-Hybrid Approach to Fair Value

Plus

-Antifraud Tips -Criminal Tax Evasion

er

CONTENTS

June 2 009

26 Accounting & Auditing I Standards Setting

Fair Value Accounting and the Current Financial Crisis

By John M. Trussel and Laura C. Rose

I International Auditing Audit Risk and IFRS: Does Increased

Flexibility Increase Audit Risk? By Ronald E. Marden and Kennard S. Brackney

38 Taxation I Compliance & Enforcement

Criminal Tax Evasion and Taxpayer Intent: Supreme Court Says No Harm, No Foul

By Stanley A. Leasure and Debra H. Oden

I Federal Taxation How Deductions, Credits, and Other Benefits

Impact the Actual Marginal Rate By Jan L. Williams, Phillip J. Korb, John N. Sigle!;

and Thomas E. Vermeer

48 Finance I Succession Planning

Guiding Family Businesses Through the Succession Process: A Step-by-Step Guide for CPA Advisors

By James J. Chrisman, Jess H. Chua, Pran1.Odita Sharma, alld Timothy R. Yoder

52 Management I CPA Consultant

How Nonaudit Services Affect Objectivity: What the Research Reveals

By Duane M. Brandon and M. Mueller

I Fraud Practical and Ethical Considerations

in Fraud Examination By Joseph T Wells

I Practice Management The Human Side of IFRS

By G. Stevenson Smith and C. W Von Bergen

62 Responsibilities & Leadership I Ethics

Accountant Confidentiality: The Duty to Remain Silent vs. the Duty to Speak

By Charles A. Werner

68 Technology I The CPA & the Computer Evaluating Software Risk as

Part of a Financial Audit By Yigal Rechtman

I Whatto Bookmark Website of the Month: Financial Crimes

Enforcement Network By Susan B. Anders

vol . LXXIX / no.6

6 Perspectives 18 Recognizing the Red Flags of a Ponzi Scheme:I

Stepping Up Investor Protection Will You Be Blamed for Not Heeding the Warning Signs?

Publi sher's Column: Navigating the State's New Accountancy Law

By Sandra S. Benson

Mentoring the Next Generation Even after Bernard L. Madoff pleaded guilty to operating a $65 billion

Ponzi scheme, the fallout continues to spread, not only to directFrom Crisis to Confidence: What investors but also to the auditors of funds that invested with Madoff.Is the Role of Regulation?

Investors in numerous funds were "fed" to Madoff, in some cases allegedly without the knowledge that Madoff was going to manageBook Review: Accounting Irregularities

much or all of the funds . Now, investors are looking to the auditors ofalld Financial Fraud: A Corporate these funds for answers-in the form of class-action lawsuits. Governance Guide, Third Edition

This should serve as a wake-up call to the profession. What can accountants do to protect themselves and their clients from the

far-reaching effects of Ponzi schemes in the future?74 Classified Ads

79 Economic & Market Data

80 Editorial Tax Havens: When Avoiding

Taxes Is Un-American

The CPA Journal is a technical-refereed publication aimed at practitioners, educators, regulators. and other financial professionals. Our goal is to provide insight and analysis on developments in the areas of accounting, auditing. taxation, finance. management, technology, and professional ethics.

Permission to reprint The CPA Journal articles granted with exceptions. Written requests indicating litle, author, publication date, and intended use of the reprint should be made prior to each use by to the Associate Editor.The views expressed in articles published in The CPA Journal are those of the authors and not necessarily those of The CPA Journal, unless otherwise indicated. Articles con­tain information believed by the authors to be accurate as of original publication. The reader should not construe the content included ;n The CPA Journal as accounting, legal, or other professional advice. II specific professional advice or assistance is required , the services of a competent professional should be sought.

The CPA Journal (ISSN 0732-8435) is published monthly by The New York State Society of Certified Public Accoun tants, 3 Park Avenue, New York, NY 100 16-5991. Subscrip tion Rate: $42.00: Periodicals postage paid at NY, NY and additional mailing off ices. POSTMASTER: Send address changes to CPA Journal, 3 Park Avenue, New York, NY 10016-599 1, Altn: Subscription Department.

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The Human Side of IFRS

By G. Stevenson Smith and C. W. Von Bergen

The ongoing-convergence of U.S . GAAP with Intemational Financial Reporting Standards (IFRS) will

have a profound effect on the accounting profession. The upcoming changes will require more probing and extensive inquiries to reduce ambiguity and uncer­tainty in fUlancial statement audits where the number of "bright-line" rules has been reduced. Highly valued accounting character traits that have worked well in a regulated environment-such as attention to detail and adherence to clear rules-may need to be reevaluated as changes are made from the rules-based U.S. GAAP to the principles-based !FRS.

U.S. Move to IFRS The continued globalization of the

world's economy has resulted in the adop­tion of IFRS by nearly 100 countries, including five G-8 countries, with plans for adoption by a number of others. !FRS is being considered for adoption in the United States by 2014.

In formulating IFRS, the International Accounting Standards Board (lASB) chose not to use the detailed rules-based approach found in U.S. GAAP. For example, U.S. GAAP requires that a cap­ital lease be recognized when the lease term is equal to or greater than 75% of the asset ' s economic life (SFAS 13, Accounting for Leases), while IFRS guidelines only require such treatment when the lease term is a "major part" of the asset ' s economic life [International Accounting Standard (lAS) 17, Leases]. Under IASB standards, management may argue that the lease is not a capital lease, but instead an operating lease, even when the lease term is more than 75% of the asset's life due to contractual asset

JUNE 2009/ THE CPA JOURNAL

renewals and replacements. The meaning of "major part" is decided by the auditor. In lAS 17, there is no "90% rule" with regard to the present value of the mini­mum lease payments as found in SFAS 13. Under lAS 17, the auditor must inter­

pret "substantially all " with regard to the present value of the minimum lease payments. Such differences create the need for increased background informa­tion to eliminate ambiguity in deciding whether a lease is an operating lease or

capital lease. In order to make such a decision, the economic effects of a lease on company operations are examined, rather than a specific percentage cutoff being used. These economic effects can only be evaluated with more disclosures

about business activities that would not have been as important under rules-based standards.

Additionally, deferred taxes under U.S. GAAP are recognized in full (SFAS 109, Accounting for Income Tw:es), whereas

59

under IFRS guidelines, they are recognized when it is "more likely than not" that they will be realized (lAS 12, Income Taxes) . This criterion requires more judg­ment from the auditor than simply recog­nizing all deferred taxes. Thus, the audi­tor' s judgment of the economic condi­tions facing the company becomes more important under IFRS. Effective auditor decision making requires the company to provide more information to meet the IFRS's "more likely than not" criteria.

The transition to IFRS will require accounting firms to deal with adapting

human resources to this new work envi­ronment. Such changes may be more daunting than other recent changes the pro­fession has faced.

What Is the Origin of the Rules-Based Accounting System?

Rules-based approaches slowly devel­oped over the decades by accounting and auditing standards-setting bodies. The result is a detailed set of rules that are used to cover almost every recognized or developing accounting problem and transaction. This approach was not always

EXHIBIT 1 Traits Needed in a Principles-Based Environment

Ability to Find Undisclosed Events

Principles-based standards require preparers and auditors to exercise profession­

al judgment in interpreting accounting transactions. Such judgments may require

that individuals take more aggressive steps in identifying undisclosed economic

events and strategic changes without alienating a client.

Facing Ambiguity

Individuals with a tolerance for ambiguity are more at ease in an environment with

fewer rules. Although more expansive business information is needed to make

decisions in a principles-based environment, not all of this information will be

available. Individuals who can make effective decisions with an acceptable level

of ambiguity are needed in a principles-based environment.

Identifying Inferred Relationships

Individuals gather information in different ways. A person may prefer to collect

information by focusing on what is explicitly stated, as opposed to inferring what

might have been expected or forecasted to exist. Individuals who use their intu­

ition, are concerned with seeing the "big picture," and possess the ability to

change their decisions based on such a perspective will excel in this new

accounting environment, and they may become more valuable employees.

Working with Uncertainty

Uncertainty avoidance is a personality characteristic often associated with closely

following rules. When faced with uncertain situations, some individuals feel

increased stress. Such individuals tend to feel more comfortable working with

specific procedures and explicit information rather than making decisions based

on probabilities of uncertainty. The new accounting environment will likely favor

those who can make decisions in uncertain situations.

practiced. At one time, it was believed the subjective nature of accounting made the judgment of the accountant superior to a set of detailed lules for recording com­plex transactions. George May, a leading accounting practitioner during the first half of the 20th century, believed that the sub­stance of the accounts often varied with the reason they were established. May stated that "no amount of standardization will either a) make an understanding of the nature of accounting process less nec­essary to a proper interpretation of such determinations; or b) convert those determinations into findings of fact." May's arguments were not successful in influencing the direction taken by the accounting profession, and the application of U.S. GAAP and GAAS changed from a principles-based approach relying on the judgment of the accountant into a set of detailed prescriptions.

Approaches to Client Interactions For decades, auditors have had to face

clients who try to stl1Jcture transactions to specifically meet U.S. GAAP rules regard­less of the underlying substance of the transaction. Soon, attempts at transaction structuring to meet technical rule critelia will be replaced by an evaluation of the underlying economic nature of a business transaction. A business will not be able to use a rule as leverage against the audi­tor's judgment. Under U.S. GAAP, man­agement could claim, "the transaction meets the rule's criteria, so what are you worried about?" Without the detailed rules found in U.S. GAAP, the level of uncer­tainty attached to properly recording a transaction is likely to increase, and the chances of auditor-client disagreements may also increase as less defined standards are applied. Such disagreements may

from the need for more extensive dis­closures of corporate activities that allow auditors to apply their judgment regarding the true nature of economic events. In fol­lowing a rule, such supplemental disclo­sures about future business events and plivate contractual relationships may not have been as critical in making a determi­nation about a transaction.

Accounting choices will be directly tied to the economic impact of the busi­ness transaction rather than the rule. Instead of tactically applying a rule, it will be

JUNE 2009/ THE CPA JOURNAL 60

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necessary to adopt strategic financial per­spectives and apply an in-depth under­standing of relationships between account­ing concepts and economic issues.

Value-Added Personality Attributes According to the FASB, the main dif­

ferences between IUles-based accounting standards principles-based standards are that principles are broad and there is less guidance on implementation. Such dif­ferences suggest that personal attributes that were once highly sought after in accoun­tants may no longer be as important.

If a work environment remains relatively unchanged, it is likely that new employees similar to employees will be and become successful. In a dynamic work setting, such as the one by dle move from rules-based to account­ing systems, employers may which attributes are desirable in new hires. Although inteUectual and cognitive skills will remain

certain other personal traits will need to be for their importance in a plinciples-based environment. The exam-

pies provided in £rhibit f highlight several traits more desirable in a principles-based work envimnment.

should highlight the

enhancement of personality

that may have remained unused

in a rules-based

accounting environment

Value-Added Training In addition to addressing new hiring cri­

teria, employers that effectively adjust to these changes must implement training pro­grams that give workers guidance on how

EXHIBIT 2 Training and Developmental Focus

Logical Application of Broad Standards

Employees should receive training in IFRS and learn how to use the principles in specific situations. This is essentially a deductive learning approach following the principles advocated here. Particular emphasis should be placed on the applica­tion of broad standards to specific accounting and auditing events. The impor­tance of judgment and the use of personality traits that lead to logical decision making in a principles-based environment should be illustrated.

Using a New Approach

Accountants should be trained in how to persuasively respond to clients who aggressively say: "Show me in the rules where it says I can't do that," or "Why do you need that information?" With fewer rules and more judgment required, accountants, especially junior-level professionals, must be able to competently and vigorously respond to such statements without alienating a client.

Follow More than Rules

Accounting personnel must recognize the meaning of truthful presentation. Training should emphasize that fair presentation, in all economic respects, is to be certified, not fair presentation with U.S. GAAP in all material respects. This is clearly a requirement to do more than follow rules. It is the beginning of a funda­mental attitude shift.

to successfully operate in the new envi­ronment. Such training goes beyond the technical training needed to understand new accounting standards.

Training for a principles-based work environment should include leaming how to apply strategic judgment to identify the substance of economic events without the guidance of bright-line accounting stan­dards. In order to apply longer-ranged per­spectives, information acquisition tech­niques need to be redirected to investiga­tions of corporate economic risks. This is a much broader perspective than one nar­rowly focused on specific accounting rules. Training should highlight the enhancement of personality traits that may have unused in a traditional account­ing environment, such as the ability to deal with restructured client arguments for recording business events. Training and development programs should focus on the attributes outlined in Erhibit 2.

The Role of Accounting Education Without question, a university account­

ing education has a significant role to play in preparing a new cadre of account­ing graduates. Although accounting edu­cators have explored ways in which the curriculum should cover IFRS guidelines, few accounting programs have actually incorporated LFRS material, according to recent surveys. Even fewer accounting edu­cators have considered that the presenta­tion of IFRS material will need to take a stmnger critical-thinking approach than is practiced today, when the FASB's bright-line rules are studied in the class­room. To deal with these changes, teach­ing methodologies may the use of case studies that provide for real uncer­tainty in finding solutions. The problems of how to adjust presentations and how to incorporate IFRS and FASB materials into an already crowded curriculum have yet to be solved. 0

G. Smith, PhD, CPA, CMA, the John Massey Endowed Chair (/lui a

professor of accounting, and C. W. VOIl

Bergen, PhD, is the John Massey Endowed Chair and a professor of man­agement. both at the school of business at Southeastem Oklahoma State University, Durant, Okla.

JUNE 2009/ THE CPA JOURNAL 61