Updated audit risk alert: A view from the trenches

The American Institute of Certified Public Accountants (AICPA) recently issued the 2019/2020 edition of the Audit Risk Alert (ARA), General Accounting and Auditing Developments. This publication provides auditors with an overview of recent economic, industry and regulatory developments that might affect how they conduct audits. Here are some highlights to help private companies understand the auditor’s mindset in the current audit season — and beyond.

Economic uncertainty

When assessing risk, auditors must consider the effects of external forces on the organization. These forces are constantly changing, causing auditors to modify their procedures for every audit.

In 2019, the stock markets exceeded expectations, unemployment hit a 50-year low and consumer confidence was high. But not all news was positive. In July 2019, the Federal Reserve lowered the federal funds rate to 2%, citing weak global economic growth, trade policy uncertainty and inflation pressure. Though U.S. gross domestic product (GDP) increased 3.1% in the first quarter and 2.1% in the second quarter, it actually decreased in the second half of 2019.

Though the economic outlook for 2020 is generally positive, uncertainties abound. Moderate U.S. economic growth is likely to continue this year, but at a slower pace than in 2019. In addition to global trade tensions, it’s uncertain how the outcome of the 2020 elections will impact tax policy and government regulations.

This audit season, auditors may ask what your company is doing to fortify its balance sheet against a possible downturn, as well as discussing possible strategies to reduce risk in today’s uncertain environment. They also might be increasingly cautious when setting materiality levels and skeptical when reviewing accounting estimates and going concern assessments.

New accounting rules

In recent years, the Financial Accounting Standards Board (FASB) has updated several major accounting rules. The first major change was the updated guidance on recognizing revenue from contracts. These rules went into effect for public companies and certain not-for-profits in 2018 and for private companies in 2019. So, private companies can expect their auditors to give special attention to contract revenue and related disclosures this audit season.

In general, Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, replaces the transaction- and industry-specific revenue recognition guidance with a principles-based approach for revenue recognition. The core principle of the revised standard is seemingly straightforward: “An entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”

However, implementing the updated revenue recognition guidance has been more difficult than expected. As a result, the FASB has published additional updates to clarify the guidance on performance obligations, licensing, principal vs. agent considerations, and other narrow-scope improvements and practical expedients. The implementation process has strained the accounting resources of many private companies as they’ve struggled to update their systems, gather data and resolve implementation questions.

As a result, in October 2019, the FASB delayed the effective dates of other major updates as follows:

  • From 2020 to 2021 for ASU 2016-02, Leases, for private companies and not-for-profits,
  • From 2020 to 2021 for ASU 2017-12, Derivatives and Hedging, for private companies and not-for-profits,
  • From 2021 to 2023 for ASU 2016-13, Financial Instruments — Credit Losses, for smaller reporting companies,
  • From 2022 to 2023 for ASU 2016-13, Financial Instruments — Credit Losses, for private companies and not-for-profits,
  • From 2021 to 2022 for ASU 2018-12, Financial Services — Insurance, for public companies, and
  • From 2022 to 2024 for ASU 2018-12, Financial Services — Insurance, for smaller reporting companies, private companies and not-for-profits.

These deferrals will give private companies more time to learn best practices from public companies. Going forward, private companies will generally be allowed to implement major updates two years after public companies.

These deferrals aren’t an excuse to procrastinate, however. Be ready for auditors to ask questions about what your company is currently doing to implement the updated leases standard. It goes into effect for fiscal years ending in 2021, but companies may need to identify leases and gather the requisite information now in order to report comparative results by the effective date.

Updated auditing standards

Recent amendments to the auditing standards, which go into effect for fiscal year 2020, bring renewed attention to relationships and transactions with related parties. Expect your auditors to enhance their procedures for 1) identifying previously unidentified or undisclosed related parties, and 2) testing the accuracy and completeness of the related party relationships and transactions.

In addition, the amendments will require additional procedures to evaluate the business purpose of “significant unusual transactions.” These are “outside the normal course of business for the entity or that otherwise appear to be unusual due to their timing, size, or nature.” Auditors must perform procedures to assess whether the transactions may be used to engage in fraudulent financial reporting or conceal misappropriation of assets.

Emerging technologies

Eventually, technology is expected to move the accounting profession toward real-time reporting, real-time analysis and continuous access to data. Technological advances — such as blockchain, artificial intelligence, machine learning and robotic process automation — will be used to revolutionize the audit process, altering such tasks as planning, sampling and data analysis.

On the flip side, some applications of technology — like cloud computing, online transactions and data-sharing with third parties — may expose organizations to cyber-risks. Auditors are expected to play a critical role in identifying those risks and helping to safeguard against potential losses of data and intangible assets.

For more information

To accurately assess audit risk, CPAs must stay on top of changes in market conditions, accounting and auditing standards, and technology — and adjust their audit procedures accordingly. Contact us for the latest developments in these areas and how they’ll affect audit fieldwork in the future.