implications of EDP Processing. The use of electronic data processing (EDP) has changed dramatically since the old guide was written. Technology has changed the financial services industry from a paper to an electronic marketplace in all aspects, from day-to-day back office operations to the pricing and valuation of complex financial instruments. The guide cautions auditors to consider the methods the broker-dealer uses to process accounting information, because the methods used, together with the complexity of the processing system, may influence the nature, timing, and extent of audit procedures to be performed.

The guide also reminds auditors that the use of EDP does not influence the objectives of the audit; however, it does influence the broker-dealer's internal control and, therefore, the nature and extent of audit procedures. The guide does not provide any specific guidance for auditing in an EDP environment but rather directs attention to the AICPA Audit Guide, Consideration of the Internal Control Structure in a Financial Statement Audit.

Review of Controls at EDP Service Centers. If a broker-dealer uses an outside service organization (service center) to execute and record transactions, the guide states the auditor must obtain an understanding of the broker-dealer's accounting and control operations and should understand what aspects of it are significantly affected by the service organization. For instance, what significant classes of transactions are processed by the service center? How do these transactions flow through the broker-dealer's entire accounting system? Can the auditor get comfort by merely reviewing the broker-dealer controls over daily input and output, or must a service auditor's report be obtained? The guide directs the auditor to SAS No. 70, Reports on the Processing of Transactions by Service Organizations for additional guidance. SAS No. 70 discusses the effect of a service organization on a user organization's internal control, risk assessment, and other considerations in using a service auditor's report.

Internal Control. The guide's focus on internal control is based on SAS No. 55, Consideration of Internal Control in a Financial Statement Audit,. as amended by SAS No. 78. SAS No. 78 incorporated the recommendations of the Committee of Sponsoring Organizations (COSO).

While the old guide provided a checklist of specific controls unique to broker-dealers, it did not incorporate adequate guidance on the three elements of internal control structure for a proper risk assessment:

* Control environment,

* Accounting system, and

* Control procedures.

In addition to providing a useful discussion of unique broker-dealer controls, the guide also considers the control environment and provides examples of business activity that may affect management's operating style such as--

* retail brokerage,

* discount brokerage,

* arbitrage trading,

* venture capital,

* merchant banking, and

* underwriting initial public offerings.

The new guide now links senior management's level of commitment in maintaining reliable accounting records to an effective (or ineffective) control environment. Auditors need to understand the degree of this commitment and consider the following broker-dealer policies regarding--

* firewalls,

* trading limits,

* sales practices,

* hiring practices, such as checking with regulators and obtaining proper documentation regarding registration,

* risk monitoring, and

* management's response and corrective action taken with respect to material inadequacies in internal control.

The guide identifies major activities such as clearance, securities settlement, and custody and includes a new discussion on derivative transactions. The guide then provides a list of control procedures typically associated with these major activities. More importantly, the guide suggests that each control policy and procedure be designed to accomplish a specific control objective. Such objectives might include the control procedures designed to provide reasonable assurance as follows:

* Validity. Assurance that recorded transactions include only those that have actually occurred.

* Completeness. Assurance that valid transactions are not omitted entirely from the accounting records.

* Authorization. Assurance that transactions are approved before they are executed and recorded.

* Valuation (accuracy). Assurance that dollar amounts are correctly determined.

* Classification. Assurance that transactions are recorded in the right accounts, charged and credited to the right customers, etc.

* Presentation and disclosure. Assurance that the accounting process for a transaction is completely performed and is in conformity with GAAP.

* Timing (cutoff). Assurance that transactions are accounted for in the proper time period.

* Regulatory. Assurance that transactions comply with the applicable laws and regulations of the SEC and other regulatory bodies.

Since the issuance of the old guide, the normal audit approach has changed from being account driven to one of risk assessment. The new guide incorporates this perspective in its discussion on broker-dealer risks and exposures. It identifies and explains each of the following risks:

* Operational.

* Credit.

* Market.

* Litigation.

* Regulatory.

While the old guide was regulatory driven as it related to internal control (i.e., it cited rules from the SEC and the Commodity Futures Trading Commission), the new guide incorporates the concepts of SAS No. 55 as amended by SAS No. 78 into the broker-dealer environment.

Accounting Standards

Unlike the old guide, which focused more on accounting records, the new guide provides insight into the use of fair value vs. historical cost, the variety of ways fair value can be measured, trade-date vs. settlement date accounting, and the overall impact of these items on financial reporting. It also includes discussions on soft dollars, asset securitizations, and derivative transactions.

Accounting Model. A broker-dealer accounts for financial instruments that it has an economic interest in at fair value, including those for futures, swaps, and options. The fair value of a financial instrument is the price at which a willing buyer and a willing seller would enter into an exchange. Fair value can be measured in a variety of ways depending on the nature of the instrument and the manner in which it is traded. Those that are publicly traded use end-of-day market quotations. The guide stresses that quoted market prices are usually the best-evidence of the fair value of a financial instrument. But what if such quotes are not available? The guide provides useful guidance for--

* financial instruments not listed on a recognized exchange, but having a readily available market price, and

* financial instruments not having a readily available market price.

For the first category of financial instruments, the guide points out that many of these instruments are traded in the over-the-counter market by dealers or other intermediaries from whom market prices are obtainable.

For the second category of instruments, the task is more difficult for two reasons. First, such instruments may have no readily available price quote, and, secondly, even if a quote was available, it may not be reliable because the underlying securities may have restrictions on them, or may be thinly traded, or may be in a market where sales are infrequent. In those cases, such financial instruments may be valued at fair value as determined in good faith by management. To determine fair value, management should satisfy itself that--

* all appropriate factors relevant to the value of the financial instruments have been considered.

* the procedures for arriving at the fair value of each financial instrument are reasonable and consistently applied.

* the underlying documentation supports fair value estimates.

The SEC's Codification of Financial Reporting Policies provides guidance (taken from ASR-118) on factors to be considered and methods used to value securities for which market quotations are not readily available. In addition, paragraphs 22-29 of SFAS No. 107, Disclosures About Fair Value of Financial Instruments, specifically address financial instruments with no quoted market prices.

Certain broker-dealers may make investments in the form of equity or provide financing to another entity in connection with financial restructuring transactions. These investments should be presented at fair value as determined by management as there may be an absence of a ready market. Although the investment may be such that consolidation of the investee company or use of the equity method of accounting may be required, it is prevalent industry practice not to do so because control of the company may be temporary.

Soft Dollars. The term soft dollars refers to the use of brokerage commissions, spreads, mark-ups and mark-downs to pay for goods and services. Soft dollars provide a way for an institutional investor or money manager to purchase securities research and, in certain circumstances, other products and services, without expending its own resources (known as "hard dollars").

The guide recommends that broker-dealers analyze both commission income generated from soft-dollar customers and the research provided to the soft-dollar customers at the date of the statement of financial condition. The broker-dealer can then determine whether a liability should be accrued for research due to customers based on related commission income, or whether any soft-dollar expenses have been incurred that need to be deferred.

Asset Securitizations. Asset securitization is the process of converting receivables and other assets that are not readily marketable into securities that can be placed and traded in capital markets. Assets that have been securitized include residential mortgages, commercial mortgages, agency securities (GNMA, FNMA, FHLMC), consumer receivables (credit card loans, home equity loans), retail installment loans (automobile, recreational vehicle, mobile home), time-share mortgage loans, trade receivables, insurance-policy-related receivables, leases (equipment, operating, automobile), student loans, high-yield corporate bonds, and Federal assets.

The complexity of securitized products has significantly increased because of the nature of the underlying collateral, the complexity of the structure (for example, residual tranches and interest- and principal-only strips), and the depth of markets, all of which affect the accounting and valuation of those products. Broker-dealers may acquire, either through market purchases or through the underwriting process, securities arising from asset securitization. Those securities should be marked to market in accordance with the guidelines previously discussed. In addition, certain of those securities may raise issues of whether the underlying legal entity should be consolidated by the broker-dealer as discussed in FASB Technical Bulletin No. 85-2, Accounting for Collateralized Mortgage Obligations.

FASB Statement No. 125 provides guidance on the securitization of financial assets held by broker-dealers.

Derivatives. A derivative is a contractual agreement that derives its value from the performance of underlying assests, interest or currency-exchange rates, or a variety of indices. Broker-dealers enter into derivative transactions for a variety of reasons: to deal, to take proprietary positions, to effect economic hedges of instruments in other trading portfolios, or to execute arbitrage strategies.

Derivatives entered into by dealers should be carried at fair value, with resultant gains and losses reported currently in income. Although there is no standard for determining the fair value of a derivative, the guide notes that the Group of Thirty recommends that the midpoint between the bid and offer quotes be used for valuation purposes. Factors that could influence the pricing of an individual derivative include the counterparty's credit standing and the complexity of the derivative. When those factors differ form the basic factors underlying the quote, an adjustment to the quoted rate should be considered.

In connection with the mark-to-market of derivative contracts, unrealized gains should be recorded as assets and unrealized losses as liabilities on the statement of financial condition. In accordance with FASB Interpretation No. 39, unrealized gains and unrealized losses arising from contracts executed with the same counterparty under a master netting arrangement may be offset.

Disclosure of the underlying notional principal amounts associated with derivative contracts is required by FASB Statement No. 119.

Impact on Other Literature

The guide supersedes the old guide and the following AICPA Statements of Position (SOP's):

* SOP 89-1, Reports on Audited Financial Statements of Brokers and Dealers in Securities and

* SOP 89-4, Reports on the Internal Control Structure in Audits of Brokers and Dealers in Securities.

Effective Date and Transition

The guide's changes will become effective for annual financial statements issued for fiscal years beginning after December 15, 1997. If comparative annual financial statements are presented for earlier periods, restatement is recommended but not required. The other accounting, financial reporting, and auditing provisions of the guide reflect current authoritative literature for broker-dealers. Accordingly, effective dates should be applied as provided for in the specific authoritative literature.

This article was written by Howard Altman, CPA, and Raymond Temple, CPA, principals of Rothstein, Kass & Company, P.C., Roseland, NJ with the editorial and technical assistance of Maurice Berkower, CPA. Mr. Temple passed away on March 8, 1997. Mr. Altman and his firm dedicate this article to his memory for all his efforts and contributions to the firm and the
profession.

In Brief

All You Need to Know

There have been many changes in both the accounting profession and the securities industry since 1985. Technology, new esoteric financial instruments, and changes in accounting and the way we do audits have contributed to the obsolescence of the audit guide for brokers and dealers in securities issued in that year. A new guide has been issued and the authors walk us through its contents.

Comprehensive Guidance That Reflects the New Technologies LandscapeComprehensive Guidance That Reflects the New Technologies Landscape