Not only did the PCAOB staff cite their own inspection findings and disciplinary orders as proving the need to issue Staff Audit Practice Alert No. 12, Matters Relating to Auditing Revenue in an Audit of Financial Statements (SAPA 12) earlier this week, they also cited the revenue recognition fraud found in the most recent 10-year study of U.S. Securities and Exchange Commission enforcement actions conducted by COSO.
Additionally, the PCAOB noted that revenue recognition by companies is a significant driver of a company’s operating results and for that, and other reasons, carries a high risk of fraud.
PCAOB Board Member Jay Hanson shared with FEI Daily, “I am pleased with the revenue practice alert our staff issued this week. It summarizes existing audit standards and highlights the practice issues we have seen through our inspection process the past few years.”
Nine Areas of Auditing Revenue Addressed in SAPA 12
Weighing in at 33-pages, the alert sets forth detailed requirements in nine major areas relating to revenue recognition. As noted in PCAOB’s press release issued on September 9, these are:
- Testing the recognition of revenue from contractual arrangements
- Evaluating the presentation of revenue—gross versus net revenue
- Testing whether revenue was recognized in the correct period
- Evaluating whether the financial statements include the required disclosures regarding revenue
- Responding to risks of material misstatement due to fraud associated with revenue
- Testing and evaluating controls over revenue
- Applying audit sampling procedures to test revenue
- Performing substantive analytical procedures to test revenue
- Testing revenue in companies with multiple locations
First Things First: PCAOB Alerts Are Not Standards
PCAOB alerts do not rise to the level of new auditing standards, per se, because they have not gone through full due process. They are issued by the PCAOB staff to address the application of existing standards. A disclaimer at the top of each such alert specifies, “statements contained in Staff Audit Practice Alerts do not establish rules of the Board…”
While the alert is not a new auditing standard, it does suggest that auditors consider revenue recognition requirements in the context of the following:
- Planning and performing the audit;
- audit methodologies;
- training or other steps to assure that audit standards are followed;
- supervision; and
- engagement quality review
Given the broad-based requirements above, what is the effective date for auditors to follow the alerts direction?
The answer is there is no “effective date” is specified because these alerts are effective upon issuance, unless otherwise stated
With third quarter upon us, and calendar year-end not far behind, I believe the phrase used by PCAOB Board Member Jay Hanson in a comment to FEI Daily may be very insightful:
“While there are no new requirements established by the alert, I believe auditors will find it useful to consider as they plan and perform audits in the coming months.”
What About Rev Rec Convergence?
SAPA 12, while effective immediately for audits of revenue as recognized under current GAAP, references the new revenue recognition standard released concurrently by the FASB and IASB in May. There is a transition period for the new FASB (and IASB) standard, which will become effective at a future date, and SAPA 12 notes:
Hanson adds:
"With changes on the horizon for how companies recognize revenue, we are also carefully monitoring developments and will assess the need for changes to the standards auditors follow in auditing revenue."
I would anticipate that if the force of a Staff Audit Practice Alert does not appear strong enough to address the PCAOB’s concerns with audit deficiencies vis-à-vis existing audit standards, or any additional audit-related concerns as companies move to implement the new FASB revenue recognition standard, the PCAOB may consider a new standard-setting project. The audit regulator regularly discusses its
standard-setting agenda in connection with emerging audit issues, for example, with its
Standing Advisory Group (SAG) and in outreach with other constituents.
Audit Committees, This Means You Too
The PCAOB emphasizes in both SAPA 12 on revenue recognition and the accompanying press release, that audit committees should get their head in the game. Specifically, PCAOB staff state (reformatted to numbered outline):
- Due to the significance of revenues to many companies' financial and operating results, auditing revenue also raises matters of potential interest to audit committees.
- Audit committees might wish to discuss with their auditors their approach to auditing revenue, including the matters addressed in this alert.
With corporate governance sometimes described as a three-legged school (the external auditor, the audit committee, and corporate management or the CFO) the Chief Financial Officer, Corporate Controller, Director of Financial Reporting, Director of Accounting Policy, Chief Audit Executive/Director of Internal Audit may also be among those who will want to familiarize themselves with SAPA 12.
By releasing SAPA 12 at this time, companies and their auditors will be able to have an awareness of the PCAOB’s concerns with auditing revenue recognition including the risk of fraud. Specifically, the details in the alert may provide further transparency, into the inspection and interpretation process, as to the PCAOB staff’s view of what constitutes “compliance” vs. a “deficiency” with existing auditing standards for revenue recognition, so that auditors, their clients and audit committees can move on with this information in the public domain to freely discuss it.
Additionally, any efforts necessary for audit firms to implement SAPA 12 would be conducted at the same time that companies and their auditors are moving to implement COSO's new internal control framework - which includes the requirement for management to conduct a fraud risk assessment - and as companies are beginning to plan out their implementation of FASB’s new revenue recognition standard.