Category: FINANCIAL REPORTING DOSSIER

On 12th February, 2021, the International Accounting Standards Board (IASB) issued narrow-scope amendments to IAS 1, Presentation of Financial Statements; IFRS Practice Statement 2, Making Materiality Judgments; and IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors (effective 1st January, 2023). The IAS 1 amendments require companies to disclose their material accounting policy information rather than significant accounting policies. The amended Practice Statement provides guidance on how to apply the materiality concept to accounting policy disclosures, while the IAS 8 amendments clarify how to distinguish changes in accounting policies from changes in accounting estimates. [https://www.ifrs.org/news-and-events/news/2021/02/iasb-amends-ifrs-standards-accounting-policy-disclosures-accounting-policies-accounting-estimates/]

FRC: Virtual and Augmented Reality (VR & AR) in Corporate Reporting

On 17th February, 2021, the UK Financial Reporting Council (FRC) released a report, Virtual and Augmented Reality in Corporate Reporting – Digital Future of Corporate Reporting, that considers how VR & AR are and might be used to expand the scope and audience for corporate reporting; it includes examples of current practice and some possible future uses, and stresses on the related ability to bridge between the physical and the digital thereby giving it a useful role in supporting and building understanding about a company, its business model and its operations at a distance and scale. [https://www.frc.org.uk/getattachment/e1e6befb-d635-4284-a022-2354a04d5873/VR-and-AR-in-corporate-reporting-1702.pdf]

FRC: Updated Principles for Operational Separation of the Audit Practices of the Big 4

On 23rd February, 2021, the FRC published updated principles for the Operational Separation of the Audit Practices of the ‘Big 4’, stating its desired outcomes that include: the total amount of profits distributed to the partners in the audit practice should not persistently exceed the contribution to profits of the audit practice; individual audit partner remuneration is determined above all by contribution to audit quality; and, auditors are not (nor viewed as or considered to be) consultants. [https://www.frc.org.uk/getattachment/281a7d7e-74fe-43f7-854a-e52158bc6ae2/Operational-separation-principles-published-February-2021-(005).pdf]

IAASB: Support Material to Help Auditors Address Risk of Overreliance on Technology

On 18th March, 2021, the International Auditing and Assurance Standards Board (IAASB) released a non-authoritative support material, viz. FAQ Addressing the Risk of Overreliance on Technology – Use of ATT and Use of Information Produced by the Entity’s Systems that considers how the auditor can address automation bias and the risk of overreliance on technology when using ATT and when using the information produced by an entity’s systems. [https://www.ifac.org/system/files/publications/files/IAASB-Automated-Tools-Techniques-FAQ.pdf]

IASB: Proposed New Approach to Developing Disclosure Requirements in IFRS

On 25th March, 2021, the IASB issued an Exposure Draft, Disclosure Requirements in IFRS Standards – A Pilot Approach, setting out a new approach to developing disclosure requirements in IFRS Standards that are intended to better enable companies and auditors to make more effective materiality judgements and provide more useful disclosures to investors. This new approach has been tested for two IFRS, viz. IFRS 13, Fair Value Measurement, and IAS 19, Employee Benefits, where disclosure amendments are proposed. [https://www.ifrs.org/news-and-events/news/2021/03/iasb-proposes-a-new-approach/]

 
IESBA: New Measures to Safeguard Auditor Independence in relation to Non-Assurance Services and Fees Paid by Audit Clients

On 28th April, 2021, the International Ethics Standards Board for Accountants (IESBA) released revisions to the Non-Assurance Services (NAS) and Fee-related provisions of the International Code of Ethics for Professional Accountants (including International Independence Standards). The package of new measures (effective 15th December, 2022) includes: a far-reaching prohibition on audit firms from providing an NAS that might create a self-review threat to an audit client that is a public interest entity; strengthened provisions to address undue fee dependency on audit clients; and comprehensive guidance to steer auditor’s threat assessments and actions in relation to NAS and fees. [https://www.ethicsboard.org/news-events/2021-04/global-ethics-board-takes-major-step-forward-strengthening-auditor-independence]

2. Research – Prior Period Errors

Setting the Context

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that a) was available when financial statements for those periods were authorised for issue; and b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. [IAS 8.5]

The approaches adopted by global accounting standard-setters to correct prior period errors include a ‘current’ / ‘cumulative catch-up’ and a ‘retroactive’ / ‘retrospective restatement’ method. Both approaches do not entail ‘reissuance’ / ‘amendment’ of previously issued financial statements.

Standard-setters have, by and large, refrained from prescribing ‘reissuance’ (also termed ‘republication’ / ‘revision’ / ‘amendment’) of previously issued financial statements and have left it to be addressed by local company law / capital market regulations1 and auditing standards.

1 For instance, when previously issued financial statements contain errors, effects of which are so large that they are considered to be no longer reliable, the Indian Company Law contains provisions with respect to revising such previously issued financial statements (section 131). In the US, the capital market regulator (SEC) requires material misstatements in previously issued financial statements to be dealt with via a restatement wherein financial statements previously issued are declared as unreliable and are required to be republished. In this context, it may be noted that IFRS (and Ind AS) mandate the presentation of a third balance sheet at the beginning of the comparative period in case of correction of material prior period errors, which to an extent could be perceived as a form of modified reissuance

In the following sections, an attempt is made to address the following questions: What have been the historical developments and approaches adopted by global standard-setters, and what is the current position under prominent GAAPs?

The position under prominent GAAPs

Current Position

Extant USGAAP defines ‘Error in Previously Issued Financial Statements’ as an error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles, or oversight or misuse of facts that existed at the time that the financial statements were prepared. [ASC 250-10-20]

Errors in the financial statements of a prior period discovered after the financial statements are issued need to be reported as an error correction by restating the prior-period financial statements. In the context of restatement, ASC 250-10-45-23 requires all of the following:

i) The cumulative effect of the error on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented.

ii) An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period.

iii) Financial statements for each individual prior period presented shall be adjusted to reflect correction of the period-specific effects of the error.

An entity is also required to disclose the following: a) that its previously issued financial statements have been restated; b) the effect of the correction on each financial statement line item and EPS for each prior period; and c) the cumulative effect of the change on retained earnings as of the beginning of the earliest period presented. [ASC 250-10-50-7]

While the above is the position under USGAAP as issued by the Financial Accounting Standards Board (FASB), it may be noted that US-listed entities (‘SEC registrants’) need to additionally comply with SEC regulations including the provisions of Staff Accounting Bulletin (SAB) 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. As per this SAB, in general, the manner in which prior period errors are corrected is a function of its materiality. In case prior period financial statements are materially misstated, they need to be corrected via a restatement (also referred to as a ‘Big R’ Restatement), while prior period errors that do not result in material misstatements are corrected via a revision (that is also referred to as a ‘little r’ revision).

A Big R restatement involves a declaration to be made by the entity (for which SEC prescribes a Form) that its previously filed financial statements (annual / quarterly reports in Form 10-K/10-Q) are unreliable and the previously misstated annual / quarterly reports are required to be restated by amending (i.e., reissuing) them. Further, in the current period financial statements the corrected prior year figures are labelled as being ‘restated’.

On the other hand, the correction of non-material errors (i.e., a little r revision) does not entail amendment of previously filed annual / quarterly reports. In the current period, the nature and impact of the error needs to be disclosed in the notes and it may be noted that the comparative figures are not labelled as restated on account of them being non-material in prior periods.

Historical developments

The Accounting Principles Board (APB) Opinion No. 20, Accounting Changes (issued 1971) dealt with this accounting topic and the Board opined that the correction of an error in the financial statements of a prior period discovered subsequent to their issuance should be reported as a prior period adjustment [Para 36]. In this context, one had to refer the related guidance provided in APB Opinion No. 9, Reporting the Results of Operations which prescribed that when comparative statements are presented, corresponding adjustments should be made of amounts of net income and retained earnings balances for all of the periods presented therein, to reflect the retroactive application of the prior period adjustment [Para 18]. Disclosures were required about the nature of error and the effect of its correction on income before extraordinary items, net income and related EPS amounts in the period in which the error was discovered and corrected. [APB Opinion No. 20.37]

In 2005, the FASB replaced APB Opinion No. 20 by issuing SFAS No. 154, Accounting Changes and Error Corrections (which is the current codified USGAAP standard) that redefined restatement as the process of revising previously issued financial statements to reflect the correction of an error in those financial statements. It also carried forward, without change, the related guidance contained in APB Opinion No. 20.

IFRS

Current Position

The position under IFRS (IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors) is as follows: ‘an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:

a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or

b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. [IAS 8.42]

In the above context, retrospective restatement is correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred. [IAS 8.5]

Further, IAS 1, Presentation of Financial Statements mandates presentation of a third Statement of Financial Position (SOFP) [‘3rd Balance Sheet’] as at the beginning of the preceding period if an entity makes a retrospective restatement of items in its financial statements that has a material effect on information in the SOFP at the beginning of the preceding period. [IAS 1.40A]

Historical developments

Under International Accounting Standards (now IFRS) IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies was issued in 1993 (replacing an earlier 1978 version). The standard categorised prior period errors as: (i) Fundamental errors, and (ii) Other material prior period errors.

Fundamental errors was defined as errors discovered in the current period that are of such significance that the financial statements of one or more prior periods could no longer be considered to have been reliable at the date of their issue. The 1993 version of IAS 8 permitted an accounting choice with respect to correction of fundamental errors, viz., a ‘benchmark’ treatment and an ‘allowed alternative’. Under the ‘benchmark treatment’, financial statements including comparative information for prior periods were retroactively corrected by presenting them as if the fundamental error had been corrected in those period(s) itself. Corrections related to periods prior to it was required to be adjusted against opening balance of retained earnings in the earliest period presented. While, under the ‘allowed alternative’, the amount of correction of errors was included in the determination of net profit or loss for the current period with comparative information presented as reported in financial statements of prior periods. In addition, an entity was mandated to present additional pro-forma information per the ‘benchmark treatment’.

The correction of other material prior period errors was required to be included in the determination of profit and loss for the current period.

In 2003, the IASB revised IAS 8 (rechristened as Accounting Policies, Changes in Accounting Estimates and Errors) with a view to improve the standard via removal of the accounting choice, thereby addressing criticism by regulators and other stakeholders.

The 2003 revisions to IAS 8 (extant IFRS) involved: requirement of retrospective restatement to correct prior period errors; removal of the ‘allowed alternative’ treatment; and elimination of the distinction between fundamental errors and other material errors. As a result of the removal of the allowed alternative and requirement of retrospective restatement, comparative information for prior periods is presented as if the prior period errors had never occurred.

Ind AS

Indian Accounting Standards (Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors) is aligned with its IFRS counterpart IAS 8 on error corrections.

AS

AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies defines prior period items as income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods [Para 4.3]. Such errors are corrected adopting a cumulative catch-up approach without disturbing the comparative period figures / opening retained earnings.

Per AS 5, prior period items are normally included in the determination of net profit or loss for the current period. An alternate approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss. [AS 5.19]

The Little GAAPs

US FRF for SMEs

The US Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) issued by the AICPA requires material prior period errors to be corrected retrospectively by restating the comparative amounts for the prior period(s) presented when the error occurred or, if the error occurred before the earliest prior period presented, by restating the opening balances of assets, liabilities and equity for the earliest prior period presented. [Chapter 9, Accounting Changes, Changes in Accounting Estimates, and Correction of Errors. Para 22.]

IFRS for SMEs

The accounting treatment for material prior period errors under the IFRS for SMEs framework (Section 10, Accounting Policies, Estimates and Errors. Para 21) is similar to that under the US FRF for SMEs framework.

3. Global Annual Report Extracts:

‘Reporting on Auditor’s Independence and Objectivity when Non-Audit services Provided’

 

Background

The UK Corporate Governance Code [July, 2018] issued by the FRC requires Audit Committees to explain how auditor independence and objectivity are safeguarded, if the external auditor provides non-audit services. This reporting obligation is contained in Section 4, Principle M, Provision 26 of the Code (extracted below):

Section 4 – Audit, Risk and Internal Control; Principle M – The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements; Provision 26 – The annual report should describe the work of the audit committee, including: an explanation of how auditor independence and objectivity are safeguarded, if the external auditor provides non-audit services.

Extracts from an Annual Report

Extracts from Audit Committee Report

Independence and Objectivity

In order to ensure the independence and objectivity of the external auditor, the Audit Committee maintains and regularly reviews the Auditor Independence Policy which covers non-audit services which may be provided by the external auditor, and permitted fees.

The Group has a policy on the supply of non-audit services by the external auditor. The policy prohibits certain categories of work in accordance with the guidance such as the FRC Ethical Standard. The external auditor is permitted to undertake some non-audit services under the Group’s policy, providing it has the skill, competence, integrity and appropriate independence safeguards in place to carry out the work in the best interests of the Group. All proposed permitted non-audit services are subject to the prior approval of the Audit Committee.

During 2019/20, total non-audit fees paid to the external auditor of GBP 0.3 million were 8% of the annual Group audit fee (2018/19: GBP 1.6 million: 46%). In addition GBP 9.6 million was paid to other accounting firms for non-audit work, including GBP 0.8 million for work relating to internal audit. The EU Audit Regulation and the FRC’s Revised Ethical Standard of June, 2016 mean that, with effect from the Group’s 2020/21 year, a cap on the ratio of non-audit fees to audit fees paid to the Auditor of 70% applies, which will further restrict the non-audit services permitted.

Annually, the Audit Committee receives written confirmation from the external auditor of the following:

•  Whether they have identified any relationships that might have a bearing on their independence,

•  Whether they consider themselves independent within the meaning of the UK regulatory and professional requirements,

•  The continued suitability of their quality control processes and ethical standards.

The external auditor also confirmed that no non-audit services prohibited by the FRC’s Revised Ethical Standard were provided to the Group. On the basis of the Committee’s own review, approval requirements in the non-audit services policy, and the external auditor’s confirmations, the Audit Committee is satisfied with the external auditor’s independence and effectiveness.

4. AUDITS – Enforcement Actions by Global Regulators

The Public Company Accounting Oversight Board (PCAOB)

A. Enforcement Actions

The US PCAOB imposes appropriate sanctions in settled and litigated disciplinary proceedings against audit firms and auditors. Herein below are provided summaries of certain recent orders:

1) Disciplinary proceedings against an Audit Manager for modification of audit work papers in violation of PCAOB audit documentation standards

The Case: Following the documentation completion date for a client and its subsidiary, the respondent (Audit Manager) learned that the subsidiary audit had been selected for review as part of an upcoming PCAOB inspection of the respondent’s audit firm. The respondent thereafter oversaw the modification of four work papers to add descriptions of audit procedures. Those modified work papers were then included in hard copy binders provided to PCAOB inspectors without any indication that modifications had been made, nor any information about when, why, or by whom they had been modified.

PCAOB Rules / Standards Requirement: ‘Prior to the report release date, the auditor must have completed all necessary auditing procedures and obtained sufficient evidence to support the representations in the auditor’s report. A complete and final set of audit documentation should be assembled for retention as of a date not more than 45 days after the report release date (documentation completion date)’.

The Order: The PCAOB barred the respondent manager of the audit firm from being an associated person of a registered public accounting firm. The sanction was imposed on the basis of findings that the respondent failed to co-operate with its inspection and violated audit documentation standards. [PCAOB Release No. 105-2021-001 dated 29th March, 2021]

2) Respondent audit firm violated standards for using an unregistered component auditor’s work

The Case: The respondent audit firm (‘principal auditor’), during three consecutive audits of a client, used the work of a Mexican public accounting firm (‘component auditor’) not registered with the PCAOB in opining on an issuer’s consolidated financial statements. The component auditor audited over 90% of consolidated assets and performed services that the principal auditor used or relied on in issuing its audit reports, despite knowing from inquiries that it was not PCAOB-registered. Further, the audit reports did not make reference to another auditor. The Mexican firm’s personnel were not trained in PCAOB standards and performed procedures in accordance with Mexican Auditing Standards.

PCAOB Rules / Standards requirement: An auditor may express an unqualified opinion on an issuer’s financial statements only when the auditor has formed such an opinion on the basis of an audit performed in accordance with PCAOB standards.

The Order: The PCAOB imposed sanctions on the respondent firm by censuring it and imposing a monetary penalty of $25,000 for violating PCAOB rules and standards. It held that the principal auditor failed to determine whether the component auditor’s work was compliant with PCAOB standards. [PCAOB Release No. 105-2021-002 dated 30th March, 2021]

B. Deficiencies identified in audits

The PCAOB annually inspects registered audit firms that issue more than 100 audit reports (and all other firms, at least once every three years) aimed at assessing compliance with certain laws, rules and professional standards in connection with a firm’s audit work. Herein below are extracted audit deficiencies identified in the work of audit firms from its recently released inspection reports:

1) Buchbinder Tunick & Company LLP, New York

Audit area: Equity – The audit client (in ‘Healthcare’ sector) engaged an external party to perform testing of controls over equity and used it as evidence of the effectiveness of related controls.

Audit deficiency identified: Since the audit firm identified a significant risk associated with an equity transaction that the client entered into during the year, the audit firm’s use of the work of the external party, without performing its own work, did not provide sufficient appropriate audit evidence that such controls were designed and operating effectively. Further, the audit firm did not perform any procedures to evaluate the quality and effectiveness of the external party’s work. [Release No. 104-2021-066 dated 24th February, 2021]

2) Pricewaterhouse Coopers AS, Norway

Audit area: Revenue – A component of the audit client (in ‘Energy’ sector) entered into long-term contractual arrangements with customers for products and services, and the management represented that contracts generally contained one performance obligation.

Audit deficiency identified: The audit firm (that played a role but was not the principal auditor of the audit component) did not evaluate whether contracts contained multiple performance obligations and, if they did, whether revenue was appropriately allocated to each distinct performance obligation and recognised only when the related performance obligations were satisfied. [Release No. 104-2021-075 dated 24th February, 2021]

 

The Securities Exchange Commission (SEC)

The US SEC, in the public interest institutes public administrative proceedings against audit firms and securities issuers pursuant to the Securities Exchange Act of 1934. Herein below is provided a summary of a recent order:

1. Audit partner and audit manager suspended for improper professional conduct during an audit of a not-for-profit college

The Case: The audited financial statements of a not-for-profit college, submitted to the Municipal Securities Rulemaking Board (pursuant to its obligation to provide continuing disclosure to investors) had an unmodified audit opinion (F.Y. 2015), despite the existence of numerous outstanding open items, unanswered questions and not having completed critical audit steps. The college, in order to bridge an increasing gap between its revenues and expenses, began using funds (from 2013) in its endowment to pay for operating expenses. Such consumption of funds resulted in a precipitous decline in its net assets. In order to conceal it, the controller engaged in a fraudulent scheme including intentionally withholding payroll tax remittances and, instead of reporting the liabilities, it recorded a series of improper and unsupported journal entries to conceal them. The controller also hid numerous past due vendor invoices in his office, preventing them from being recorded and allowed receivables to be reported at inflated values. As a result of such practices, the college’s net assets were overstated by $33.8 million, an overstatement that impacted virtually every amount reported on the balance sheet.

The Violations: The auditors failed to comply with auditing standards stemming from failures to: obtain sufficient appropriate audit evidence; properly prepare audit documentation; properly examine journal entries for evidence of fraud due to management override; adequately assess the risk of material misstatement; communicate significant audit challenges to those charged with governance; properly supervise the audit; and exercise due professional care and professional scepticism. These pervasive audit failures significantly reduced the audit team’s ability to detect the fraud.

The Order: The SEC ordered the suspension of the audit partner and audit manager from appearing or practicing before the SEC as an accountant with the right to apply for reinstatement after three years and one year, respectively. [Press Release 2021-32 dated 23rd February, 2021]

The Financial Reporting Council (FRC)

The FRC (the competent authority for statutory audit in the UK) operates the Audit Enforcement Procedure that sets out the rules and procedures for investigation, prosecution and sanctioning of breaches of relevant requirements. Herein below are summarised key adverse findings from a recent Final Decision Notice following an investigation:

1) Adverse finding – Key Audit Matters: The respondent’s (audit firm’s) audit work in the area of revenue recognition and recoverability of debtors did not comply with requirements of ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. That area was identified, both in the audit file and the auditor’s report, as a KAM. However, the reasoning behind that identification was lacking; the audit team’s assessment of the risks in relation to revenue recognition had, in fact, led them to a contrary conclusion; and the identification of this matter as a KAM was an error.

2) Adverse finding – Going Concern: It was noted that there was a material uncertainty in relation to going concern in the directors’ report, the notes to the financial statements and the audit report. The respondents, in the audit report, drew attention to the directors’ consideration of going concern and the measures which could be taken by the directors to mitigate the material uncertainty as to going concern. The respondents’ opinion in this regard depended upon their appropriate challenge to management in areas including the feasibility of raising funds and the adequacy of the disclosures related to going concern. Although the respondents recorded, in the relevant work-paper on the audit file, that they had performed the necessary audit work in this area, including the required challenge to management, the evidence of the work is not otherwise sufficiently documented on the audit file. This deficiency was a breach of the requirements of ISA 230, Audit Documentation. [https://www.frc.org.uk/news/may-2021/sanctions-against-haysmacintyre-and-a-partner]

5. COMPLIANCE: Investment Property Disclosures Under Ind AS

Background

Under Ind AS, Investment Property is property (land or a building, or part of a building or both) held to earn rentals, or for capital appreciation, or both. An investment property generates cash flows largely independently of the other assets held by an entity. This is a key distinguishing factor between owner-occupied property (accounted under Ind AS 16, Property, Plant and Equipment) and investment property (accounted under Ind AS 40, Investment Property).

An entity needs to take into consideration relevant requirements of Ind AS 40 in complying with the related disclosure requirements. The same is summarised in Table A below:

Table A: Disclosure requirements
(investment property)

6. INTEGRATED REPORTING

a) Key Recent Updates

IOSCO: Encouraging Globally Consistent Standards for Sustainability Reporting Identified as a Priority Area

On 24th February, 2021, the International Organization of Securities Commissions (IOSCO), issued a statement which underscores the urgent need to progress towards a globally consistent application of a common set of international standards for sustainability-related disclosure across jurisdictions. Other priority areas identified by the Board include promoting greater emphasis on industry-specific, quantitative metrics in companies’ sustainability-related disclosures and standardisation of narrative information.

IFRS Foundation Announcement: Global Sustainability Reporting Standards

And on 22nd March, 2021, the IFRS Foundation Trustees announced the formation of a working group to accelerate convergence in global sustainability reporting standards (focused on enterprise value) and to undertake technical preparation for a potential International Sustainability Reporting Standards Board under the governance of the IFRS Foundation. [https://www.ifrs.org/news-and-events/news/2021/03/trustees-announce-working-group/]

b) Reporting on factors affecting an organisation’s ability to create value over time

Background

The International Integrated Reporting Council’s (IIRC) long-term vision is a world in which integrated thinking is embedded within mainstream business practice in public and private sectors, facilitated by Integrated Reporting as the corporate reporting norm. According to the IIRC, the cycle of Integrated Reporting and thinking, resulting in efficient and productive capital allocation, will act as a force for financial stability and sustainable development.

One of the Guiding Principles of Integrated Reporting is that ‘an Integrated Report should show a holistic picture of the combination, interrelatedness and dependencies between the factors that affect the organisation’s ability to create value over time. [Para 3.6, Part 2]

Extracts from Integrated Report of The Crown Estate (an independent organisation created by UK Statute) [2019/20 revenue – GBP 516.2 million]

Creating Value

We seek to deliver our purpose through our strategy, enabled by our business model. Our competitive advantage comes from bringing our capabilities to bear on a diverse and world-class portfolio of assets, using scale and our expertise to generate outperformance and create value for our customers, stakeholders, environment and society.

c) INTEGRATED REPORTING MATERIAL

1. IIRC: International <IR> Framework – 2013/2021 Comparison Document. [11th March, 2021]

2. GRI and SASB: A Practical Guide to Sustainability Reporting Using GRI and SASB Standards. [8th April, 2021]

3. SASB: Climate Risk Technical Bulletin – 2021 Edition. [13th April, 2021]

7. FROM THE PAST – ‘Dispelling Myths about IFRS’

Extracts from a speech by Hans Hoogervorst (Chairman of the IASB) in November, 2012 while inaugurating the first office of the IASB outside London in the Asia-Oceania region is reproduced below:

‘One persistent myth about the IASB is that we (perhaps secretly) would only be interested in fair value. The truth is that we have always been proponents of a mixed measurement model. We understand fully well that while fair value measurement is very relevant for actively traded financial instruments, for a manufacturing company it does normally not make a lot of sense to fair value its Property, Plant and Equipment.

The second myth that I would like to touch upon is that the IASB is only interested in the balance sheet, and that we aim to replace net income with comprehensive income. Again, I see no evidence of such bias. We do not designate one type of information, about balance sheet or about profit and loss, as the primary focus of financial reporting. Both are indeed complementary. We also view net income as an important performance indicator.

The two preceding misconceptions have led to a third persistent myth, namely, that IFRSs are only of use to the financial whizz-kids in London and Wall Street. This myth holds that our standards are incompatible with the culture of countries with a strong manufacturing tradition. Again, this is not true. Around the world, the vast majority of companies using IFRS are normal businesses involved in normal business activities such as manufacturing, retail and the services sector. Since the global financial crisis first broke out in 2007, media coverage of IFRS has been dominated by what it means for financial institutions. Media coverage is one thing, but the reality is that IFRSs are used day in, day out by businesses in the “real economy”.’

1. SEC – ENHANCED DISCLOSURES FOR SPACs AND SHELL COMPANIES

On 30th March 2022, the US Securities and Exchange Commission (SEC) proposed new rules to enhance disclosure and investor protection in IPOs by special purpose acquisition companies (SPACs) and in business combination transactions involving shell companies (such as SPACs and private operating companies). The proposals, inter-alia, include additional disclosures about SPAC sponsors, conflicts of interest and sources of dilution. Additional disclosures are required regarding business combination transactions between SPACs and private operating companies, including disclosures relating to the fairness of the transactions. [https://www.sec.gov/rules/proposed/2022/33-11048.pdf]

2. PCAOB – KEY CONSIDERATIONS FOR AUDITORS RELATED TO THE RUSSIAN INVASION OF UKRAINE

On 31st March, 2022, the Public Company Accounting Oversight Board (PCAOB) released a staff Spotlight document, Auditing Considerations Related to the Invasion of Ukraine, that highlights important considerations for auditors of issuers and broker-dealers in conducting audits in the current evolving geo-political environment.  It covers a range of audit-related matters, including identifying and assessing risks, planning, and performing audit procedures, possible illegal acts, reviews of interim financial information, and acceptance and continuance of clients and engagements. The Spotlight also reminds auditors to remain aware of developments that may affect the issuer company. [https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/documents/auditing-considerations-related-invasion-ukraine-spotlight.pdf?sfvrsn=19dc6043_3]

3. IAASB – STANDARD FOR GROUP AUDITS MODERNIZED IN SUPPORT OF AUDIT QUALITY

On 7th April, 2022, the International Auditing and Assurance Standards Board (IAASB) released International Standard on Auditing (ISA) 600 (Revised), Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors). The revised ISA includes a robust risk-based approach to planning and performing a group audit. The approach focuses the group auditor’s attention and work effort on identifying and assessing the risks of material misstatement of the group financial statements and designing and performing further audit procedures to respond to those assessed risks. It also recognizes that component auditors can be, and often are, involved in all phases of the group audit. The revised standard promotes a clear, proactive, and scalable approach for group audits that can be applied to current evolving group audit structures. The revised standard is effective for audits of group financial statements for periods beginning on or after 15th December, 2023. [https://www.iaasb.org/publications/international-standard-auditing-600-revised-special-considerations-audits-group-financial-statements]

4. IESBA – UNIVERSE OF ENTITIES THAT ARE PUBLIC INTEREST ENTITIES (PIEs) EXPANDED

On 11th April, 2022, the International Ethics Standards Board for Accountants (IESBA) released a revised definition of a PIE and other revised provisions in the International Code of Ethics for Professional Accountants (including International Independence Standards). The revised provisions specify a broader list of categories of entities as PIEs whose audits should be subject to additional independence requirements to meet stakeholders’ heightened expectations concerning auditor independence when an entity is a PIE. The revisions: articulate an overarching objective for additional independence requirements for audits of financial statements of PIEs; provide guidance on factors to consider when determining the level of public interest in an entity and replaces the term ‘listed entity’ with a new term ‘publicly traded entity’. The revised PIE definition and related provisions are effective for audits of financial statements for periods beginning on or after 15th December, 2024. [https://www.ethicsboard.org/publications/final-pronouncement-revisions-definitions-listed-entity-and-public-interest-entity-code]

5. IAASB – ‘ENGAGEMENT TEAM’ – QUALITY MANAGEMENT STANDARDS

And on 2nd May, 2022, the IAASB released a Fact Sheet, ISA 220 (Revised), Definition of Engagement Team, to facilitate users of auditing standards to adapt to the clarified and updated definition of ‘Engagement Team’. The fact sheet addresses the clarified definition and its possible impacts, including the recognition that engagement teams may be organized in various ways, including across different locations or by the activity they are performing. The fact sheet also includes a diagram that walks users through who specifically is included and excluded. It may be noted that the new definition of ‘engagement team’ applies to ISAs and ISQMs. [https://www.iaasb.org/publications/isa-220-revised-definition-engagement-team-fact-sheet]

• INTERNATIONAL FINANCIAL REPORTING MATERIAL

1. IFAC – Exploring the IESBA Code, A Focus on Technology – Artificial Intelligence. [11th March, 2022.]

2. IFAC – Auditing Accounting Estimates: ISA 540 (Revised) Implementation Tool. [5th April, 2022.]

3. IFAC – Audit Fees Survey 2022: Understanding Audit and Non-Audit Service Fees, 2013-2020. [25th April, 2022.]

4. IFAC – Mindset and Enabling Skills of Professional Accountants – A Competence Paradigm Shift – Thought Leadership Series. [27th April, 2022.]

5. UK FRC – Supply Chain Disclosure – Lab Insight. [29th April, 2022.]

6. IAASB – The Fraud Lens – Interactions Between ISA 240 and Other ISAs – A Non-authoritative Guidance on Fraud in an Audit of Financial Statements. [5th May, 2022.]

B. EVOLUTION AND ANALYSIS OF ACCOUNTING CONCEPTS – LIFO

SETTING THE CONTEXT
The objective of inventory valuation for financial reporting purposes is to facilitate periodic income determination. Accounting frameworks guide the determination of inventory costs and the related cost formulas. The cost formula to be used is a function of whether the inventories held by a reporting entity are ‘ordinarily interchangeable’ or ‘not ordinarily interchangeable’. For instance, generally across prominent GAAPs dealt in this feature, the ‘specific identification method’ must be used for inventories that are not ordinarily interchangeable or segregated for specific projects. However, in the case of other inventories, barring US standards, inventory cost can be assigned using either the ‘first-in, first-out’ (FIFO) or ‘weighted average’ cost formula. USGAAP permits the use of the ‘last-in, first-out’ (LIFO) cost formula too.

In the US, LIFOs entry into the accounting literature and the vehement resistance to its repeal is courtesy of US tax laws. Using LIFO for tax purposes while using FIFO for financial reporting purposes provided the advantage of reporting higher accounting earnings to shareholders. For this reason, the ‘LIFO conformity rules’ were instituted in the US tax laws– whereby a company that opts to use LIFO for tax purposes must compulsorily use LIFO for financial reporting purposes. Historically, companies that desired to save taxes pressurised regulators to embed it in USGAAP. It may also be noted that a significant showstopper for a complete USGAAP convergence with IFRS has been LIFO.

Under IFRS (IAS 2), LIFO was an accepted cost formula until its prohibition effective 2005. The IASB believed that tax considerations do not provide an adequate conceptual basis for selecting an appropriate accounting treatment and that it is not acceptable to allow an inferior accounting treatment purely because of tax regulations and advantages in particular jurisdictions. [IAS 2. BC 20.]  (emphasis supplied)

THE POSITION UNDER PROMINENT GAAPS

US GAAP

HISTORICAL DEVELOPMENTS
The genesis of the LIFO concept (as a basis for accounting inventories) can be traced to the base stock method. Base stock is a minimum inventory quantity identified as essential in certain operations to maintain continuity, with the cost of minimum inventories being analogous to investment in fixed assets. The base tock method assigns an arbitrary/ nominal cost basis to such fixed minimum quantity (the base quantity being carried forward from year to year at its original cost or an arbitrary nominal cost). In the United States, this method was disallowed for income tax purposes in the 1920s, with LIFO adopted as a substitute. The American Petroleum Institute recommended the adoption of LIFO for the oil industry in 1934 which was approved by a special committee of the American Institute of Accountants (in 1936). In 1938, Congress amended the tax law to recognize LIFO as an acceptable method for specified sectors. The tax law was further amended in 1939, permitting LIFO to all industries, with the condition that taxpayers using LIFO must compulsorily use it for general financial reporting purposes, too (LIFO Conformity Requirement Rules).

According to Accounting Research Study (ARS) No. 13, Accounting Basis of Inventories, a non-official pronouncement of the AICPA issued in 1973: ‘LIFO is a compromise method of achieving a matching of costs and revenue recommended under base stock theory, without a theory of its own. It is not a method of determining cost of products as such. It is, instead, a method of matching costs and revenue under an artificial assumption that dissociates the flow of cost incurrence from the physical flow of product’.

The first general pronouncement on inventories issued by the American Institute of Certified Public Accountants’ (AICPA) Committee on Accounting Procedure (CAP) was Accounting Research Bulletin (ARB) No. 29, Inventory Pricing. The bulletin issued in July, 1947, contained the following statement and discussion in the context of the fact that one of several cost flow assumptions may be made to arrive at the financial accounting basis of inventories:

Statement 4 – ‘Cost for inventory purposes may be determined under any one of several assumptions as to the flow of cost factors (such as “first-in first out,” “average,” and “last-in first-out”); the major objective in selecting a method should be to choose the one which, under the circumstances, most clearly reflects periodic income.’

Extracts of accompanying discussion to Statement 4 – The cost to be matched against revenue from a sale may not be the identified cost of the specific item which is sold, especially in cases in which similar goods are purchased at different times and at different prices. Ordinarily, under those circumstances, the identity of goods is lost between the time of acquisition and the time of sale. In any event, if the materials purchased in various lots are identical and interchangeable, the use of identified cost of the various lots may not produce the most useful financial statements. This fact has resulted in the development and general acceptance of several assumptions with respect to the flow of cost factors to provide practical bases for the measurement of periodic income. These methods recognize the variations which exist in the relationships of costs to sales prices under different economic conditions. These methods recognize the variations which exist in the relationships of costs to sales prices under different economic conditions. Thus, where sales prices are promptly influenced by changes in reproductive costs, an assumption of the “last-in first- out” flow of cost factors may be the more appropriate. Where no such cost-price relationship exists, the “first-in first-out” or an “average” method may be more properly utilized.’

In 1953, ARB No. 43 – Restatement and Revision of Accounting Research Bulletins were issued by the Accounting Principles Board (APB), which superseded the CAP, consolidating all the previously published 42 bulletins. Chapter No. 4, Inventory Pricing of ARB No. 43, carried forward the guidance in ARB No. 29 (except for the description of the circumstances under which various cost flows might be appropriate).

CURRENT POSITION
It may be noted that the Statement No.4 of ARB No. 29 (Issued 1947) discussed above is also the current codified USGAAP Topic 330, Inventory.

Accounting Standards Codification, Topic 330 – Inventory issued by the IASB states as follows:

‘Cost for inventory purposes may be determined under any one of several assumptions as to the flow of cost factors, such as first-in first-out (FIFO), average, and last-in first-out (LIFO). The major objective in selecting a method should be to choose the one which, under the circumstances, most clearly reflects periodic income’. [USGAAP 330-10-30-9.]   

IFRS

HISTORICAL DEVELOPMENTS

IAS 2, Inventories (issued in 1993 and that replaced IAS 2, Valuation and Presentation of Inventories in the Context of the Historical Cost System issued in 1975) and an interpretation (SIC – 1, Consistency – Different Cost Formulas for Inventories) provided an accounting alternate in the form of a ‘benchmark treatment’, and an ‘allowed alternative treatment’. For inventories, the benchmark treatment required either the FIFO or weighted average cost formulas. The allowed alternative was the LIFO cost formula.

The IASB made limited revisions to IASs in 2003 as part of its Improvements Project undertaken in the light of criticisms raised by securities regulators and other stakeholders. The project’s objectives were to reduce or eliminate alternatives, redundancies and conflicts within the standards, deal with some convergence issues, and make other improvements. For IAS 2, the Board’s main objective was a limited revision to reduce alternatives for the measurement of inventories.

The Board decided to eliminate the LIFO method because of its lack of representational faithfulness of inventory flows. This decision does not rule out specific cost methods that reflect inventory flows similar to LIFO. [IAS 2 BC.18.] Accordingly, LIFO was prohibited under IFRS effective 1st January, 2005.

CURRENT POSITION
The relevant extracts from extant IFRS (IAS 2, Inventories) are provided below.

‘The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.’ [IAS 2.23.]

‘The cost of inventories, other than those dealt with in paragraph 23, shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified.’ [IAS 2.25.]

AS

CURRENT POSITION
AS 2, Valuation of Inventories permits only the FIFO and weighted average cost formula. As per the standard, ‘the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs.’ [AS 2.14.] And para 16 of AS 2 states – ‘The cost of inventories, other than those dealt with in paragraph 14, should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.’

THE LITTLE GAAPS
 
US FRF FOR SMEs
Chapter 12, Inventories of the AICPA’s US Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs), a self-contained framework not based on USGAAP provides related guidance as follows:

The cost of inventories of items that are not ordinarily inter-changeable, and goods or services produced and segregated for specific projects, should be assigned by using specific identification of their individual costs. [12.16.]

The cost of inventories, other than those dealt with in paragraph 12.16, should be assigned by using the first in, first out (FIFO), last in, first out (LIFO), or weighted average cost formulas. [12.18.]

IFRS FOR SMEs
International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), Section 13, Inventories prohibits the use of the LIFO method. Relevant extracts are provided below.

An entity shall measure the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects by using specific identification of their individual costs. [13.17.]

An entity shall measure the cost of inventories, other than those dealt with in paragraph 13.17, by using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. The last-in, first-out method (LIFO) is not permitted by this Standard. [13.18.]

C. GLOBAL ANNUAL REPORT EXTRACTS – DISCLOSURE: COMPETITIVE TENDER PROCESS FOR STATUTORY AUDITOR APPOINTMENT

BACKGROUND
The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 applies to providing statutory audit services in the UK to large companies. The provisions of the Order (effective 1st January, 2015) apply to a Company from the date on which it enters the FTSE 100 or FTSE 250 index until the date on which it ceases to be an FTSE 350 Company.

The relevant extracts from the Order are provided below.

‘3.1 An Auditor and a FTSE 350 Company must not enter into or give effect to a Statutory Audit Services Agreement unless:

(a)  subject to Article 6, the FTSE 350 Company has made an Auditor Appointment pursuant to a Competitive Tender Process in relation to one or more of the preceding nine consecutive Financial Years or has conducted a Competitive Tender Process for an Auditor Appointment in relation to the Financial Year immediately following these preceding nine consecutive Financial Years; and

(b)  the terms of the Statutory Audit Services Agreement, including, to the extent permissible by law and regulations, the Statutory Audit fee and the scope of the Statutory Audit, have been negotiated and agreed only between:

(i)  the Audit Committee, either acting collectively or through its chairman, for and on behalf of the board of directors; and

(ii)  the Auditor; and

(c)  the provisions of Article 4 have been complied with.’

In this context, ‘competitive tender process’ means a process by which a Company invites and evaluates bids for the provision of statutory audit services from two or more Auditors.

The Order mandates in-scope companies to include a statement of compliance with the provisions of the Order in the Audit Committee Report for each Financial Year. [Part 7.1.]

EXTRACTS FROM ANNUAL REPORTS

1. Taylor Wimpey Plc, (FTSE 100 index constituent); 2021 Revenue – £4.3 billion

Audit Committee Report [2021 Annual Report]

Statement of Compliance
The company has complied throughout the reporting year with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014.

2. Vodafone Group Plc, (FTSE 100 index constituent); 2021 Revenue – €43 billion

Audit Committee Report [2021 Annual Report]

External Audit
The Committee will continue to review the auditor appointment and anticipates that the audit will be put out to tender at least every 10 years. The Company has complied with the Statutory Audit Services Order 2014 for the financial year under review. The last external audit tender took place in 2019 which resulted in the appointment of EY.

3. InterContinental Hotels Group Plc, (FTSE 100 index constituent); 2019 Revenue – $ 4.6 billion

Audit Committee Report [2019 Annual Report]

Audit tender
In accordance with regulations mandating a tender for the 2021 financial year, the Group conducted an audit contract tender in 2019. A sub-committee, including members of the Audit Committee, was established to manage and govern the audit tender process and was accountable to the Audit Committee, which maintained overall ownership of the tender process and ensured that it was run in a fair and balanced manner. The sub-committee was supported by a project team, led by the Group Financial Controller. A summary of the timeline and key activities carried out during the tender process is set out below:

• The request for proposal was issued to firms in May 2019. A data room was established to provide the firms with sufficient information to be able to establish an audit plan. A Q&A process was also set up through a centralised mailbox, allowing the firms to ask questions on the content of the data room or request further information.

• The audit firms participated in a series of meetings with management, which provided a forum for the firms to ask questions arising from their review of the data room, as well as enabling management to interact directly with each proposed audit team.

• Each firm met with the Chair of the Audit Committee.

• Due diligence activities conducted as part of the tender process included:

–  Consideration of the Competition and Market Authority’s review of the effectiveness of competition in the audit market and Sir John Kingman’s independent review of the FRC;

– A review of audit quality reports on the firms issued by the FRC and the Public Company Accounting Oversight Board;

– Each firm completed an independence return, which were reviewed to assess consistency with the Company’s own assessment; and

• Reference checks with comparable companies were completed.

• Written proposals were received in June 2019 and the participating firms presented their proposals to the sub- committee in July 2019.

The principal evaluation criteria used to assess the firms were:

• Audit Quality, including the firm’s internal and external audit inspection results, the ongoing work in respect of quality being undertaken by the firm, how the firm will execute group oversight in areas of significant risk, and how the firm will challenge management; and

• Experience and Capability of each firm to address IHG’s structure and its areas of uniqueness.

Following a detailed review of the performance of each firm and an evaluation against all of the criteria, the sub-committee recommended Pricewaterhouse Coopers LLP (PwC) as its preferred candidate. The factors contributing to the selection of PwC as the preferred candidate included its understanding of the complexities specific to IHG including IHG Rewards Club and the impact of a shared service centre structure on the audit; external quality ratings across the past six years, and the firm’s response to quality findings; internal quality ratings for the proposed team; clear insight into IHG’s control environment; and a robust approach to the audit of IT.

In accordance with statutory requirements, a report on the tender selection procedure and conclusions was prepared and validated by the Audit Committee. The Audit Committee and subsequently the Board approved the recommendation to appoint PwC. In August 2019, the Company announced the Board’s intention to propose to shareholders at the 2021 AGM that PwC be appointed as the Company’s statutory auditor for the financial year ending 31 December 2021.

EY will remain the Group’s auditor for the financial year ending 31 December 2020. Over the intervening period PwC and IHG will run the transition process. The principal activities completed so far include reviewing non-audit services provided to the Group and taking appropriate steps to achieve audit independence during the first half of 2020.

The Group confirms that it has complied with the requirements of The Competition and Markets Authority Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014, which relates to the frequency and governance of tenders for the appointment of the external auditor and the setting of a policy on the provision of non-audit services.

D. FROM THE PAST – ‘RESTORING PUBLIC CONFIDENCE IS SOMETHING THAT THE PROFESSION ITSELF MUST DO’

Extracts from a speech by Daniel L. Goelzer (PCAOB Board Member) at the Investment Company Institute Tax Conference held in 2003:

“It has become commonplace for observers of the accounting profession to open speeches by asserting that the profession is in the midst of the greatest crisis in public confidence in its history. That may well be true. However, it is useful to keep in mind that the profession’s evolution over the last century has been marked by a series of crises, followed by tougher standards and renewed commitment to the public interest. In fact, an argument can be made that the accounting scandal with the most far-reaching impact on the way auditors do their work occurred, not in the 1990s at Enron’s offices in Houston or at WordCom’s headquarters in Mississippi, but during the 1930s in Bridgeport, Connecticut.

Sixty-five years ago, McKesson & Robbins, a pharmaceutical company listed on the New York Stock Exchange and the predecessor of today’s McKesson Corporation, was the focus of the most infamous audit failure in U.S. history.

The corporate collapses, audit failures, and litany of restatements — and the resulting losses suffered by average investors — that marked the last several years have bred deep cynicism and public anger. A good share of that anger and cynicism is directed at the accounting profession. In my view, it is critical to the long-term health of our capital markets that that phenomenon be reversed, and that the public once again view auditors as watchdogs of corporate integrity, rather than as lapdogs of their corporate clients.

I believe that the Board’s aggressive implementation of the blueprint Congress laid out in the Sarbanes-Oxley Act will go a long way toward accomplishing that goal. Ultimately, however, restoring public confidence is something that the profession itself must do.”