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Auditors Urged to Tell More

June 27th, 2011

By MICHAEL RAPOPORT

Regulators took the first step Tuesday toward requiring companies’ auditors to tell investors more of what they know about their clients—including, possibly, any concerns the auditors might have about the companies’ accounting.

The Public Company Accounting Oversight Board, which regulates audit firms, proposed a series of ways auditors might disclose more of the information they gather and the views they develop about the quality of a company’s financial reporting when they conduct an audit.

Proposals include requiring auditors to pass judgment on more of what a company does and says than is currently required, weighing in on the quality of a company’s disclosures in its earnings releases, for instance, or on what the company says in the narrative Management’s Disclosure and Analysis section of its annual report.

The intent of the proposals, which are still in the early stages, is to give investors more useful information and make the audit process more transparent, PCAOB Chairman James Doty said. “It’s about how audits can provide investors more insightful assessments of management stewardship,” he said at a PCAOB meeting Tuesday.

Currently, the auditor’s opinion included in every annual report is “pass-fail”: Either a company is fairly presenting its financial statements in the auditor’s eyes, or it isn’t. Typically, the auditor doesn’t discuss further its views of the company, unless it says the company is facing risks severe enough that there is doubt it can continue as a “going concern.”

But with large financial institutions failing or requiring government bailouts during the financial crisis even though they had clean audit opinions, investors want to know more about what auditors know. A March survey of its members by the CFA Institute, a group of financial analysts who work with individual investors, found 58% of those surveyed think the auditor’s report should provide more specific information.

The board’s most far-reaching idea is a new “Auditor’s Discussion and Analysis” report that would supplement the main audit opinion. Such a report could include information about the auditor’s views on matters like the judgments, estimates and accounting policies a company’s management uses to formulate its financial statements. That would enable an auditor to opine on whether management’s financial reporting is aggressive.

The board’s other ideas include required “emphasis paragraphs” in which the auditor would highlight the most significant matters in the financial statements, and opinions from auditors about matters outside the financial statements, like what a company says in earnings releases.

“We look forward to participating with investors, audit committee members, preparers and others in a constructive dialogue as to how audit reporting can be improved to better meet the needs of investors,” said Michael J. Gallagher, managing partner for assurance quality and transformation at PricewaterhouseCoopers LLP. It is important, he added, that “any changes at least maintain, if not improve, the quality of financial reporting.”

The Auditor’s Discussion and Analysis report is the approach that investors would prefer, said the CFA Institute’s Kurt Schacht. If an auditor can assess and discuss whether a company is being too aggressive in its financial reporting, “that’s a very important piece of information,” he said.

The PCAOB ultimately might adopt any or all of the proposals, or other ideas that might come up in public comments that are due Sept. 30. The board also plans to hold a public roundtable before then.

The board expects to formally propose changes by the end of 2011 and approve a final rule by the end of 2012. Any changes would be subject to Securities and Exchange Commission approval.

Another possible auditing change Mr. Doty recently floated, “term limits” for audit firms to require companies to change auditors after a period of years, will be the subject of a separate proposal that is still in the works.

June 24th, 2011

By Rachel Armstrong | June 24, 2011

The string of accounting problems and stock plunges at publicly traded Chinese groups has sparked deep concerns across the world’s biggest audit firms, putting the so-called Big Four on alert from worries that their reputation could be brought down along with a growing list of stricken companies.

Auditing Chinese firms preparing to go public on overseas exchanges is a lucrative business and one that plays into the strengths of the top, international auditing partnerships known as the Big Four: KPMG, Ernst & Young, Deloitte Touche Tohmatsu and PricewaterhouseCoopers.

Yet fears are growing that the struggle to find enough high-quality auditors in China and Hong Kong means it may only be a matter of time until one of the top firms finds itself caught in a blow-up rivaling Enron, which brought down their old rival Arthur Andersen.

“Costs have gone up; fees have gone down, as competition for fees is enormous. You can easily see there is a real risk of an audit firm failing,” said Paul Winkelmann, the partner in charge of risk and compliance for PWC in Greater China.

According to interviews with professionals at the four firms, each firm is getting more and more cautious about the work they take on from mainland companies looking to IPO.

”The whole industry, I will say, is very sensitive and cautious to China IPOs,” said an auditor at one of the Big Four, who handles IPO work, who did not want to be named.

The Big Four are also getting nervous about work with existing Chinese clients, turning to lawyers at an earlier stage if they think something might be amiss.

“If a risk situation arises they’re now consulting lawyers earlier and dealing with it in a much more structured way than was perhaps the case in the past,” said Tom Fyfe, a partner at law firm Barlow, Lyde & Gilbert in Hong Kong who acts for some of the big four in litigation issues.

All four of the audit firms responded to a Reuters request to comment on the matter. The four firms said they have a rigorous approach to risk management.

CHINA BOOMING BIZ
The big four have basked in China’s emergence as an economic powerhouse. In 2009 their revenue from work on the mainland stood at 9.1 billion yuan ($1.41 billion) according to the Chinese Institute of CPAs (CICPA), around half of China’s accounting industry’s revenue. Last year’s figures were not immediately available.

As the revenues have risen, so have the risks.

Most of the accounting scandals in the U.S. have come from small Chinese companies who went public via a reverse takeover. Those companies were audited by smaller U.S or Hong Kong-based accountancy practices, not the Big Four’s China firms.

But some recent high profile cases have started to drag in the names of the world’s most prestigious auditors.

Last month, Deloitte quit as auditor of Longtop Financial Technologies after working on the company’s books for six years, citing “recently identified falsity” in their finances.

Ernst & Young was named in two class action lawsuits over its work on Sino-Forest, the Toronto-listed company accused by short-seller Muddy Waters of accounting fraud.

In Hong Kong, KPMG said in January that it had found possible irregularities in the books of China Forestry, leading to a suspension of its shares.

Accounting experts say the firms have been acting as they should by raising the alarm once they find irregularities that can’t be explained by the company. They also point out that the Big Four’s China businesses and its broad global resources are much better placed than small U.S. firms to conduct audits on Chinese companies.

“I think firms here have always been aware of the risks associated with audit work in China. There is more endemic fraud in Asia, but people are much more aware of it here and so manage the risks accordingly,” said PWC’s Winkelmann.

Winkelmann, on behalf of the Hong Kong Institute of CPAs (HKICPA), is drafting a paper to present to the Hong Kong government later this year calling for changes to the law on auditor liability. The IPOs are now so large — last year saw two greater than $20 billion in Hong Kong — the worry is that a massive IPO liability, if it were to hit an auditing firm, would be too big for the firm to handle. The change calls for a cap on the liability.

The latest string of scandals has laid bare some of the difficulties auditors have in China, forcing the big firms to reappraise their methods, given that a loss of reputation could bring them to their knees.

“There’s no doubt about it — the firms are very alert to these issues and very sensitive to what it means. They will be looking at their risk assessment procedures,” said Chris Joy, executive director, HKICPA.

STAFF SHORTAGES
Two of the biggest challenges facing the big four are staffing and the type of companies they audit.

Together the firms now employ just fewer than 40,000 people in mainland China, Hong Kong and Taiwan. While that’s a relatively high number compared to other regions, it’s not enough to handle the huge demand created by the rapid economic growth of the world’s most populous country, experts say.

“We are in tremendous need of experienced accounting professionals and graduating college students,” said a spokeswoman for Ernst & Young, which plans to recruit 1500 new staff this year.

Finding them might be tough.

“Between us and the CICPA and other bodies that offer qualifications, we can’t produce enough at the moment, but we’re not going to compromise the quality of our program just to mass produce accountants,” said Joy at the HKICPA.

That skill shortage is likely to be felt even more keenly now that the type of IPO work the big firms are handling is shifting. Whereas 10 years ago the majority of firms going public in China were state-owned enterprises (SOEs), a lot more of the work now is for privately-run businesses.

“Previously the market was for SOEs, and China is not going to allow a major embarrassment with an SOE,” said PWC’s Winkelmann. “But now it’s changing as international firms are starting to do more of the private enterprises in China, which don’t come with that government support.” (Reporting by Rachel Armstrong; Additional reporting by Benjamin Lim in BEIJING, George Chen in HONG KONG; Editing by Michael Flaherty)

June 21st, 2011

WASHINGTON, D.C. (JUNE 21, 2011)

Among the alternatives are the inclusion of an auditor’s discussion and analysis with an audit report, and audit assurance on information outside the financial statements, such as non-GAAP information on earnings releases. The changes would go well beyond the traditional pass/fail model.

The board plans to convene a public roundtable to discuss the concept release in the third quarter of 2011.

“The concept release we issue today represents a significant step for investor protection in response to the financial crisis, and a first step toward a holistic consideration of reforms designed to foster the relevance, transparency and reliability of the audit process,” said PCAOB chairman James R. Doty in a statement.

The PCAOB is seeking comment on alternatives and other matters presented in the concept release regarding possible enhancements in the auditor’s reporting model. The auditor’s report is the primary means by which the auditor communicates to investors and other financial statement users about information regarding the audit of the financial statements.

“The auditor is in a unique position to provide relevant and useful information, because of the auditor’s extensive knowledge of the company and as an independent third-party,” said PCAOB Chief Auditor and Director of Professional Standards Martin F. Baumann. “The concept release explores ways to expand the auditor’s communication in the auditor’s report about the audit and the company’s financial statements.”

The concept release presents several alternatives for changing the auditor’s reporting model and is seeking specific comment on these or other alternatives that could provide investors with more transparency in the audit process and more insight into the company’s financial statements or other information outside the financial statements. These alternatives include:

•    An auditor’s discussion and analysis;
•    Required and expanded use of emphasis paragraphs;
•    Auditor assurance on other information outside the financial statements; and,
•    Clarification of language in the standard auditor’s report.

The current release seeks public comment on alternatives for amendments to, or the development of new, auditing standards that would supersede the board’s current standards on the auditors’ report.  The PCAOB also released a fact sheet that provides a summary of the matters included in the concept release.

Several board members that a number of issues remain unresolved.

“One threshold question is whether auditors should move beyond their traditional role of attesting to information that management prepares,” said PCAOB member Daniel Goelzer. “Under some of the ideas floated in the concept release, auditors would be required to provide commentary on such matters as management’s judgments and estimates and its selection of accounting policies and practices. The auditor might also be asked to characterize particular auditing judgments on which the decision to issue a clean opinion is based as ‘close calls.’”

“As someone who performed audits for over thirty years, I would like to sound one note of caution,” said PCAOB member Jay Hanson. “Auditors do a great deal of work and obtain important insights about the information that goes into their client’s financial statements. They may be able to provide additional information about the audit work they performed and what it means, or about the risks of a material misstatement of the company’s financial statements, or about the company’s accounting policies and significant judgments and estimates. However, auditors are not analysts or investment advisers. They are not trained to evaluate and communicate the overall business and strategic risks of the companies they audit.” He said he looked forward to hearing the input the board would receive.

Earlier this year, PCAOB staff reached out to investors, auditors, preparers of financial statements, audit committee members, and other interested parties to seek their views on potential changes to the auditor’s report.  The staff reported its findings to the board on March 22.
Comments on the concept release are due Sept. 30, 2011.

Additional details about the roundtable discussion on the auditor’s reporting model concept release will be announced at a later date.

BY ACCOUNTING TODAY STAFF
June 20th, 2011

By JOANN S. LUBLIN And MICHAEL RAPOPORT

Audit and consulting firm Deloitte Touche Tohmatsu Ltd. is poised to name Barry Salzberg, the chief executive of its Deloitte LLP arm in the U.S., as its new global CEO.

Mr. Salzberg will replace James H. Quigley, who has been Deloitte’s global CEO since 2007. CEOs at the firm serve four-year terms, and Mr. Quigley, 59 years old, is stepping down when his term ends June 1.

“Last summer, Jim made a personal decision that he wouldn’t seek re-election,” a spokeswoman said. In June, Mr. Quigley will become a senior partner in a client service role, the spokeswoman said. Deloitte is expected to announce the move Thursday.

For the fiscal year ended last May, Deloitte posted $26.6 billion in revenue and had 170,000 employees globally, making it the largest private professional services firm.

Under Mr. Quigley, the firm has bolstered its consulting arms and made moves into emerging markets. In 2010, Deloitte announced it would spend $1 billion on new hires, development and other strategic investments in a five-year period. Over the same period, the group said it would grow to 225,000 employees.

“I am pleased with how we have positioned our businesses broadly,” Mr. Quigley said in an interview with The Wall Street Journal in December.

Mr. Salzberg’s successor as U.S. CEO will be Joseph Echevarria, Deloitte’s U.S. managing partner and chief operating officer. Messrs. Quigley, Salzberg and Echevarria couldn’t be reached for comment.

Mr. Salzberg has been with Deloitte since 1977 and became a partner in 1985. He was named head of Deloitte’s U.S. tax practice in 2000 before becoming U.S. managing partner in 2003 and U.S. CEO in 2007.

Like the other Big Four accounting firms, Deloitte is organized as a global partnership whose affiliates in individual countries operate independently of each other.

Deloitte is also appointing a new U.S. chairman, Punit Renjen, who will replace Sharon Allen, who is retiring, a spokesman said.

—Dana Mattioli contributed to this article.

Write to Joann S. Lublin at joann.lublin@wsj.com and Michael Rapoport atMichael.Rapoport@dowjones.com

June 16th, 2011

By MICHAEL RAPOPORT

Accounting rule makers tweaked their guidelines for valuing assets based on market prices, a move that will bring U.S. and international accounting rules closer together and will require companies to disclose more about how they value their most exotic assets.

The changes adopted by the Financial Accounting Standards Board and the International Accounting Standards Board will provide a more consistent definition of “fair value,” which is the market value or the closest approximation of it. Though most of the specific changes are relatively minor and won’t affect the core aspects of how companies calculate fair value, the move better aligns U.S. and global accounting rules on asset valuation.

Perhaps the most significant changes affect companies’ disclosures about their “Level 3” assets, which are the risky, illiquid securities valued using a company’s own estimates and models rather than market prices. Companies will have to disclose more about the processes and assumptions they use in their Level 3 valuations. They will also have to discuss what might happen to the company’s valuations if the factors they are using were to change.

Companies will have to disclose any movements of securities between the other two classes of fair-value assets: Level 1, those valued strictly using market prices, and Level 2, those for which a blend of market prices and a company’s own models are used.

The fair-value changes are part of the rule makers’ “convergence” project, their attempt to bring U.S. and international rules closer together in an effort to standardize the accounting rules used world-wide. The Securities and Exchange Commission is expected to vote later this year on whether U.S. companies should switch to using international rules altogether.

Most companies will adopt the fair-value measurement changes in early 2012.

June 16th, 2011

By MICHAEL RAPOPORT

A proposed accounting rule that will change how companies book revenue was delayed again Wednesday, as rule makers said more work is needed that will push the rule’s issuance into 2012.

The Financial Accounting Standards Board and International Accounting Standards Board said they will issue a revised proposal to overhaul the rules on revenue recognition, updating a proposal they first made last year. The revised proposal is planned for the third quarter, and companies, investors and other observers will have 120 days to comment on it after it is issued.

Revenue recognition is a crucial area of accounting that is often implicated in frauds, because it governs when and how companies can count revenue after making a sale. The accounting boards’ proposal would simplify and align the booking of revenue with the transfers of products and services that generate it, which don’t always happen at the same time under current rules. The proposal would eliminate special revenue-recognition models used in some industries, like software and construction.

The FASB received nearly 1,000 comment letters responding to its initial proposal. The boards have since made numerous changes to the plan’s details, though Prasadh Cadmabi, a FASB project manager, said the overall thrust remains the same.

The boards said it is necessary to introduce a revised proposal and seek further comment because calculating revenue is so important to all companies, and rule makers want to make sure they understand the impact of what they are proposing.

The revenue-recognition overhaul is a key part of the two accounting boards’ “convergence” attempt to bring U.S. and global accounting rules closer together. The Securities and Exchange Commission is slated to decide later this year whether U.S. companies should switch over to using international rules altogether.

The FASB and IASB initially wanted the new rule and other major convergence projects to be done by the end of this month. But in April, the boards pushed back that target to the end of 2011, and the latest move will delay the revenue-recognition rule further. Mr. Cadmabi said final issuance of the rule is now expected in 2012.

Write to Michael Rapoport at Michael.Rapoport@dowjones.com

June 15th, 2011

When the IRS wants to correspond with your client, it generally uses as the address of record the one on the most recently filed and “properly processed return.” When IRS regs require that refunds or various notices be sent to the taxpayer’s last known address, this is the one the IRS uses.

A tax return generally is not considered properly processed until 45 days after filing—longer for returns filed during the tax filing season. In other words, notices sent to the old address during the return processing period are valid. The IRS automatically updates an address of record by using the U.S. Postal Service National Change of Address database.

A taxpayer who wants to change the address of record by other means must give the IRS a clear, concise notice, as described in the revenue procedure.

Best method: IRS Form 8822, Change of Address.

Also acceptable: A written statement of the new address, with full name, old address, SSN and individual TIN or EIN, signed by the taxpayer and mailed to an appropriate IRS address.

Electronic notification qualifies as proper notice—if given using a secure application on the IRS Web site. Warning: E-mail is not proper notification.

AIPB tip: For clients who have moved, it is critical that they not only inform the IRS, but that they document having done so, because the IRS considers its notices valid when sent to the “last known address”—even if the person moved and never received it. While the IRS searches for your client, penalties and interest mount and the right to appeal may lapse. [Rev. Proc. 2010-16; 2010-19 IRB 1]

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June 14th, 2011

The Public Accounting Oversight Board, or PCAOB, agreed to establish an interim inspection program for auditors of broker dealers, as it considers the scope and form of a permanent program for investor protection while minimizing burdens on smaller auditors.

The board gained inspection, standard-setting and enforcement authority over auditors of registered securities brokers and dealers under the Dodd-Frank financial-overhaul law, adding another level of oversight. It intends to have a permanent program in place by 2013.

Under the temporary program, the board will begin to inspect auditors of brokers and dealers and address with the firms any significant issues in those audits. The program won’t include firm-specific inspection reports, but rather will periodically publish reports on the types of investor risk it encounters. However, PCAOB Chairman James R. Doty said that, if violations are found, the board will act on them.

The interim program will be used to determine whether the permanent one should apply to all brokerage-firm audits. There are about 5,000 broker-dealers that provide a diverse range of services, raising questions about whether some types can be excluding without comprising investor protection, according to board member Daniel L. Goelzer.

Doty said that, as a result of the interim effort, the board may be able to “narrow the scope and cost of the law to focus on areas where our oversight would make a difference.”

The group also amended some of its funding rules.

-By Tess Stynes, Dow Jones Newswires; 212-416-2481; Tess.Stynes@dowjones.com

June 12th, 2011

Working as a derivatives trader on Wall Street right after graduating college in 2005, Maia Josebachvili missed the outdoor activities of her undergraduate years at Dartmouth College. So the then-21-year-old started organizing weekend trips with friends by email to go whitewater rafting, hiking or camping. Soon, hundreds of friends-of-friends-of-friends were attending the trips she planned.

In 2008, Ms. Josebachvili decided to turn her weekend hobby into a full-time gig by launching her own company, Urban Escapes, which plans outdoor trips for young professionals. Last year, it was acquired by online coupon site LivingSocial.

Starting a business is an enticing idea for many young professionals. After all, you’ll be able to work at something you’re passionate about, exercise your creativity and be your own boss. And your twenties are a good time to take career risks since younger workers typically don’t have commitments like a family or a mortgage.

But success like Ms. Josebachvili’s isn’t the norm, experts say. It’s often a hard climb, and many small businesses fail — especially if a young entrepreneur lacks a business plan that suits his or her limited expertise and isn’t willing to sacrifice time and money.

With limited business expertise and knowledge, twentysomething entrepreneurs should capitalize on what they do know. For instance, you could turn a hobby into a business, like Ms. Josebachvili, or invent something you’ve seen a need for.

Web or mobile-application businesses are good ideas for young people because they don’t require much capital to start, says Gregg Fairbrothers, an adjunct professor at Dartmouth’s Tuck School of Business in Hanover, N.H., and director of the Dartmouth Entrepreneurial Network. So are restaurants and other service businesses because they’re labor intensive but don’t require much experience.

And when it comes to picking a market, it may be best to go with the demographic you know best — your own. When Austin Lavin was 23, he started Myfirstpaycheck.com, a teen-job-board website, with his teen sister. The site thrived in part because the two entrepreneurs knew, from their own experiences, what would attract their target customers: local job listings, combined with a r[eacute]sum[eacute]-building tool and employment advice.

Since younger entrepreneurs typically don’t have a family to care and provide for, they can devote more time to getting a business off the ground and are often more willing to take a salary cut than older entrepreneurs. Ms. Josebachvili estimates she made 2% of her former salary and was working three times as many hours when launching Urban Escapes.

But with school loans and other expenses and limited savings, many younger entrepreneurs can’t afford to focus on a venture full time. You can use that to your advantage, however, by finding a job in the industry in which you want to launch your business. Even something that may seem like grunt work can give you a better understanding of how the industry works. And you’ll meet people who may be able to help you later on.

Spencer Rubin, who wanted to run his own restaurant, took a job with a restaurant-development firm after graduating from college in 2008. He met his future business partners there and learned what it takes to build a restaurant that attracts customers and turns a profit. In April, Mr. Rubin, 25, opened up Melt Shop, a grilled-cheese take-out restaurant in Manhattan.

June 12th, 2011

The Securities and Exchange Commission is investigating some accounting firms over their audits of Chinese companies whose shares trade in the U.S., and the inquiry is expected to lead to enforcement cases, people familiar with the situation said.

The SEC has publicly indicated it was examining accounting and disclosure issues regarding Chinese companies that engaged in “reverse mergers,” which allow companies to list on U.S. exchanges without as much regulatory scrutiny as an initial public offering. People familiar with the matter say the investigation also includes auditors, which hadn’t previously been known. As part of its inquiry, the SEC has suspended trading on some Chinese companies, questioning their truthfulness about their finances and operations.

The Public Company Accounting Oversight Board, or PCAOB, the governments accounting regulator, said it is investigating some audit firms over whether their audits of Chinese clients are are stringent enough.

The regulators’ investigations involve both large and small accounting firms.  It isn’t known which accounting firms are part of regulators’ probes.

If regulators find violations, they could file administrative proceedings against audit firms over allegations such as improper professional conduct, and the SEC could file civil lawsuits as well.  It is unclear when regulators might act.

The accounting oversight board says the audits are sometimes weak in part because of obstacles that make it hard to sniff out problems: Some U.S. auditing firms outsource accounting work to inadequately trained Chinese accounting firms, and China has blocked the board from inspecting audits onsite, though PCAOB Chairman James Doty said he was optimistic the inspection issue could be resolved by year’s end.

“Right now, the auditing and regulation of U.S.-listed Chinese companies isn’t working very well,” said Paul Gillis, a visiting professor of accounting at Peking University’s Guangha School of Management.

In reverse mergers, a foreign company is “bought” by a publicly traded U.S. shell company.  But the foreign company assumes control and gets the shell’s U.S. listing without the level of scrutiny that an IPO entails.  Though companies from other countries also engage in reverse mergers, such deals are especially common among the Chinese.  The PCAOB says nearly three-quarters of the 215 Chinese companies listing in the U.S. from 2007 to early 2010 did so via reverse merger.

Since Feb., about 40 Chinese companies have either acknowledged accounting problems or seen the SEC or U.S. exchanges halt trading in their stocks because of accounting questions.

The U.S. firms that audit Chinese companies are mostly small shops.  From 2008 to early 2010, at least 40 U.S. firms with fewer than five partners and 10 professional staff issued audit reports on China-based companies, according to the PCAOB.

Regulators’ scrutiny puts these accounting firms in a difficult position: Some firms whose Chinese clients have seen their accounting questioned say they are doing everything they can to perform strong audits, including maintaining their own offices in China and employing bilingual staffers, and they are intensifying their efforts to detect improper accounting.

But that may raise questions about whether their past efforts were strong enough, especially among some investors who have criticized Chines companies.

The PCAOB says some U.S. auditors who farm out work to local Chinese auditors are not verifying that the work complies with U.S. auditing standards.  In 09, the board barred an Arizona firm from auditing public companies, in part over that issue.  In April, the PCAPB barred Utah’s Chisholm Bierwolf Nilson& Morril LLC, in part because of a similar issue; the board said Chisholm Bierwolf relied on inexperienced Chinese-speaking assistants to help audit Chinese clients without adequately supervising them.

The Chisholm Bierwolf ban is permanent.

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