Accounting
Both auditors, management must prepare for AI impact
As AI works its way into more and more business processes, it has become increasingly important for auditors to understand where, why, when and how organizations use it and what impact it is having not only on the entity itself but its various stakeholders as well.
Speaking at a virtual conference on AI and finance hosted by Financial Executives International, Ryan Hittner, an audit and assurance principal with Big Four firm Deloitte, noted that since the technology is still relatively new it has not yet had time to significantly impact the audit process. However, given AI’s rapid rate of development and adoption throughout the economy, he expects this will change soon, and it won’t be long before auditors are routinely examining AI systems as a natural part of the engagement. As auditors are preparing for this future, he recommended that companies do as well.
“We expect lots of AI tools to inject themselves into multiple areas. We think most companies should be getting ready for this. If you’re using AI and doing it in a way where no one is aware it is being used, or without controls on top of it, I think there is some risk for audits, both internal and external,” he said.
Andrey Popov/stock.adobe.com
There are several risks that are especially relevant to the audit process. The primary risk, he said, is accuracy. While models are improving in this area, they still have the tendency to make things up, which might be fine for creative writing but terrible for financial data reporting. Second, AI tends to lack transparency, which is especially problematic for auditors, as their decision making process is often opaque, so unlike a human, an AI may not necessarily be able to explain why it classified an invoice a particular way, or how it decided on this specific chart of accounts for that invoice. Finally, there is the fact that AI can be unpredictable. Auditors, he said, are used to processes with consistent steps and consistent results that can be reviewed and tested; AI, however, can produce wildly inconsistent outputs even from the same prompt, making it difficult to test.
This does not mean auditors are helpless, but that they need to adjust their approach. Hittner said that an auditor will likely need to consider the impact of AI on the entity and its internal controls over financial reporting; assess the impact of AI on their risk assessment procedures; consider an entity’s use of AI when identifying relevant controls and AI technologies or applications; and assess the impact of AI on their audit response.
In order to best assist auditors evaluating AI, management should be able to answer relevant questions when it comes to their AI systems. Hittner said auditors might want to know how the entity assesses the appropriate of AI for the intended purpose, what governance controls are in place around the use of AI, how the entity measures and monitors AI performance metrics, whether or how often they backtest the AI system, and what is the level of human oversight over the model and what approach does the entity take for overriding outputs when necessary.
“Management should really be able to answer these kinds of questions,” he said, adding that one of the biggest questions an auditor might ask is “how did the organization get comfortable with the result of what is coming out of this box. Is it a low risk area with lots of review levels? … How do you measure the risk and how do you measure whether something is acceptable for use or not, and what is your threshold? If it’s 100% accurate, that’s pretty good, but no backtesting, no understanding of performance would give auditors pause.”
He also said that it’s important that organizations be transparent about their AI use not just with auditors but stakeholders as well. He said cases are already starting to appear where people unaware that generative AI was producing the information they were reviewing.
Morgan Dove, a Deloitte senior manager within the AI & Algorithmic Assurance practice, stressed the importance of human review and oversight of AI systems, as well as documenting how that oversight works for auditors. When should there be human review? Anywhere in the AI lifecycle, according to Dove.
“Even the most powerful AIs can make mistakes, which is why human review is essential for accuracy and reliability. Depending on use case and model, human review may be incorporated in any stage of the AI lifecycle, starting with data processing and feature selection to development and training, validation and testing, to ongoing use,” she said.
But how does one perform this oversight? Dove said data control is a big part of it, as the quality and accuracy of a model hinges on its data stores. Organizations need to verify the quality, completeness, relevance and accuracy of any data they put into an AI, not just the training data but also what is fed into the AI in its day to day functions.
She also said that organizations need to archive the inputs and outputs of their AI models, without this documentation it becomes very difficult for auditors to review the system because it allows them to trace the inputs to the outputs to test consistency and reliability. When archiving data she said organizations should include details like the name and title of the dataset, and its source. They should also document the prompts fed into the system, with timestamps, so they can possibly be linked with related outputs.
Dove added that effective change management is also essential, as even little changes in model behaviors can create large variations in performance and outputs. It is therefore important to document any changes to the model, along with the rationale for the change, the expected impact and the results of testing, all of which supports a robust audit trail. She said this should be done regardless of whether the organization is using its own proprietary models or a third party vendor model.
“There are maybe two nuances. One is, as you know, vendor solutions are proprietary so that contributes to the black box lack of transparency, and consequently does not provide users with the appropriate visibility … into the testing and how the given model makes decisions. So organizations may need to arrange for additional oversight in outputs made by the AI system in question. The second point is around the integration and adoption of a chosen solution, they need to figure out how they process data from existing systems, they also need to devote necessary resources to train personnel in using the solution and making sure there’s controls at the input and output levels as well as pertinent data integration points,” she said.
When monitoring an AI, what exactly should people be looking for? Dove said people have already developed many different metrics for AI performance. Some include what’s called a SemScore, which measures how similar the meaning of the generated text is to the reference text, BLEU (bilingual evaluation understudy), which measures how many words or phrases in the generated text match the reference text, or ROC-AUC (Receiver Operating Characteristic Area Under the Curve) which measures the overall ability of an AI model to distinguish between positive and negative classes.
Mark Hughes, an audit and assurance consultant with Deloitte, added that humans can also monitor the Character Error Rate, which measures the exact accuracy of an output down to the character (important for processes like calculating the exact dollar amount of an invoice), Word Error Rate, which is similar but does the evaluation at the word level, and the “Levenshtein distance,” defined as the number of single character edits needed to fix an extracted text to see how far away the output is from the ground truth text.
Hittner said that even if an organization is only just experimenting with AI now, it is critical to understand where AI is used, what tools the finance and accounting function have at their disposal to use, and how it will impact the financial statement process.
“Are they just drafting emails, or are they drafting actual parts of the financial statements or management estimates or [are] replacing a control? All these are questions we have to think about,” he said.
The Financial Accounting Standards Board met this week to discuss its projects on accounting for transfers of cryptocurrency assets and enhancing the disclosures around certain digital assets, such as stablecoins.
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During Wednesday’s meeting, FASB’s board made certain tentative decisions, according to a
At a future meeting, the board plans to consider clarifying the derecognition guidance for crypto transfer arrangements to assess whether the control of a crypto asset has been transferred.
FASB also began deliberations on the
The board decided to provide illustrative examples in Topic 230, Statement of Cash Flows, to clarify whether certain digital assets such as stablecoins can meet the definition of cash equivalents. It also decided to include the following concepts in the illustrative examples:
- Interpretive explanations that link to the current cash equivalents definition;
- The amount and composition of reserve assets; and,
- The nature of qualifying on-demand, contractual cash redemption rights directly with the issuer.
FASB plans to clarify that an entity should consider compliance with relevant laws and regulations when it’s creating a policy concerning which assets that satisfy the Master Glossary definition of the term “cash equivalents“ will be treated as cash equivalents.
“I agree with the staff suggestion to look at examples,” said FASB vice chair Hillary Salo. “From my perspective, I think that is going to help level the playing field. People have been making reasonable judgments. I agree with that. And I think that this is really going to help show those goalposts or guardrails of what types of stablecoins would be in the scope of cash equivalents, and which ones would not be in the scope of cash equivalents. I certainly appreciate that approach, and I think it has the least potential impact of unintended consequences, because I do agree with my fellow board members that we shouldn’t be changing the definition of cash equivalents, and it’s a high bar to get into the cash equivalent definition.”
“I’m definitely supportive of not changing the definition of cash equivalents,” said FASB chair Richard Jones. “I believe that’s settled GAAP in a way, and we’re not really seeing a call to change it for broader issues. I am supportive of the example-based approach. The challenge with examples, though, is everybody’s going to want their exact pattern, but that’s not what we’re doing.”
The examples will explain the rationale for how digital assets such as stablecoins do or do not qualify as cash equivalents and give a roadmap for other types of digital assets with varying fact patterns to be able to apply.
“We really don’t want to be as a board facing a situation where something was a cash equivalent and then no longer is at a later date,” said Jones. “That’s not good for anyone, so keeping it as a high bar with certain rigid criteria, I think, is fine.”
Stablecoins are supposed to be pegged to fiat currencies such as U.S. dollars and thus provide more stability to investors. “In my view, while a stablecoin may meet the accounting definition established for cash equivalents, not every one of those stablecoins in the cash equivalent classification represents the same level of risk,” said FASB member Joyce Joseph.
She noted that the capital markets recognize the distinctions and have established a Stablecoin Stability Assessment Framework to evaluate a stablecoin’s ability to maintain its peg to a fiat currency. Such assessments look at the legal and regulatory framework associated with the stablecoin, and provide investors with information that could enable them to do forward-looking assessments about the stability of the stablecoin.
“However, for an investor to consider and utilize such information for a company analysis the financial statement disclosures would need to include information about the stablecoin itself,” Joseph added. “In outreach, the staff learned that investors supported classifying certain stablecoins as cash equivalents when transparent information is available about the entities at which the reserve assets are held. Therefore, in my view, taking all of this into consideration a relevant and informative company disclosure would include providing investors with the name of the stablecoin and the amount of the stablecoin that is classified as a cash equivalent, so investors can independently assess the liquidity risks more meaningfully and more comprehensively by utilizing broader information that is available in the capital markets and its emerging information.”
Such information could include the issuer, reserves, governance and management, she noted, so investors would get a more holistic look at the risks that holding the stablecoin would entail for a given company.
The board decided to require all entities to disclose the significant classes and related amounts of cash equivalents on an annual basis for each period that a statement of financial position is presented.
Entities should apply the amendments related to the classification of certain digital assets as cash equivalents on a modified prospective basis as of the beginning of the annual reporting period in the year of adoption.
FASB decided that entities should apply the amendments related to the disclosure of the significant classes and amounts of cash equivalents on a prospective basis as of the date of the most recent statement of financial position presented in the period of adoption.
The board will allow early adoption in both interim and annual reporting periods in which financial statements have not been issued or made available for issuance.
FASB also decided to permit entities to adopt the amendments to be illustrated in the examples related to the classification of certain digital assets as cash equivalents without the need to perform a preferability assessment as described in Topic 250, Accounting Changes and Error Corrections.
The board directed the staff to draft a proposed accounting standards update to be voted on by written ballot. The proposed update will have a 90-day comment period.
Senators introduced several pieces of tax-related legislation this week, including measures aimed at improving customer service at the Internal Revenue Service, cracking down on tax evasion and curbing the carried interest tax break, in addition to efforts in the House to repeal the Corporate Transparency Act.
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Senators Bill Cassidy, R-Louisiana, and Mark Warner, D-Virginia, teamed up on introducing a bipartisan bill, the
The bill would establish a dashboard to inform taxpayers of backlogs and wait times; expand electronic access to information and refunds; expand callback technology and online accounts; and inform individuals facing economic hardship about collection alternatives.
“Taxpayers deserve a simple, stress-free experience when dealing with the IRS,” Cassidy said in a statement Wednesday. “This bill makes the process quicker and easier for taxpayers to get the information they need.”
He also mentioned the bill during a
“I’m happy to meet with the team … and do all I can to make it as good as you want it to be,” said Bisignano.
“My bill would equip the IRS with the legislative mandate to create an online dashboard so that taxpayers can monitor average call wait time and budget time accordingly,” said Cassidy. He noted that the bill would allow a callback for taxpayers that might need to wait longer than five minutes to speak to a representative, and establish a program to identify and support taxpayers struggling to make ends meet by providing information about alternative payment methods, such as installments, partial payments and offers in compromise.
“I know people are kind of desperate and don’t know where to turn for cash, so I think this could really ease anxiety,” he added. “This legislation is bipartisan and is likely to pass this Congress.”
Cassidy and Warner
“Taxpayers shouldn’t have to jump through hoops to get basic answers from the IRS — and in the last year, those challenges have only gotten worse,” Warner said in a statement. “I am glad to reintroduce this bipartisan legislation on Tax Day to ease some of this frustration by increasing clear communication and making IRS resources more readily available.”
Stop CHEATERS Act
Also on Tax Day, a group of Senate Democrats and an independent who usually caucuses with Democrats teamed up to introduce the Stop Corporations and High Earners from Avoiding Taxes and Enforce the Rules Strictly (Stop CHEATERS) Act.
Senate Finance Committee ranking member Ron Wyden, D-Oregon, joined with Senators Angus King, I-Maine, Elizabeth Warren, D-Massachusetts, Tim Kaine, D-Virginia, and Sheldon Whitehouse, D-Rhode Island. The bill would provide additional funding for the IRS to strengthen and expand tax collection services and systems and crack down on tax cheating by the wealthy.
“Wealthy tax cheats and scofflaw corporations are stealing billions and billions from the American people by refusing to pay what they legally owe, and far too many of them are getting a free pass because Republicans gutted the enforcement capacity of the IRS,” Wyden said in a statement. “A rich tax cheat who shelters mountains of cash among a web of shell companies and passthroughs is likelier to be struck by lightning than face an IRS audit, and Republicans want to keep it that way. This bill is about making sure the IRS has the resources it needs to go after wealthy tax cheats while improving customer service for the vast majority of American taxpayers who follow the law every year.”
Earlier this week. Wyden also
The Stop CHEATERS Act would provide the IRS with additional funding for tax enforcement focused upon high-income tax evasion, technology operations support, systems modernization, and taxpayer services like free tax-payer assistance.
“As Congress seeks ways to fund much-needed policy priorities and address our growing national debt, there is one common sense solution that should have unanimous bipartisan support: let’s enforce the tax laws already on the books,” said King in a statement. “Our legislation will make sure the IRS has the resources it needs to confront the gap between taxes owed and taxes paid – while ensuring that our tax enforcement professionals are focused on the high-income earners who account for the most tax evasion. This is a serious problem with an easy solution; let’s pass this legislation and make sure every American pays what they owe in taxes.”
Carried interest
Wyden, King and Whitehouse also teamed up on another bill Thursday to close the carried interest tax break for hedge fund managers that
Carried interest is a form of compensation received by a fund manager in exchange for investment management services, according to a
Under the bill, the
“Our tax code is rigged to favor ultra-wealthy investors who know how to game the system to dodge paying a fair share, and there is no better example of how it works in practice than the carried interest loophole,” Wyden said in a statement. “For several decades now we’ve had a tax system that rewards the accumulation of wealth by the rich while punishing middle-class wage earners, and the effect of that system has been the strangulation of prosperity and opportunity for everybody but the ultra-wealthy. There are a lot of problems to fix to restore fairness and common sense to our tax code, and closing the carried interest loophole is a great place to start.”
Repealing Corporate Transparency Act
The House Financial Services Committee is also planning to markup a bill next Tuesday that would fully repeal the Corporate Transparency Act, which has already been significantly
If enacted, the repeal would eliminate beneficial ownership reporting requirements, removing a transparency measure designed to help law enforcement and national security officials identify who is behind U.S. companies.
“This repeal would turn the United States back into one of the easiest places in the world to set up anonymous shell companies, something Congress worked for years to fix,” said Erica Hanichak, deputy director of the FACT Coalition, in a statement. “These entities are routinely used to facilitate corruption, financial crime, and abuse. Rolling back the CTA doesn’t just weaken transparency, it signals to bad actors around the world that the U.S. is once again open for illicit business.”
The Internal Revenue Service rarely penalizes taxpayers who have high balances in foreign bank accounts and fail to file the proper forms, according to a new report.
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The
Taxpayers with specified foreign financial assets that meet a certain dollar threshold are also required to report the information to the IRS by filing Form 8938. Failure to file the form can result in penalties of up to $60,000. However, TIGTA’s previous reports have demonstrated that the IRS rarely enforces these penalties.
The IRS created an Offshore Private Banking Campaign initiative to address tax noncompliance related to taxpayers’ failure to file Form 8938 and information reporting associated with offshore banking accounts, but it’s had limited success.
Even though the initiative identified hundreds of individual taxpayers with significant foreign bank account deposits who failed to file Forms 8938, the campaign only resulted in relatively few taxpayer examinations and a small number of nonfiling penalties. The campaign identified 405 taxpayers with significant foreign account balances who appeared to be noncompliant with their FATCA reporting requirements.
The IRS used two ways to address the 405 noncompliant taxpayers: referral for examinations and the issuance of letters to them.
- 164 taxpayers (who had an average unreported foreign account balance of $1.3 billion) were referred for possible examination, but only 12 of the 164 were examined, with five having $39.7 million in additional tax and $80,000 in penalties assessed.
- 241 noncompliant taxpayers (who had an average unreported account balance of $377 million) received a combination of 225 educational letters (requiring no response from the taxpayers) and 16 soft letters (requiring taxpayers to respond). None of the 241 taxpayers were assessed the initial $10,000 FATCA nonfiling penalty.
“While taxpayers can hold offshore banking accounts for a number of legitimate reasons, some taxpayers have also used them to hide income and evade taxes,” said the report.
Significant assets and income are factors considered by the IRS when assessing whether taxpayers intentionally evaded their tax responsibilities, the report noted. Given the large size of the average unreported foreign account balances, these taxpayers probably have higher levels of sophistication and an awareness of their obligation to comply with the law.
TIGTA believes the IRS needs to establish specific performance measures to determine the effectiveness of the FATCA program. “If the IRS does not plan to enforce the FATCA provisions even where obvious noncompliance is identified, it should at least quantify the enforcement impact of its efforts,” said the report. “This will ensure that IRS decision makers have the information they need to determine if the FATCA program is worth the investment and improves taxpayer compliance.
TIGTA made three recommendations in the report, including revising Campaign 896 processes to include assessing FATCA failure to file penalties; assessing the viability of using Form 1099 data to identify Form 8938 nonfilers; and implementing additional performance measures to give decision makers comprehensive information about the effectiveness of the FATCA program. The IRS disagreed with two of TIGTA’s recommendations and partially agreed with the remaining recommendation. IRS officials didn’t agree to assess penalties in Campaign 896 or with implementing performance measures to assess the effectiveness of the FATCA program.
“From our perspective, TIGTA’s conclusions regarding IRS Campaign 896 are based, in part, on a misguided premise and overgeneralizations, including the treatment of ‘potential noncompliance’ as tantamount to ‘egregious noncompliance’ that warrants a monetary penalty without contemplating the variety of justifications that may exempt a taxpayer from having to file Form 8938,” wrote Mabeline Baldwin, acting commissioner of the IRS’s Large Business and International Division, in response to the report.
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