There has been a drive to encourage the amalgamation of audit firms. For instance, there is legislation ensuring that sole practitioners cannot be appointed auditors of Public Interest Entities (Listed firms, Insurance Cos, Banks,deposit taking SACCOS etc). However, this hasn't had a great impact on amalgamation of audit firms. Most sole practitioners prefer to stay that way......I guess its due to their desire for control and lack of compatibility with others.
The situation got me thinking. Can auditors still remain as sole practitioners and yet reap from economies of scale? I turned to our doctors for inspiration. There has been a growth in medical centres.......where doctors have individual clinics housed in one building. There are shared services e.g. xrays department but each doctor maintains their own space.
Why cant small practitioners do the same? Is it workable? I think it is a great idea. In fact, its the foundation that the big audit firms have. Come to think of it, each partner has their own portfolio and the staff are shared resources. The partners have appropriate revenue/costs sharing mechanisms etc and they trade under a common brand name.
Why not ape the big firms in all except the common brand name?
Wednesday, April 18, 2012
Auditor independence. A myth or reality?
Auditors are required to be independent. This is the reason behind legislation that seeks to curb the service offerings that audit firms can have. All the major audit firms have various divisions, each with its own partners. In some cases, the division has an independent legal status. A good example is having ABC certified Public Accountants and ABC Limited all trading under one brand name.
Proposed legislation in the EU seeks to do away with this model. Under the proposals, we expect the audit firms to spin off their non audit divisions and thus operate solely as audit practitioners.
Proponents argue that audit firms cant be independent as long as they provide (lucrative)non audit services since there is a conflict of interest.
Opponents argue that many talented individuals will leave the profession.
My perspective is that auditors cannot be independent. I am not saying that auditors are unethical.....far from it. There are two types of biases: overt and covert. Overt bias will be where individuals conciously take a certain position. This can be easily identified and corrective action taken. Covert biases are however more subtle and thus harder to detect.For example, one may have an unconcious bias against a certain person/group and will tend to discriminate for/against them unknowingly. You probably have had of "gut feelings". Well, your gut is not always right, and this is due to unconcious bias that you may have.
Auditors will interact with their clients and unconciously develop relationships which will impair their judgement. This will happen whether the firm is a pure audit firm or is offering other services.
Auditors are human beings.....we interact with others, develop a liking or dislike for them. This has an impact on our judgements about whatever representations the person provides us with.
In scientific tests conducted by harvard professors, it was discovered that auditors were prone to agreeing with their client's positions and were not as sceptical as other auditors who were not the auditors of their client.
So, is disclosure the way out? Not by a long shot. Even though I know that my doctor gets more money when he/she performs an operation, I trust that his/her advice recommending an operation is unbiased. This trust is not logical. The doctor has an incentive to increase their monetary reward. I believe accountants and auditors will face the same challenges.
Auditors will always suffer from impaired independence due to unconcious bias. The sooner we accept that, the earlier we can think of alternative ways of overcoming the bias.
Proposed legislation in the EU seeks to do away with this model. Under the proposals, we expect the audit firms to spin off their non audit divisions and thus operate solely as audit practitioners.
Proponents argue that audit firms cant be independent as long as they provide (lucrative)non audit services since there is a conflict of interest.
Opponents argue that many talented individuals will leave the profession.
My perspective is that auditors cannot be independent. I am not saying that auditors are unethical.....far from it. There are two types of biases: overt and covert. Overt bias will be where individuals conciously take a certain position. This can be easily identified and corrective action taken. Covert biases are however more subtle and thus harder to detect.For example, one may have an unconcious bias against a certain person/group and will tend to discriminate for/against them unknowingly. You probably have had of "gut feelings". Well, your gut is not always right, and this is due to unconcious bias that you may have.
Auditors will interact with their clients and unconciously develop relationships which will impair their judgement. This will happen whether the firm is a pure audit firm or is offering other services.
Auditors are human beings.....we interact with others, develop a liking or dislike for them. This has an impact on our judgements about whatever representations the person provides us with.
In scientific tests conducted by harvard professors, it was discovered that auditors were prone to agreeing with their client's positions and were not as sceptical as other auditors who were not the auditors of their client.
So, is disclosure the way out? Not by a long shot. Even though I know that my doctor gets more money when he/she performs an operation, I trust that his/her advice recommending an operation is unbiased. This trust is not logical. The doctor has an incentive to increase their monetary reward. I believe accountants and auditors will face the same challenges.
Auditors will always suffer from impaired independence due to unconcious bias. The sooner we accept that, the earlier we can think of alternative ways of overcoming the bias.
Wednesday, September 28, 2011
IAS 27 - Consolidated and Separate Financial Statements - Statement of Financial Position
A parent is an entity that controls another entity. An entity that is controlled by the parent is called a subsidiary.
Control is the ability to govern the financial and operating policy decisions of an entity.It is commonly expressed by having a significant shareholding (greater than 50%), although this is not the only indicator of control.
The consolidated Statement of Financial Position
The key concept is called SIMPLE ADDITION. it applies to all assets and liabilities of the parent and the subsidiary. For instance, if a parent has inventory of 100/- and the subsidiary has inventory of 50/-, the consolidated inventory is 100+50=150! So simple, isn't it?
However, there are several adjustments to this rule of simple addition:
Property Plant and Equipment = Parent + Subsidiary + Revaluation gain - Additional depreciation due to revaluation - Unrealised profit on intragroup sale of PPE + Excess depreciation due to the unrealised profit.
Inventory = Parent + Subsidiary - unrealized profit on closing inventory
Receivables = Parent + Subsidiary - intragroup receivables
Payables = Parent + Subsidiary - intragroup payables
EQUITY
We only take the parent's equity (share capital, share premium,reserves etc). A common trick is that if a parent paid for its stake in the subsidiary or associate in form of shares, then we will have to consider the additional shares that have been issued. This will thus have an impact on share capital and share premium.
For retained earnings, we take the parent's retained earnings + parent's share of subsidiary's post acquisition profits + parent's share of associate's post acquisition profits.
Note that any adjustments that affect profit and loss will be adjusted from the retained earnings, for example, depreciation, impairment, armortisation, unrealised profits etc.Now, here's the catch: for any adjustments affecting the subsidiary, take the group's share of the adjustment, while for any adjustment affecting the parent, take the entire adjustment. Just think of a scenario: parent sells to subsidiary goods and makes unrealized profit of 10/-. The entire profit of 10/- is due to the parent and will thus be adjusted from the retained earnings. if however, the transaction were a sale from subsidiary to parent, then the subsidiary would make the profit of 10/-. if the parent owns say 80% of the subsidiary, then it should only adjust a relevant 80% of the unrealised profit i.e. 8/-. The balance of 2/- will be adjusted from the Non controlling interest.
Control is the ability to govern the financial and operating policy decisions of an entity.It is commonly expressed by having a significant shareholding (greater than 50%), although this is not the only indicator of control.
The consolidated Statement of Financial Position
The key concept is called SIMPLE ADDITION. it applies to all assets and liabilities of the parent and the subsidiary. For instance, if a parent has inventory of 100/- and the subsidiary has inventory of 50/-, the consolidated inventory is 100+50=150! So simple, isn't it?
However, there are several adjustments to this rule of simple addition:
Property Plant and Equipment = Parent + Subsidiary + Revaluation gain - Additional depreciation due to revaluation - Unrealised profit on intragroup sale of PPE + Excess depreciation due to the unrealised profit.
Inventory = Parent + Subsidiary - unrealized profit on closing inventory
Receivables = Parent + Subsidiary - intragroup receivables
Payables = Parent + Subsidiary - intragroup payables
EQUITY
We only take the parent's equity (share capital, share premium,reserves etc). A common trick is that if a parent paid for its stake in the subsidiary or associate in form of shares, then we will have to consider the additional shares that have been issued. This will thus have an impact on share capital and share premium.
For retained earnings, we take the parent's retained earnings + parent's share of subsidiary's post acquisition profits + parent's share of associate's post acquisition profits.
Note that any adjustments that affect profit and loss will be adjusted from the retained earnings, for example, depreciation, impairment, armortisation, unrealised profits etc.Now, here's the catch: for any adjustments affecting the subsidiary, take the group's share of the adjustment, while for any adjustment affecting the parent, take the entire adjustment. Just think of a scenario: parent sells to subsidiary goods and makes unrealized profit of 10/-. The entire profit of 10/- is due to the parent and will thus be adjusted from the retained earnings. if however, the transaction were a sale from subsidiary to parent, then the subsidiary would make the profit of 10/-. if the parent owns say 80% of the subsidiary, then it should only adjust a relevant 80% of the unrealised profit i.e. 8/-. The balance of 2/- will be adjusted from the Non controlling interest.
Monday, August 15, 2011
IAS 28 INVESTMENT IN ASSOCIATES
An associate is an entity over which another entity can exercise SIGNIFICANT INFLUENCE. Significant influence refers to the ability to participate in, but not control the financial and operating policy decisions of an entity.
A shareholding of > 20% is normally assumed to give significant influence.
An important distinction is that if the balance of interest is owned by a single entity/individual, or by a diverse body of shareholders acting in concert, then significant influence cant be said to exist. i.e. if Company A owns 40% of Company B, and the balance of 60% is owned by Company C, then B cant be said to be an associate of Company A. If however, the 60% shareholding is by several investors and they are not acting in concert as a group, then Company B is an associate.
Associates are not consolidated but are equity accounted for.
The equity method is basically:
Cost of investment XXX
Add group's share of associate's post acquisition profits XXX
Less impairment losses, if any (XXX)
=Amount recognised in the Statement of Financial Position XXX
A shareholding of > 20% is normally assumed to give significant influence.
An important distinction is that if the balance of interest is owned by a single entity/individual, or by a diverse body of shareholders acting in concert, then significant influence cant be said to exist. i.e. if Company A owns 40% of Company B, and the balance of 60% is owned by Company C, then B cant be said to be an associate of Company A. If however, the 60% shareholding is by several investors and they are not acting in concert as a group, then Company B is an associate.
Associates are not consolidated but are equity accounted for.
The equity method is basically:
Cost of investment XXX
Add group's share of associate's post acquisition profits XXX
Less impairment losses, if any (XXX)
=Amount recognised in the Statement of Financial Position XXX
Saturday, January 29, 2011
IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
Provisions are liabilities of uncertain timing or amount. We are sure to incur the obligation, but we are not sure about either the exact amount of obligation or date when we will be required to pay.
As such, we are required to make ESTIMATES of the expected obligation and recognise the amount in the Statement of Financial Position as a liability.
Contingent liabilities on the other hand refers to POSSIBLE obligations arising from past events that MAY/MAY NOT CRYSTALLISE depending on uncertain future events which are not within the control of the entity. These are not presented on the face of the financials but are shown in the notes to the accounts.
For example: A has been sued by B in the high court. As at the year end, A is not sure of whether he will win or lose the case. He will thus consider the liability to be a contingent liability.
If on the other hand, there is judicial precedent that means that there is a high chance of A losing the case, then A will present the liability as a Provision.He is supposed to estimate the damages he will be required to pay and present the amount under liabilities section of statement of financial position.
It is only when the judge delivers an actual judgment that the provision now becomes an actual liability.
Contingent assets are similar to contingent liabilities. they are possible assets arising from past events and whose existence will be confirmed only the existence or non existence of uncertain future events not wholly within the control of the entity.
where an inflow of economic benefits is probable, the entity may disclose the contingent asset in the notes.
As such, we are required to make ESTIMATES of the expected obligation and recognise the amount in the Statement of Financial Position as a liability.
Contingent liabilities on the other hand refers to POSSIBLE obligations arising from past events that MAY/MAY NOT CRYSTALLISE depending on uncertain future events which are not within the control of the entity. These are not presented on the face of the financials but are shown in the notes to the accounts.
For example: A has been sued by B in the high court. As at the year end, A is not sure of whether he will win or lose the case. He will thus consider the liability to be a contingent liability.
If on the other hand, there is judicial precedent that means that there is a high chance of A losing the case, then A will present the liability as a Provision.He is supposed to estimate the damages he will be required to pay and present the amount under liabilities section of statement of financial position.
It is only when the judge delivers an actual judgment that the provision now becomes an actual liability.
Contingent assets are similar to contingent liabilities. they are possible assets arising from past events and whose existence will be confirmed only the existence or non existence of uncertain future events not wholly within the control of the entity.
where an inflow of economic benefits is probable, the entity may disclose the contingent asset in the notes.
Saturday, January 22, 2011
IAS 23 BORROWING COSTS
This standard builds on IAS 16 PROPERTY PLANT AND EQUIPMENT.(http://mwalimuwetuaccounting.blogspot.com/2010_10_01_archive.html)
IAS 16 requires that all costs incurred that are incidental to bringing the asset to the location and condition that management intended should be capitalised.
The question is; supposing that a loan had to be taken in order to finance the acquisition of an asset, would the interest expense on the loan be capitalised?
Per IAS 16, if the asset couldn't have been acquired without the loan, then the loan interest must be capitalised.
IAS 23 builds on the concept further; it says that interest costs for a "qualifying asset" must be capitalised. A qualifying asset is an asset that takes a LONG TIME to get ready for its intended use or sale. As such, it normally refers to assets that are being constructed instead of assets that are being bought in a sale transaction.
In case only part of a loan is used in constructing an asset, then the interest to be capitalised should be proportionate.
For borrowing costs to be capitalised, the following conditions must be met;
a)the borrowing costs are being incurred
b)expenses are being incurred
c)construction activities are going on
in case construction is suspended, the interest for the period that construction is suspended is expensed.In addition, if construction is over, then any subsequent interest till the date of loan repayment should be expensed.
IAS 16 requires that all costs incurred that are incidental to bringing the asset to the location and condition that management intended should be capitalised.
The question is; supposing that a loan had to be taken in order to finance the acquisition of an asset, would the interest expense on the loan be capitalised?
Per IAS 16, if the asset couldn't have been acquired without the loan, then the loan interest must be capitalised.
IAS 23 builds on the concept further; it says that interest costs for a "qualifying asset" must be capitalised. A qualifying asset is an asset that takes a LONG TIME to get ready for its intended use or sale. As such, it normally refers to assets that are being constructed instead of assets that are being bought in a sale transaction.
In case only part of a loan is used in constructing an asset, then the interest to be capitalised should be proportionate.
For borrowing costs to be capitalised, the following conditions must be met;
a)the borrowing costs are being incurred
b)expenses are being incurred
c)construction activities are going on
in case construction is suspended, the interest for the period that construction is suspended is expensed.In addition, if construction is over, then any subsequent interest till the date of loan repayment should be expensed.
IAS 40 INVESTMENT PROPERTY
This standard deals with tangible items of land and building (or part thereof) which are held mainly for capital appreciation or for rental. The purpose of use can be contrasted with IAS 16 Property Plant and Equipment which deals with items whose purpose is production of goods/services or administration.
The concepts in initial recognition are the same as those under IAS 16.
The difference is in the subsequent measurement; instead of cost model and revaluation model (per IAS 16),we now have cost model and fair value model (per IAS 40)
The cost model under the two standards is basically the same; ie cost less accumulated depreciation less impairment losses.
The key difference is between the revaluation model and the fair value model;
Revaluation model
any increases in revaluation are taken to revaluation surplus/reserve account
depreciation is computed based on this revalued amount
Fair value model
there is no revaluation reserve/surplus account. Any changes in fair value are taken immediately to the income statement.
there is no depreciation computed.
The concepts in initial recognition are the same as those under IAS 16.
The difference is in the subsequent measurement; instead of cost model and revaluation model (per IAS 16),we now have cost model and fair value model (per IAS 40)
The cost model under the two standards is basically the same; ie cost less accumulated depreciation less impairment losses.
The key difference is between the revaluation model and the fair value model;
Revaluation model
any increases in revaluation are taken to revaluation surplus/reserve account
depreciation is computed based on this revalued amount
Fair value model
there is no revaluation reserve/surplus account. Any changes in fair value are taken immediately to the income statement.
there is no depreciation computed.
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