Test Your Accounting IQ

Regarding Some Fairly Heavy Topics

Introduction to the Quiz

Are you ready to put your accounting expertise to the test? This quick quiz dives into five significant areas shaping public accounting today — from leasing and credit loss estimates to risk assessments, quality management standards, and revenue recognition. Designed for CPAs with a couple of years under their belts, this quiz challenges your knowledge of recent standards and their real-world application. Answers and brief explanations follow — so you can check your score and sharpen your skills. This quiz covers five complex accounting, auditing, and firm quality management areas relevant to accountants in public practice. The topics include:

Benefits of AI in Audit and Accounting Research

  • ASC 842 – Leases, which has significantly impacted how companies account for leases;
  • ASC 326 – Current Expected Credit Losses (CECL), which introduces a forward-looking approach to estimating credit losses;
  • SAS 145 – Risk Assessment, which enhances audit quality by refining and clarifying the risk assessment processes;
  • Quality Management Standards (SQMS No. 1, SQMS No. 2, SAS No. 146, and SSARS No. 26), which aim to improve firm-wide quality management systems; and
  • ASC 606 – Revenue Recognition, which provides a unified framework for recognizing revenue across industries.

The best responses and explanations are provided following the quiz.

Quiz Questions

ASC 842 – Leases

  1. What is the purpose of the lease classification tests under ASC 842?
    • A) To determine whether leases should be capitalized
    • B) To decide if leases are finance or operating leases
    • C) To eliminate lease liabilities from the balance sheet
    • D) To reassess lease terms annually
  2. Under ASC 842, what happens if a lease meets one or more classification test criteria?
    • A) It is classified as an operating lease
    • B) It is classified as a finance lease
    • C) It is excluded from financial reporting
    • D) It is classified as a short-term lease
  3. Which test was added under ASC 842 to classify leases?
    • A) Bargain purchase option test
    • B) Present value test
    • C) Alternative use test
    • D) Lease term test
  4. How does ASC 842 impact transparency in financial reporting?
    • A) By eliminating lease liabilities from the balance sheet
    • B) By requiring all leases to be classified as operating leases
    • C) By reducing disclosure requirements for leases
    • D) By requiring recognition of Right-of-Use (ROU) assets and lease liabilities
  5. What is considered a key challenge for construction companies under ASC 842?
    • A) Eliminating ROU assets
    • B) Reducing lease liabilities on the balance sheet
    • C) Increasing lease term flexibility
    • D) Identifying embedded leases in service contracts

    ASC 326 – Current Expected Credit Losses (CECL)

  6. What distinguishes CECL from the legacy incurred loss model?
    • A) CECL estimates losses only when they are probable and estimable
    • B) CECL incorporates forward-looking information into credit loss estimates
    • C) CECL eliminates the need for credit loss reserves entirely
    • D) CECL applies only to large entities
  7. What methodology can construction companies use to estimate credit losses under CECL?
    • A) Historical write-offs only
    • B) Solely qualitative assessments without quantitative data
    • C) Pool-based assumptions incorporating reasonable forecasts of future conditions
    • D) Ignoring aging categories for receivables
  8. What defines a collateral-dependent loan under CECL?
    • A) Loans secured by collateral that must be sold immediately upon default
    • B) Loans secured by high-value collateral without borrower difficulty considerations
    • C) Loans where repayment depends substantially on the operation or sale of collateral due to borrower financial difficulty
    • D) Loans excluded from CECL requirements
  9. How are expected credit losses estimated for collateral-dependent loans under CECL?
    • A) Based on the fair value of collateral adjusted for costs to sell if foreclosure is probable
    • B) Using historical data only, without considering collateral value adjustments
    • C) Ignoring fair value considerations entirely in favor of qualitative assessments
    • D) Using arbitrary percentages assigned by management
  10. Why is CECL important for construction industry financial reporting?
    • A) It simplifies reporting by eliminating credit loss reserves entirely
    • B) It reduces reporting complexity by standardizing all methods across industries
    • C) It enhances transparency by incorporating forward-looking estimates of credit losses across financial assets like receivables and retainage balances
    • D) It applies only to government contracts

    SAS 145 – Risk Assessment

  11. How does SAS 145 refine risk assessment procedures?
    • A) By eliminating walkthroughs during audits
    • B) By removing material misstatement considerations
    • C) By combining inherent risk and control risk into a single assessment
    • D) By requiring auditors to assess inherent risk and control risk separately
  12. What must auditors evaluate regarding identified controls under SAS 145?
    • A) Whether controls are designed effectively and implemented properly
    • B) Whether controls can be ignored during substantive testing
    • C) Whether controls reduce inherent risk directly
    • D) Whether controls eliminate material misstatements entirely
  13. What happens if control risk is assessed at maximum under SAS 145?
    • A) Inherent risk is reduced automatically
    • B) Control risk is ignored during testing
    • C) The risk of material misstatement equals inherent risk
    • D) Audit procedures are terminated
  14. Why did SAS 145 revise the definition of relevant assertions?
    • A) To eliminate assertions altogether
    • B) To clarify that assertions are relevant only when there is both a reasonable possibility for the misstatement to occur and a reasonable possibility for it to be material
    • C) To expand the scope of relevant assertions to include all risks
    • D) To reduce auditor judgment during testing
  15. What impact does SAS 145 have on audit planning for areas with low inherent risks?
    • A) Reduced sample sizes, allowing focus on higher-risk areas
    • B) Increased sample sizes for testing
    • C) Elimination of testing in low-risk areas
    • D) Increased documentation requirements

    Quality Management Standards

  16. What is the primary objective of SQMS No. 1?
    • A) To design and implement a proactive, risk-based quality management system tailored to firm operations
    • B) To eliminate quality management systems altogether
    • C) To standardize quality management processes across all firms
    • D) To reduce audit costs by minimizing quality control measures
  17. How do SQMS No. 1 and SQMS No. 2 work together?
    • A) SQMS No. 1 replaces SQMS No. 2
    • B) Both standards eliminate the need for quality management
    • C) SQMS No. 1 is only for small firms, while SQMS No. 2 is for large firms
    • D) SQMS No. 1 focuses on quality management systems, while SQMS No. 2 addresses engagement quality reviews
  18. What is the role of the engagement partner under SAS No. 146?
    • A) To reduce professional skepticism
    • B) To ensure appropriate involvement and quality in audits
    • C) To eliminate audit documentation
    • D) To ignore firm policies
  19. How do the new Quality Management Standards enhance firm leadership?
    • A) By reducing accountability and governance
    • B) By increasing accountability and governance through a risk-based approach
    • C) By eliminating technology considerations
    • D) By ignoring external service providers
  20. What is the impact of SSARS No. 26 on quality management?
    • A) It reduces the importance of quality management
    • B) It eliminates the need for engagement quality reviews
    • C) It aligns with SQMS by enhancing quality management processes
    • D) It only applies to audits, not reviews

    ASC 606 – Revenue Recognition

  21. How does ASC 606 change revenue recognition for construction companies?
    • A) It eliminates the percentage of completion method
    • B) It reduces the need for contract modifications
    • C) It introduces a five-step model to determine revenue recognition timing
    • D) It only applies to point-in-time revenue recognition
  22. What is the first step in the ASC 606 revenue recognition model?
    • A) Recognize revenue at a point in time
    • B) Determine the transaction price
    • C) Identify the contract with the customer
    • D) Allocate the transaction price to performance obligations
  23. How do construction companies determine if revenue is recognized over time or at a point in time under ASC 606?
    • A) Based solely on contract duration
    • B) Based on whether the customer receives benefits as work is performed
    • C) Based on the type of construction project
    • D) Based on the contractor’s preference
  24. What is a key challenge in applying ASC 606 to construction contracts?
    • A) Determining the transaction price
    • B) Identifying performance obligations and their satisfaction timing
    • C) Ignoring contract modifications
    • D) Reducing costs to obtain and fulfill contracts
  25. Why is collaboration between accounting and project management teams important under ASC 606?
    • A) To reduce project costs
    • B) To increase audit risks
    • C) To eliminate the need for contract reviews
    • D) To ensure accurate revenue recognition and reflect the financial status of projects

Best Responses and Brief Explanations

  1. B) To decide if leases are finance or operating leases.

    ASC 842 uses classification tests to determine if a lease is a finance lease or operating lease.

  2. B) It is classified as a finance lease.

    If a lease meets one or more of the classification criteria, it is classified as a finance lease. Otherwise, it is classified as an operating lease.

  3. C) Alternative use test.

    Is the asset so specialized that it is only useful to the lessee is one of the criteria used to classify leases under ASC 842.

  4. D) By requiring recognition of Right-of-Use (ROU) assets and lease liabilities.

    ASC 842 enhances transparency by recognizing ROU assets and lease liabilities on the balance sheet.

  5. D) Identifying embedded leases in service contracts.

    Identifying embedded leases is a key challenge under ASC 842 because they are often disguised and not referred to as leases.

  6. B) CECL incorporates forward-looking information into credit loss estimates.

    CECL introduces a forward-looking approach to estimating credit losses, and credit losses are recognized even if the possibility is remote.

  7. C) Pool-based assumptions incorporating reasonable forecasts of future conditions.

    CECL allows for pool-based assumptions that incorporate future conditions.

  8. C) Loans where repayment depends substantially on the operation or sale of collateral due to borrower financial difficulty.

    This defines a collateral-dependent loan under CECL.

  9. A) Based on the fair value of collateral adjusted for costs to sell if foreclosure is probable.

    Expected credit losses for collateral-dependent loans are estimated based on collateral value.

  10. C) It enhances transparency by incorporating forward-looking estimates of credit losses.

    CECL improves financial reporting by incorporating future expectations.

  11. D) By requiring auditors to assess inherent risk and control risk separately.

    SAS 145 mandates separate assessments for inherent and control risk.

  12. A) Whether controls are designed effectively and implemented properly.

    Auditors must evaluate whether controls are effective and properly implemented.

  13. C) The risk of material misstatement equals inherent risk.

    If control risk is maximum, the risk of material misstatement equals inherent risk

  14. B) To clarify that assertions are relevant only when there is a reasonable possibility for the misstatement to occur and a reasonable possibility for it to be material.

    SAS 145 clarifies relevant assertions to enhance audit risk assessments.

  15. A) Reduced sample sizes, allowing focus on higher-risk areas.

    SAS 145 allows for reduced testing in low-risk areas, focusing on higher-risk ones.

  16. A) To design and implement a proactive, risk-based quality management system tailored to firm operations.

    SQMS No. 1 aims to create a customized quality management system.

  17. D) SQMS No. 1 focuses on quality management systems, while SQMS No. 2 addresses engagement quality reviews.

    Both standards work together to enhance quality management.

  18. B) To ensure appropriate involvement and quality in audits.

    The engagement partner ensures quality and involvement in audits under SAS No. 146.

  19. B) By increasing accountability and governance through a risk-based approach.

    The new Quality Management Standards enhance firm leadership by increasing accountability.

  20. C) It aligns with SQMS by enhancing quality management processes.

    SSARS No. 26 aligns with SQMS to enhance quality management.

  21. C) It introduces a five-step model to determine revenue recognition timing.

    ASC 606 introduces a five-step model for revenue recognition.

  22. C) Identify the contract with the customer.

    The first step in ASC 606 is identifying the contract with the customer.

  23. B) Based on whether the customer receives benefits as work is performed.

    Revenue is recognized over time if the customer receives benefits as work is performed.

  24. B) Identifying performance obligations and their satisfaction timing.

    Identifying performance obligations is a key challenge under ASC 606. However, a robust case can be made for A) Determining the transaction price.

  25. D) To ensure accurate revenue recognition and reflect the financial status of projects.

    Collaboration between accounting and project management teams helps ensure accurate revenue recognition under ASC 606.

How Did You Score?

Whether you aced it or picked up a few new insights, staying sharp on these evolving standards is key to staying ahead in public accounting. If you’d like to dive deeper into any of these areas, reach out to our team — we’re always here to help navigate the complexities.

ASC Topic 326 – Current Expected Credit Losses

Give Credit Where Credit is Due

For the non-public, non-financial sector, it took a while for the new standard on credit losses to get here. But it’s here now and breathing down our necks with a vengeance. CECL (pronounced cecil) was issued by the FASB in 2016. For the non-financial sector, it’s somewhat of a wolf in sheep’s clothing. Not that it was intended to be that way, but it just is. So beware. It’s a peer review “gotcha” event. As the song says, “Things ain’t what they used to be.” This article will address some CECL issues in a question-and-answer format.

  1. When was CECL’s (ASC 326) effective for non-public companies?

    ASC 326 was effective for all non-public companies for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. So, in other words, it is effective for calendar year 2023 financial statements, including interim financial statements that begin in 2023.

    The interim financial statement’s effective date for non-public companies is a change from the customary practice of the FASB. Usually, for private companies, new standards are effective for interim financial statements the year after it is effective for the annual financial statements. When the original pronouncement was issued in 2016, that’s how it was – the interim financial statement’s effective date was a year later. However, this decision was later reversed by the FASB in an ASU released in 2018. This change may have flown under the radar screen for many busy accountants.

  2. To whom does CECL apply?

    While the standard was primarily directed to financial institutions like banks and credit unions, it also applies to non-financial institutions. That includes construction companies, manufacturing companies, and non-profit entities, to name a few. However, as discussed in the next question, the standard does scope out specific areas.

  3. So, what is CECL, and which financial assets does it apply to?

    CECL stands for “current expected credit losses” related to financial instruments. The key phrase is “current expected.” The standard intends to inform the financial statement user what credit losses (bad debts) the company currently (upfront) expects to incur on its financial assets over the contractual life of those assets (the future). Generally, the standard applies to financial assets carried at amortized cost and includes:

    • Cash equivalents
    • Trade receivable
    • Contract assets (such as underbillings and retainage receivables)
    • Loans receivable/Notes receivable
    • Loans to officers and employees
    • Investment in debt securities held-to-maturity
    • A lessor’s receivables from sales-type or direct financing leases

    Notably, the following financial assets are not within the scope of CECL:

    • Receivables between entities under common control (see following two paragraphs)
    • Equity securities
    • Loans made to participants by defined contribution employee benefit plans
    • Pledge receivables of a not-for-profit organization
    • Lessor receivables from operating leases
    • Other financial assets measured at fair value through net income
    • Securities available-for-sale (though ASC 326-30 did make targeted changes to this area related to CECL)

    The AICPA’s Center for Plain English Accounting report for August 16, 2023, observed that “(T)he scope exception in FASB ASC 326-20-15-3f is for loans and receivables between “entities” under common control and makes no mention of “individuals.” Therefore, it is not clear based on the omissions in the plain language whether individuals (natural persons) such as a controlling shareholder are within the scope exception for CECL in FASB ASC 326-20-15-3f.”

    However, the article further states: “FASB staff has indicated that the scope exception for entities under common control also applies to natural persons (i.e., controlling shareholder) within a common control group. We should note that the scope exception for common control entities would NOT extend to an (sic) loan to an unrelated officer of one of the entities who did not hold a controlling financial interest.”

  4. What is the difference between the legacy standard and ASC 326?

    The former standard used an “incurred loss” methodology to recognize credit losses if it was deemed probable to be uncollectible. While probable is not defined, many practitioners consider probable equal to or greater than a 75% threshold. The collection loss had to be incurred and probable under the previous standard to be recognized.

    The new accounting standard’s model is designed to be forward-looking and considers the entire contractual life of a financial instrument. Moreover, it significantly reduces the threshold for recognizing credit losses. Under ASC 326, a credit loss can be recognized on financial assets, such as a class of trade receivables, at the asset’s inception, even if the likelihood of a loss is considered remote. CECL mandates that management consider expected credit losses throughout the entire life of a group of financial assets, regardless of the absence of any current signs of trouble. Accordingly, under CECL, losses are expected to be recognized sooner than losses were under legacy GAAP.

    Key takeaway: The loss recognition is forward-looking over the contractual life of the financial instrument, recognized at the asset’s inception, and the loss recognition threshold is considerably lower than previous GAAP.

  5. Does ASC 326 specify a particular way to estimate current expected credit losses?

    No. The standard is principle-based. The particular methodology used to arrive at the expected loss at the origination or acquisition date of the financial instrument is management’s decision. In a broad sense, the standard requires that the company base its estimate on:

    • Relevant information about past events, such as historical loss experiences,
    • Current conditions,
    • Reasonable and supportable forecasts.
    • For periods when the company cannot obtain supportable forecasts for expected credit losses, it may revert to historical loss information.

    ASC 326-20-30-7 states, in part, that “(A)n entity shall consider relevant qualitative and quantitative factors that relate to the environment in which the entity operates and are specific to the borrower(s).”

    Additionally, as stated in the AICPA’s Center for Plain English Accounting report, same date given above, “…CECL requires measurement of the expected credit loss even if that risk of loss is remote, regardless of the method applied to estimate the credit losses.”

  6. Can an entity ever have an expected credit loss of zero?

    It’s possible. But in most cases, it’s unlikely or even rare. The standard permits a zero credit loss in narrow situations where the expectation of not being paid is zero, even if a technical default were to occur. An example would be U.S. treasury securities guaranteed by the good faith and credit of the U.S. government, which can also print currency to retire the debt.

  7. Does ASC 326 require additional disclosure?

    As you probably expect, the answer is yes.

    On the balance sheet, there is a requirement to separately present the allowance for credit losses for financial assets measured at amortized cost, such as trade receivables, contract assets, and loans receivable. Also, investments in available-for-sale debt securities carried at fair value must present both amortized cost and allowance for credit losses parenthetically on the balance sheet.

    There are many required disclosures to achieve the stated objectives of ASC 326. For example, ASC 326 requires a roll-forward of the allowance for credit loss accounts. We suggest having your disclosure checklist for non-public companies readily available for reference as you draft the disclosures for financial instruments.

In summary, ASC 326, the credit loss standard, has a broad scope encompassing financial institutions and non-financial companies, including entities like construction firms. It applies to a wide array of financial assets measured at amortized cost, including items like trade receivables and contract assets. Notably, the threshold for recognizing credit losses has shifted from probable to remote, and this new standard mandates a forward-looking estimation of credit losses. It’s important to note that the new standard does not apply to specific financial instruments that are excluded, such as receivables between entities under common control or between companies and majority owners who are natural persons, in my opinion. Additionally, recognition is only required for amounts and disclosures considered material.

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