Public company adoption of ASC 606 / IFRS 15, Revenue from Contracts with Customers, is about two months away! What a perfect time for the PCAOB to release Staff Practice Alert No. 15, Matters Related to Auditing Revenue from Contracts with Customers. Keep in mind that a Staff Practice Alert does not represent guidance - its purpose is to highlight any new, emerging, or otherwise important circumstances that may impact how an auditor will perform an audit. While the alert is aimed at auditors, it also represents a great roadmap for companies about how to prepare for the audit of their implementation of the new standard.
Alert No. 15 reminds us that when companies are implementing the new standard, changes to existing (or developing new) processes, systems, and controls might be needed to gather all contract data, determine significant estimates, and compile accurate disclosures. Changes to processes, systems, and controls can create inadequate design and implementation, which in turn can lead to heightened risks of material misstatement, including fraud. There are many things to consider for your audit of the implementation and beyond, so let’s take a look at the key considerations the PCAOB discussed in the alert.
Transition disclosures and adjustments
Auditors are required to perform procedures to identify and assess risks of material misstatement, which can include inaccurate, incomplete, or omitted transition disclosures on implementing the new standard. Even if a company discloses that the new standard is not expected to be material, the auditor needs to be able to support that conclusion! It’s important to know that auditing the transition disclosures also includes any interim disclosures. The alert discusses the importance of quarterly inquiries on the anticipated impacts of the new standard and whether interim transition disclosures agree or reconcile to supporting data.
Adopting the new revenue recognition standard represents a change in accounting principle; therefore, auditors need to conclude that the method of adoption is in conformity with GAAP and the disclosures are adequate. Identifying and assessing the risks of material misstatement as it relates to the transition adjustments is required and when designing and implementing audit procedures, it’s important to consider internal controls, any data that might not have been previously audited, any prior-period misstatements, and opportunities for fraud. For example, a company could improperly identify performance obligations or improperly allocate transaction prices to performance obligations to defer revenue, so direct testing of controls and company produced evidence (i.e. verifying standalone prices) are critical.
Internal control over financial reporting
Components of internal control can be affected from the adoption of the new standard so it’s important to consider each component when you are understanding your company’s control environment. Specific risks to IT general controls also need to be considered. For example, a company might be temporarily using spreadsheets or manual processes to track information while automated processes and controls are being implemented so you need to evaluate whether these present greater risks of material misstatement. Also, make sure you are testing how management review controls are designed and operating. Refer to Alert No. 11 for a reminder on the precision of management review controls.
Identifying and assessing fraud risks
When identifying fraud risks arising from the implementation, make sure you have a sufficient understanding of the standard as well as the company’s processes, systems, and controls over the implementation. And don’t forget that the fraud risks need to be as specific as possible! Be sure to consider any incentives the company might have on improving financial performance, the opportunity to establish fraudulent estimates (i.e. variable consideration and standalone pricing), and the involvement of non-management personnel in developing processes and estimates.
Other key considerations
Other considerations mentioned in the Staff Alert include evaluating how revenue is recognized and determining if the financial statements include the required disclosures. Frequent deficiencies identified when testing revenue relate to understanding contractual arrangements, auditing estimates, and substantive analytical procedures. New disclosures as a result of adopting the standard include disaggregated revenue, contract balances, performance obligations, and costs to obtain or fulfill a contract (to name a few) can lead to new risks, so be sure to plan your audit procedures accordingly!
We’re here to help
Feeling anxious? Need someone to turn to? GAAP Dynamics is here to help you! We have compiled a variety of resources, including Big 4 publications, and have put together three eLearning modules on the new standard. Also feel free to browse some of our revenue recognition micro-learning videos on our YouTube channel. Additionally, we offer customized revenue recognition workshops, so contact us today!
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