The editors look back at a busy and active year. (1994)
December is the usual month that the editors of The CPA Journal present a year-end accounting and auditing tune-up. Because of the many important events that took place this past year, we are presenting a multi-dimensional approach. Leading off is this summary of the many events that took place. Second, we present our annual listing of pronouncements that were issued or become effective this year. But still wanting to assist practitioners during the year-end crunch, third, we present a sidebar by two professionals active in the Indiana quality review program that talks about the importance of documentation in accounting and auditing engagements.
In almost every sector of, or sphere of influence on, the profession, there was activity in 1994, some of which was very significant and of utmost importance.
Limited Liability Entities Come of Age. Perhaps the most visible area of activity for 1994 had to do with relief from accountants' liability or the perception of relief. Heading the visibility list was the addition of three letters to the names of the Big Six accounting firms--"LLP." They all registered as limited liability partnerships and, as required by the laws and regulations surrounding such registration, added the initials to their names. The firms were waiting until the necessary action was taken by state legislatures and boards of accountancy to permit them to operate in that form of practice in a sufficient number of jurisdictions.
Many local and regional firms are giving serious consideration to joining the club. Limited liability partnerships (LLPs), like limited liability companies (LLCs) and professional corporations (PCs), protect the individual assets of owners and partners from the exposure of vicarious liability arising from the professional acts of other owners and partners and the employees they supervise. The assets of the firm remain at risk, and in many jurisdictions the individual owners and partners remain responsible for the commercial liabilities (e.g., lease obligations) of the firm to the extent the assets of the firm are deficient. New York's LLC/LLP legislation, which was passed this summer, does offer protection from commercial liabilities.
The main advantage of the LLP over the LLC is that existing partnerships can convert to LLP status simply by registering in an appropriate jurisdiction and following certain procedures, such as publishing notice of the change and properly identifying the new status in the name of the firm.
Proposed Relief from Joint and Several Liability. A very important development was the introduction by Senators Christopher Dodd (D-Conn.) and Peter Domenici (R-NM) of proposed legislation in the Senate, Private Securities Litigation Reform Act of 1994. While calling for many procedural changes in securities fraud litigation under the Federal securities laws to reduce the number of frivolous suits, it also provides for liability reform that would directly benefit the auditing profession. Specifically, the proposed legislation has the following provisions:
* The SEC would be directed to consider establishing a safe harbor so that forward-looking statements will not become the basis of a lawsuit.
* Joint and several liability would be retained for defendants who are primary wrongdoers, who substantially assist primary wrongdoers, or who knowingly engage in fraudulent activity. However, proportionate liability, based on level or responsibility, would be introduced for those defendants who are found to be less culpable.
* Auditors of public companies would be required to more quickly report to the SEC about illegal acts that have not been properly addressed by company management. The provisions mirror those in the Wyden bill introduced previously in Congress.
* A Public Auditing Self-Disciplinary Board, subject to oversight by the SEC, would be established to provide for the timely and effective discipline of public auditors and firms that are guilty of substandard work or professional misconduct.
The bottom line is that the auditing profession is trading proportionate liability in securities litigation for a statutory-based self- disciplinary system. The AICPA and many state societies of CPAs support the legislation.
The risk in the legislative process is that the disciplinary aspects of the legislation may pass, but proportionate liability may not. There are many interest groups that oppose the legislation--e.g., the plaintiffs' bar, Ralph Nader-type consumer groups, and AARP--and therefore the road to passage will be narrow, slow, and treacherous.
Aiding and Abetting is Out. At first the news of the U.S. Supreme Court decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver N.A. in April 1994 was cheered as a victory for accountants who find themselves defending their actions in private litigation under Federal securities laws. The court ruled that since the Federal securities laws did not specifically provide for a claim of aiding and abetting, the courts had no power to create such a claim. It has been common practice to sue auditors in private litigation as aiders and abettors as well as primary wrongdoers. If an accountant were found to be even partially liable under a claim for aiding and abetting, under joint and several liability the accounting firm's insurance and assets could be exposed to the full liability. No wonder the elimination of aiding and abetting as a cause of action was greeted so enthusiastically.
However, the SEC institutes suits against accountants on the same basis. Because of the court decision, the SEC has become reluctant to pursue such cases because of the possibility they may also be set aside by the Supreme Court. As a result, the SEC may seek legislation that will specifically provide for claims for aiding and abetting a wrongdoer. (See "Liability of Accountants Under the Federal Securities Law" by Barry S. Augenbraun in this issue.)
In the meantime plaintiffs will no doubt seek to expand the nature of the accountants' alleged misdeeds into that of primary wrongdoer.
Complicating the issue, the Dodd legislation does not provide for relief from joint and several liability for the primary wrongdoer, presumably only for the aider and abettor.
Liability in Litigation Consulting is In. Previously considered off limits for liability, a recent court decision found an accountant liable for claims arising from services performed as an expert witness in a litigation consulting engagement. While the facts surrounding this case are somewhat unusual, the case constitutes a wake-up call to the risks and exposures of this type of work.
While the number of pronouncements issued by the standard setters for 1994 did not attract much attention, their content did.
FASB. The biggest fuss came from FASB's proposed statement, Accounting for Stock-Based Compensation. Objections came from Congress, auditors, investors, and preparers over a proposal to require recognition of compensation expense for stock options and other awards of equity instruments based upon their fair value as of the date of grant. Especially loud objections were voiced by high-tech and start-up industries who claim the recognition of expense would put them at a competitive disadvantage.
FASB has stuck to its guns and is moving ahead with the project, with some modification. The latest development is a petition from executives representing over 600 companies requesting FASB to issue a new exposure draft in order to allow comment on the revisions decided upon by FASB.
Accounting Standards Executive Committee (AcSEC). More than a year after its proposal to require disclosure of certain risks and uncertainties was issued for comment, AcSEC received clearance from FASB to issue a final statement of position (SOP). AcSEC chose to make changes based on the many comments it received but without re-exposing the specifics of the changes. The fear of many observers is the additional liability risk that might arise to auditors for having to give an opinion on what is clearly very "soft" information about the risks and uncertainties to which most businesses are exposed. The final SOP will be issued in late 1994. Authors Reva Steinberg and Judith Weiss, who wrote for The CPA Journal about the ED, are in the process of developing an article on the final statement. The article will be published in early 1995.
GASB. The Government Accounting Standards Board continues to act somewhat like the two-headed monster suggested in the June issue of The CPA Journal. It seems to be headed in two different directions in two respects:
* First, the Board itself can't seem to decide on the basis of accounting governmental units should follow. A change was first proposed over five years ago (Statement No. 11), and yet the board continues to pursue two different approaches. The Board is back to the point of issuing an invitation to comment showing two approaches. The invitation to comment was issued this June. Along the same line at the same time, GASB issued an invitation to comment on three methods of accounting for colleges and universities.
* Second, GASB is establishing standards on issues that have already been dealt with by FASB, but with different requirements. The result is confusion. Examples are the statement of cash flows and accounting for the effects of defeasance of debt.
A major accomplishment for GASB in 1994, after years of study, was the issuance of three exposure drafts on pension reporting--accounting for employers, pension plans, and post-employment plans administered by defined benefit pension plans.
Auditing Standards Board. The ASB in 1994 continued turning to the attestation standards as a means of satisfying users' needs. Last year an attestation statement was issued relating to management's assertion on internal control. This year (issued in December 1993), SSAE No. 3, Compliance Attestation is operative to address compliance with laws and regulations. The SSAE exempts single audit and A-133 audits from its coverage; its primary use is for engagement under FDICIA.
The ASB is also working on standards that would facilitate the expanded use of agreed-upon-procedures engagements, especially in new areas of coverage where both the user and the accountant are not exactly sure what to expect.
U.S. General Accounting Office. A revised edition of Government Auditing Standards 1994 Revision, better known by its yellow color, was issued in TABULAR DATA OMITTED 1994 and becomes effective for audits for periods ending after January 1, 1995. GAO backed off from some of its originally proposed revisions, principally in the area of internal control. The final document continues to be a general wrap around to GAAS, but with some specific guidance on how to interpret GAAS as it relates to governmental audits. An article on the revisions to the "yellow book" is scheduled for publication in The CPA Journal in early 1995.
Other AICPA Activities
There were a number of significant developments flowing from other activities of the AICPA outside of standard setting.
AICPA Special Committee on Financial Reporting. On September 26, 1994 the "Jenkins" committee issued its long awaited report. After more than three years of deliberation, the report is only 24 pages in length. Implementation guidance in a much longer format (some 200 or so pages) will be issued at a later date. The special committee focused on the needs of users, which has caused the preparer community to feel neglected. And they're the ones that will bear the cost of satisfying the recommendations. Particularly interesting is that the committee has begun using the phrase "business reporting" instead of financial reporting. The specifics of the recommendations and a report of The CPA Journal's symposium on the report will appear in next month's journal.
AICPA Special Committee on Assurance Function. Following on the heels of the Jenkins Committee, the AICPA Board of Directors in 1994 established a special committee to focus on the audit (or more broadly speaking, the assurance) function. The broader notion came out of an AICPA conference held in 1993. An assurance service involves the expression of a written or oral conclusion on the reliability and/or relevance of information and/or information systems (the new items are italicized). The committee, under the leadership of Robert Elliott, will explore the expansion of the assurance function (see "Leading the Profession: A Conversation with Robert Elliott" in the October issue).
Quality Review and Peer Review Will Merge. The merger of peer review and quality review has been approved by the AICPA Board of Directors and will take effect with the 1995 review year. During 1994 an implementation committee has been hard at work on the details. The combined program will likely be called peer review.
Special Panel on Independence. At a January 1994 AICPA conference, Walter Schuetze, Chief Accountant of the SEC, commented upon what he considered to be a growing lack of independence on the part of the auditing community. The Public Oversight Board (POB) of the AICPA SEC Practice Section (SECPS) formed a special panel under the leadership of Donald Kirk, former chair of the FASB to investigate. Its report, Strengthening the Professionalism of the Independent Auditor, was issued September 22, 1994, and recommends several steps to enhance the integrity of financial reporting through strengthening the relationship between a company's independent auditor and its board of directors, as well as suggestions to improve the professionalism of auditors. An article on the report of the panel and a discussion with its chair is scheduled for the February issue.
Non-CPA Ownership of CPA Firms. At its May meeting, AICPA Council approved the amendment of Rule 505 of the Code of Conduct that has the effect of allowing non-CPA ownership, under certain conditions, of CPA firms with AICPA members. The conditions limit the percentage of non-CPA ownership to one third, and such owners cannot use the title of "partner." The change passed rather comfortably, considering the years of fierce debate on the issue. The issue relates to other than the partnership form of practice; the AICPA already permits non-CPA partners.
The change will have very little immediate practical impact as state statutes are the governing factor.
Accreditation. AICPA Council also approved a proposal relating to accreditation of CPAs in practice areas. Accreditation is different than specialization; it merely asserts a CPA has passed an exam and actively practices in the area. Presently the personal financial planning area is the only active accreditation program. Future programs will be approved based on demonstrating the viability of the proposed program including some assurance that sufficient interest exists on the part of members.
Practice Alerts. The POB report In the Public Interest made a number of recommendations to various bodies including the SECPS. As part of its response, the SECPS Executive Committee established two committees, a Professional Issues Task Force (PITF) and a Detection and Prevention of Fraud Task Force (DPFTF).
The PITF is a non-standard-setting body responsible for accumulating and considering practice issues that appear to present audit concerns for practitioners and for disseminating information in the form of practice alerts. It will also refer matters to standard-setting bodies it believes are appropriate for consideration or interpretation. It is a 10-member group and includes members from the SECPS Executive Committee, Quality Control Inquiry Committee, SECPS and PCPS Peer Review Committees, Auditing Standards Board, Professional Ethics Executive Committee, and the legal or related departments of accounting firms.
During the year the PITF issued two practice alerts. No. 94-1, Dealing with Audit Differences, suggests factors to be considered by the auditor in proposing that such differences be adjusted. No. 942, Auditing Inventories--Physical Observations, provides guidance to auditors for uncovering fraudulent inventory schemes. The charge of the DPFTF is to develop information to assist auditors in the detection of financial fraud and in the management of overall engagement risk. In 1994, the DPFTF issued one unnumbered practice alert, Acceptance and Continuance of Audit Clients. This practice alert contains information on client acceptance and continuance procedures to help firms manage risk.
This will be the first and only practice alert of the DPFTF as it will soon go out of existence. The PITF, which may be changed to a full- standing committee, will continue to issue practice alerts. When it started, it identified 15 issues for consideration.
These practice alerts are nonauthoritative. Consideration is being given to including them in the AICPA loose-leaf service, Technical Practice Aids, that includes nonauthoritative examples and commentaries.
Small Firm Advocacy Committee. The AICPA Board of Directors, at its July meeting, established a small firm advocacy committee (SFAC) trader the jurisdiction of the PCP Executive Committee to act as an advocate in all areas of practice for firms with no more than 10 professionals. William Brown, CPA, a New York City practitioner, was appointed chair of the new committee.
Loan Application Package from Robert Morris Associates. Working with the Technical Issues Committee of PCPS, Robert Morris Associates (the association of loan officers) has developed a loan-application package for use by small businesses, the "Business Credit Information Package." It is designed to provide the framework for privately owned businesses to gather and summarize financial information to be submitted to prospective lenders without significant cost. There are two aspects of the form that practitioners should be aware of:
* The accountant's report in the package, if used as designed, probably establishes privity between the bank and the firm. In certain jurisdictions this could expose the firm to additional liability risk.
* The level of reporting by the accountant is a compilation. While keeping costs to a minimum, the prospective lender may not understand that a compilation report gives no assurance about the reliability of the financial information. The practitioner should make sure the lender understands the nature of a compilation report.
Achieving Balance. In June, the AICPA, NYSSCPA, and Catalyst, a research and consulting organization on women's leadership development, sponsored a conference, "Achieving a Balance in the Accounting Workplace: Gender, Upward Mobility, Work, and Family." The conference marked the first time that high-level speakers gathered at a national conference to openly discuss women, work, and family issues in the accounting profession. The conference presented the need for accounting firms and all businesses to provide increased flexibility in the workplace to provide for the changing nature of today's work force and its increased diversity.
Score Card for the Profession
Certain members of Congress, as a condition of giving further consideration of liability reform, requested that the GAO analyze the many recommendations made by various commissions and reports--POB, Treadway, Cohen--to strengthen the profession and the response actually made to the recommendations. The AICPA has volunteered assistance for the project.
In some ways it is ironic that the profession's own attempts to respond to the needs of the public and regulators and improve the profession may end up being used against it in seeking liability reform.
1994 Was a Busy Year
Much is happening in the profession, and 1994 has been especially busy. It is important that all CPAs be aware of the many factors and forces that are being applied to the profession. We hope we have been of help.
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