In the wake of the September 11 terrorist attacks, many auditors and companies need answers to an unprecedented array of accounting and auditing questions. Certain industries, such as insurers, airlines, and businesses located in and near the World Trade Center area, have been directly affected economically. Other industries, such as hospitality and tourism, and other companies that depend on those directly affected have also suffered significant losses.
Clearly, for some companies the financial reporting and auditing considerations are dwarfed by other factors. As companies begin the process of recovering, the independent accountant can provide significant advice and support, particularly by identifying alternate working locations, recovering significant operating systems, and establishing future contingency plans. Involving the auditor in the recovery process will also help ensure proper compliance with the accounting and reporting requirements.
Accounting for the Event
The following are the most significant financial reporting questions regarding the events of September 11:
In light of the magnitude of the losses incurred and the number of affected entities, the FASB’s Emerging Issues Task Force (EITF) discussed these issues and provided guidance on how to report the financial effects. The guidance provided here applies solely to the financial reporting implications of September 11 and should not be applied by analogy to other situations (see accounting.rutgers.edu/ raw/fasb/index.html).
Losses and Costs Will Not Be Reported as Extraordinary Items. Although the losses directly related to September 11 may meet the definition of an extraordinary item, the EITF decided that they should not be reported as such. Rather, these costs should be included in operating income. (There were differing opinions on whether the losses met the extraordinary item criteria. Regardless of whether the criteria are met, however, none of the losses will be reported as such.) To the extent that the losses are considered either unusual or infrequently occurring, they should be reported as a separate item in income from continuing operations.
The task force members believe that although the losses and costs directly related to September 11 may meet the criteria to be considered extraordinary, presenting them as such in the income statement would not accomplish the primary objective of distinguishing them from other business operations—to communicate the financial impact of the event itself. In contrast, the financial effects of September 11 are so far-reaching that for companies to separate in a consistent manner the direct effects of the event from the associated indirect effects would be difficult. It would also be difficult to separate the effects of September 11 from the weakening economy that predated it. Therefore, trying to capture broad financial effects in one line on the income statement would not communicate the effects of the event.
Use existing guidance for asset impairment recognition. SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of, should be used to determine when to recognize asset impairment losses arising from September 11. That standard requires companies to review their long-lived assets and certain identifiable intangibles for impairment whenever events or changing circumstances indicate that the carrying amount of an asset may not be recoverable. When the carrying amount of an asset is deemed unrecoverable, companies should recognize an impairment loss equal to the amount of an asset’s carrying value in excess of the undiscounted net future cash flows expected to be generated by the asset.
Recognition of liabilities for losses and other costs. Existing accounting standards should be used to determine when liabilities for losses and other costs should be recognized. Companies should refer to the recognition criteria in FASB Concepts Statement 5, Recognition and Measurement in Financial Statements of Business Enterprises, the definition of a liability as articulated in FASB Concepts Statement 6, Elements of Financial Statements, and the guidance contained in SFAS 5, Accounting for Contingencies, in determining when to recognize losses or costs. Those standards require that many of the costs companies could incur as a result of September 11 be recognized as the services are performed rather than estimated and recognized immediately.
For example, the following costs would be recognized as the services are performed: costs to recreate data, costs to clean up facilities and remove debris, costs to relocate to new facilities, and costs to provide employee benefits such as counseling. In addition, companies should continue to recognize depreciation expense on equipment or facilities that are temporarily unusable or unused.
The task force did identify certain costs that should be accrued as of September 11, such as operating lease payments on buildings or equipment that are temporarily unusable because the government has denied access to the building or equipment.
Disclosure Requirements
Companies need to disclose all the information required by existing literature, including information about risks and uncertainties, restructuring charges, and contingencies. The following disclosures specific to September 11 also need to be made:
Insurance Recoveries and Other Assistance
Insurance recoveries arising from losses incurred as a result of September 11 should be classified in the income statement in the same manner as the related loss: as operating income. Assistance received from the Air Transportation Safety and Stabilization Act, however, should be reported separately within operating income and not netted with other items. Companies should follow the guidance contained in FASB Interpretation 30, Involuntary Conversions of Nonmonetary Assets to Monetary Assets, and AICPA Statement of Position No. 96-1, Environmental Remediation Liabilities, to determine when to recognize an asset related to an insurance recovery. This guidance states that such an asset should be recognized when the realization of the claim for recovery is probable, and it should be measured at fair value.
Auditing Issues
Auditors must consider the implications of September 11 for working with clients affected directly and indirectly by the disaster. In a Web-based arti- cle (www.cpa2biz.com/recovery), the AICPA Auditing Standards Board staff discussed the following issues for auditors to consider in planning and performing the audit:
Recovery of accounting records. Auditors retain detailed knowledge of their client’s accounting systems and usually maintain detailed descriptions of their client’s financial accounting and reporting systems within their auditing working papers. Companies will likely want to work with their auditors to recover lost accounting records and re-establish detailed financial systems documentation. Companies may request that their auditors work with them to ascertain the extent to which significant accounting records and financial reporting systems have been destroyed and determine whether any are recoverable. In addition, companies may request that their auditors work with them to develop a process to ensure that the recovery of accounting records and financial reporting systems is as complete as possible.
In most circumstances, auditors are precluded from providing direct support in recovering a client’s significant accounting records because of SEC independence rules. The SEC has indicated that auditors can provide bookkeeping services and other accounting data recovery assistance to audit clients that maintained offices in the affected area without violating auditor independence rules. (See www.sec.gov/rules/ interp/33-8004.htm.)
Planning the audit. Because records and supporting documentation that would typically help the auditor understand the client’s business and plan the audit might have been destroyed on September 11, auditors should consider initiating the audit planning process earlier than usual. This will facilitate the evaluation of the availability of evidence and the auditing procedures necessary to verify account balances where records are incomplete.
In addition, the auditor should determine the availability of office space to conduct the audit. Because of the significant real estate destruction surrounding the World Trade Center, an alternate working location for the client and the audit staff may be needed. If an alternate location is established, the auditor should evaluate whether this will affect the nature, extent, and timing of the auditing procedures. For example, working from an alternate location may restrict access to key accounting and reporting records and information systems.
For certain industries, September 11 will have significant negative business implications, including reduced business activity, asset impairment, diminished recoverability of loans and accounts receivables, and increased contingent liabilities. When planning the nature, extent, and timing of auditing procedures, auditors should consider the implications for significant client accounting estimates.
Obtaining audit evidence. In performing the audit, auditors must obtain sufficient evidence to provide a reasonable basis for their opinion. For companies directly affected by the events of September 11, the auditor must assess the availability of accounting records and other supporting documentation. For such engagements, the auditor should consider performing extended walk-throughs and tests of the client’s controls over accounting information to evaluate whether they are operating effectively.
Auditors must also ascertain whether records and supporting documentation provide reasonable assurance that all material transactions have been recorded. Where back-up systems are inadequate, the auditor should consider other auditing techniques to evaluate the completeness of accounting information. For example, auditors may use confirmation procedures to verify certain account balances.
The inability to recover important accounting records or perform the procedures necessary to support the auditor’s report may represent a limitation on the scope of the auditor’s work. When faced with a scope limitation, the auditor should use professional judgment and consider issuing a qualified opinion or a disclaimer of opinion. According to AICPA Professional Standards AU 508.24, “When restrictions that significantly limit the scope of the audit are imposed by the client, ordinarily the auditor should disclaim an opinion on the financial statements.” When the auditor qualifies the opinion or issues a disclaimer of opinion, the reasons for doing so should be described in the auditor’s report.
Auditing estimates. Companies in certain industries will have to develop and record significant accounting estimates related to September 11. Such estimates are typically based on management’s knowledge of and experience from past events and its assumptions about the implications of such events on future operating plans. The events of September 11 were so extraordinary that management will be challenged to make these subjective and difficult accounting estimates. When assessing the reasonableness of management’s accounting estimates, auditors must determine that—
In evaluating the reasonableness of management’s estimates, auditors should consider the key factors and assumptions used by management, including the possibility of management’s overreliance on economic information based on favorable future conditions.
Going concern judgments. When an entity has experienced events of such significant negative economic impact as those of September 11, the auditor should maintain a heightened awareness of the company’s ability to continue as a going concern. In making such an evaluation, the auditor should obtain information about management’s plan for addressing the significant negative factors and consider whether those plans might be effective.
If, after considering the implications of the management’s plan for mitigating the negative implications of September 11, the auditor has “substantial doubt” concerning the client’s ability to continue as a going concern, an explanatory paragraph should be included in the auditor’s report.
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