GAQC Alert No. 339

GAQC Alert

Proposed SLG Auditor Independence Changes; New SAS on Exempt Offerings; Auditor Guidance Addressing Use of Inappropriate GAAP
July 28, 2017
GAQC Alert #339
In This Alert
SLG Auditor Independence ED
Exempt Offerings SAS
Reporting on Inappropriate GAAP
New SLG Guide Available
The 2017 AICPA Audit and Accounting Guide, State and Local Governments is now available to online subscribers and in ebook format. It will be available in print on August 1st. The 2017 edition contains many significant changes, including a new chapter addressing OPEB. Order your copy now.
Last Chance!
Attend the AICPA's Government Accounting and Auditing Conference to be held August 7-8, 2017, in Washington DC, either in-person or virtually. Access registration information.
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Dear Center Members
This GAQC Alert informs you about important developments which may affect auditors with state and local government (SLG) clients and those with clients issuing exempt securities as follows:
  The issuance of an AICPA Exposure Draft (ED) addressing auditor independence in a SLG engagement;
  New Statement on Auditing Standards (SAS) No. 133, Addressing Auditor Involvement With Exempt Offerings, and registration information for a related Web event to be held on August 10, 2017, from 2:00 PM – 3:00 PM (Eastern); and
  Nonauthoritative guidance issued to address auditor reporting when an entity uses inappropriate accounting standards (e.g., a SLG follows accounting standards as promulgated by the Financial Accounting Standards Board (FASB)).
SLG Auditor Independence ED

The AICPA Professional Ethics Division recently issued an ED of a proposed interpretation and other guidance titled, State and Local Governmental Entities. It would supersede the existing interpretation of the AICPA Code of Professional Conduct (the Code) on this topic titled, Entities Included in State and Local Government Financial Statements (ET sec. 1.224.020). The ED requests member feedback on specific questions but also encourages comments on all aspects of the proposed interpretation. Comments are due by October 16, 2017. There are numerous exhibits, visual aids, and illustrations in the ED to help members understand the concepts in the proposed interpretation. Exhibit B of the ED provides an impact analysis of the proposed revisions to the extant guidance.

The ED proposes a Conceptual Framework assessment to determine when a member needs to be independent of SLGs for which he or she is not providing financial statement attest services. This differs from the current interpretation (i.e., the extant) which generally requires independence only from the entity being audited. The proposed interpretation may have a significant impact on auditor independence considerations in terms of which entities are subject to evaluation in determining whether the Code's "Independence Rule" and its related interpretations should be applied (e.g., consideration of areas such as financial interests, employment relationships, and nonattest services).

The proposed interpretation presents guidance for three primary scenarios: Downstream Entities, Upstream Entities, and Investments. The following sections describe, at a very high level, some of the more substantive changes proposed in the ED. However members should read the ED in its entirety.

Downstream Entities (paragraphs .04-.08 of the ED). The term downstream is used to refer to those funds or component units that are "below" the financial statement attest client in the financial reporting entity (e.g., funds and component units that are a part of the financial reporting entity of a primary government). Key changes from the extant to consider when reviewing the downstream entity scenarios include:
  Group Audits. The extant provided an independence exemption when an auditor was making reference to another auditor's report. This exemption continues to exist in the proposal for immaterial funds or component units as well as for material funds and component units where the primary government does not have more than minimal influence over the accounting or financial reporting process. However, when making reference to another auditor's report for a material fund or component unit where the primary government has more than minimal influence over its accounting or financial reporting process, the proposal requires that independence be maintained. (Note that the ED includes a carve out for prohibited nonattest services when certain specified conditions exist.)
  Excluded Funds or Component Units. The extant did not provide guidance related to funds and component units that, while required to be included in the financial reporting entity, are excluded from the financial statements. The proposed ED requires consideration of such excluded material funds or component units if the primary government has more than minimal influence over the accounting or financial reporting process. (Note that the ED includes a carve out for prohibited nonattest services when certain specified conditions exist.)
Upstream Entities (paragraph .09 of the ED). The term upstream is used to refer to those entities that are "above" the financial statement attest client in the financial reporting entity (e.g., the primary government for an auditor whose attest client is a fund or component unit that is required to be presented). A key change from the extant to consider when reviewing the ED upstream entity scenarios follows:
  Use of Conceptual Framework. The extant did not require independence of an upstream entity that the auditor does not audit, except that covered members and their immediate family and close relatives could not have a key position. However, the proposed ED requires evaluation of relations and circumstances with an upstream entity that is not a financial statement attest client using the Conceptual Framework when the following two criteria are met: (1) the downstream financial statement attest client (e.g., component unit) is material to the financial reporting entity to which it is to be included; and (2) the primary government of that financial reporting entity has more than minimal influence over the accounting or financial reporting process over that downstream entity (e.g., component unit).
Investments (paragraphs .11-.13 of the ED). Under the extant, there is no specific guidance directed to investments. Therefore, under today's rules, a member would use the Conceptual Framework to determine when to extend the Code's "Independence Rule" and related interpretations to investments held by a SLG entity. Instead of members having to evaluate every investment, the proposed ED only extends independence to: (1) controlling investments that are not de minimis to the financial statement attest client as a whole; and (2) investments that give the financial statement attest client significant influence over the entity and that is material to the financial statement attest client as a whole.

Other Considerations. The ED contains guidance to help members address situations that are not specifically addressed in the proposal such as brother-sister relationships (e.g., funds, component units, activities that are neither upstream nor downstream). It also provides factors to consider when evaluating the notion of more than minimal influence in upstream and downstream scenarios. Finally, when discussing materiality for purposes of determining whether independence is required of an entity in the above-described situations, the ED states that materiality is considered in relation to the financial reporting entity and not to materiality as determined at the individual opinion unit.
SAS Addressing Auditor Involvement with Exempt Offerings Issued

The Auditing Standards Board (ASB) recently issued SAS No. 133, Auditor Involvement With Exempt Offering Documents (AICPA, Professional Standards, AU-C sec. 945). SAS No. 133 does not amend or supersede any previous SAS, and will be effective for exempt offering documents with which the auditor is involved that are initially distributed, circulated, or submitted on or after June 15, 2018.

The primary objective in the development of SAS No. 133 was to establish standards-level requirements for when an auditor is involved with an exempt offering document and the procedures required when involved. Prior to the issuance of SAS No. 133, the AICPA provided best practice guidance on the auditor's responsibilities in municipal securities offerings through industry-specific auditing guidance appearing in the AICPA Audit and Accounting Guides, State and Local Governments, Health Care Entities, and Not-for-Profit Entities (AICPA guides). However, in developing SAS No. 133 the ASB broadened the scope of the project to address auditor involvement with offerings of all securities exempt from registration under the Securities Act of 1933, as amended, and to franchise offerings.

For those members that previously followed the best practice guidance contained in the AICPA guides relating to municipal securities offerings, SAS No. 133 will not likely have a significant impact on your practice. However there are some differences between the new SAS and best practice guidance that you need to be aware of. The following highlights some of those differences. See also the AICPA Journal of Accountancy article, ASB Issues Standard for Auditors Involved with Exempt Offering Documents, for a general summary of SAS No. 133.

Expanded Scope. As noted earlier, the scope of SAS No. 133 is broader than just municipal securities offerings. Examples of the types of offerings now covered by the SAS include:
  Securities issued by non-profit religious, education, or charitable organizations
  Small issues of securities (e.g., Regulation A offerings)
  Franchise offerings
Activities Establishing Involvement. The SAS modifies the activities (also referred to as triggers) establishing auditor involvement. All assume the auditor's report on the financial statements is included in the related offering. Changes made by the SAS primarily include modifications to broaden the involvement trigger terminology to apply to any exempt offering and other terminology changes to update previous best practice guidance for clarity. Additionally, one new trigger was added and one previous trigger was removed. The new trigger requires auditor involvement when auditors participate in due diligence discussions with underwriters, placement agents, broker-dealers, or other financial intermediaries in connection with the exempt offering used to describe the activities. The trigger removed related to when an auditor provides a revised independent auditor's report for inclusion in a specific official statement. Auditors should review the full list of involvement triggers to ensure an appropriate understanding.

Clarification of Required Procedures When Involved. The SAS clarifies what an auditor is required to do when involved in an offering. The best practice guidance in the AICPA guides broadly directed the auditor to the procedures in AU-C 720, Other Information in Documents Containing Audited Financial Statements. SAS No. 133 continues to point the auditor to AU-C section 720, but specifies that that the auditor should apply paragraphs .06–.18. The SAS also adds a new requirement for the auditor to perform procedures designed to identify events occurring between the date of the auditor's report and the date of the distribution, circulation, or submission of the exempt offering document that, had they been known to the auditor as of the date of the auditor's report, may have caused the auditor to revise the auditor's report. While we understand that many auditors previously performed these types of subsequent events procedures on a voluntary basis, SAS No. 133 establishes a requirement.

The AICPA will be hosting a 1-hour continuing professional education (CPE) Web event, Understanding SAS 133 - Auditor Involvement With Exempt Offering Documents, on Thursday, August 10, 2017, from 2:00 PM - 3:00 PM (Eastern). Registration can be accessed through the AICPA Store. GAQC members are eligible for a 20% discount. Use the code "GAQC17" when registering. A "No-CPE" option is not available for this event.
Auditor Reporting When SLG Uses Inappropriate Accounting Standards
In response to recent questions from AICPA members auditing SLGs, including Indian tribes, AICPA staff have issued Question and Answer (Q&A) section 9160.31–.35 (AICPA Technical Questions and Answers (TQAs)) to provide nonauthoritative guidance that addresses reporting on financial statements developed using an inappropriate set of standards. The TQAs also discuss whether an entity is a SLG for purposes of determining whether it is using the appropriate set of accounting standards, and how to report on the entity's financial statements when the entity elects to follow either a different set of standards or a special purpose framework. The following topics are covered in the TQAs:
  .31 - Following Accounting Standards as Promulgated by FASB by a State or Local Governmental Entity.
  .32 - Reporting on Accounting Standards as Promulgated by FASB by a State or Local Governmental Entity.
  .33 - Engagement Acceptance When a State or Local Government Elects to Follow a Special Purpose Framework.
  .34 - Accounting Standards as Promulgated by FASB as a Special Purpose Framework.
  .35 - Reporting on Indian Tribe Financial Statements Prepared in Accordance With Accounting Standards as Promulgated by FASB.
As always, thank you for your membership and dedication to audit quality.
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