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The Institute of Internal Auditors’ (IIA) new Global Internal Audit Standards, released in January 2024, provide a modernized and comprehensive framework for internal audit functions to implement that will drive positive transformation within the organization. The transition to the new Global Internal Audit Standards signifies a significant opportunity for organizations to adjust to rapidly evolving business environments, technological advancements, and emerging risks.
While the new Standards emphasize performance and continuous improvement in addition to conformance, CAEs and internal audit functions as a whole need to understand what is changing, the shifts that will need to take place, and what steps need to be taken this year, now that the standards are in effect.
A modernized framework and taxonomy
The elements of the IIA’s current International Professional Practices Framework (IPPF) have been restructured in a new modernized framework comprising five domains, 15 principles, and 52 standards. The new standards are more prescriptive in nature and provide a framework and taxonomy that enables agility, risk-focused methodologies, and enhancing Internal Audit’s strategic alignment with the organization. Each standard now includes requirements, considerations for implementation, and considerations for evidencing conformance, replacing the information contained in the current implementation guides and practice advisories.
Key takeaways of the new standards
While companies operate at different levels of maturity with respect to corporate governance and risk management, it is critical for an internal audit function to be able to rapidly respond to changing risk landscapes. The new Standards provide internal auditors with clear guidance and an increased level of agility related to executing their role within an organization. It will be crucial to understand the changes incorporated into the new Standards, the go-forward expectations related to how your internal audit function will need to operate, and the level of effort required to reshape your internal audit function.
Below are several key takeaways related to the new Global IA Standards.
1. Define the value of internal audit within an organization
The purpose of internal auditing has been revised to state that “Internal auditing strengthens the organization’s ability to create, protect, and sustain value by providing the board and management with independent, risk-based, and objective assurance, advice, insight, and foresight,” the new Standards state. This includes Internal Audit helping organizations accomplish their objectives “by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of governance, risk management, and control processes,” as written in the Glossary definition of the function.
The new Standards enable Internal Audit and its stakeholders to understand and express the significance of internal auditing within the organization. For example:
- An internal audit mandate is now required within the organization’s internal audit charter, which must reflect Internal Audit’s role, responsibility, and authority levels, as well as stakeholders’ expectations of the internal audit function.
- The new Standards highlight the importance of the internal audit function to build relationships with the first and second lines of defense, its external auditors, as well as any other external assurance providers. Internal Audit should engage in meaningful collaboration with these stakeholders to promote effective governance and communication.
- The Code of Ethics has been refined to evolve with stronger ethical practices, clearer guidelines on conflicts of interest, and evolving professional standards of internal auditing.
2. Implement a formal internal audit strategy and performance measurement methodology
Internal Audit must develop an internal audit strategy and performance measurement methodology, and report periodically to the board. While incorporating an internal audit strategy is not a new practice, this is now a requirement under the new Standards. It will require a close focus between Internal Audit and the board to tailor performance metrics and monitor progress against strategy, while promoting continuous improvement of the internal audit function.
3. Innovate and maximize the use of technology
The Standards facilitate Internal Audit to have a defined digital strategy to support the evolution of the internal audit function’s mission, objectives, and value to the organization. While not a new concept, the utilization of technology goes well beyond utilizing core analytics to support the delivery of audits and assessments.
Technology should be used comprehensively through various tools, techniques, and platforms to enhance the efficiency, effectiveness, and value of internal audit processes and operations. Some examples of technologies and tools to be considered include:
4. Enhance value through quality
The new Standards bring forth a transformative approach around elevating Internal Audit’s value through enhanced quality. Several quality standards have been refined to be more prescriptive; key changes to underscore this commitment include:
- Evaluation of Findings – When developing conclusions around a particular topical area or subject matter, internal audit functions are now required (no longer optional) to determine the significance of the risk when reporting an issue by including a rating, ranking, or other indication of significance or priority.
- Quality Assurance – The requirements around an organization’s Quality Assurance and Improvement Program (QAIP) have been elevated. Programs should now include:
- Assessments around the internal audit function’s contribution to the organization’s governance, risk, and control processes
- Evidence of QAIP documentation to demonstrate an effective program
- Assessing progress toward identified success factors and performance objectives through key performance indicators
- Continuous monitoring of any corrective actions
- External Quality Assessments – The new Standards require at least one member of the Quality Assurance Review (QAR) team to hold an active Certified Internal Auditor (CIA) designation.
How to respond to the new standards (What organizations should be considering)
The updated Standards bring the need for thoughtful consideration by the internal audit function and concerted collaboration with the board, senior management, the first and second lines of defense, and other key stakeholders. Consider the following steps to assess, plan, and implement the Standards efficiently and effectively.
- Perform a readiness assessment by reviewing the new Standards and determining the extent of change needed.
- Communicate the impact of changes with the board and key stakeholders. This may require training and/or facilitated workshops.
- Consider accelerating the timing of an external quality assessment to measure conformance to the Standards, identify gaps, and recommend actions required for implementation. This will assist with validating the size of the conformance gap.
- Review current capabilities with respect to technology, audit methodology, and resources to determine level of effort needed to effectively implement to the new Standards.
- Update quality assurance programs to address future conformance with the new Standards and changes needed to current methodology.
- Develop an internal audit implementation plan to include new opportunities, priorities for change, technology changes, response to future topical requirements, and the corresponding dependencies and investment.
In conclusion
The new Standards provide significant transformative changes for internal audit functions to consider while capitalizing on new avenues for growth, innovation, and value creation within organizations. Internal audit functions may require additional resources and expertise to bridge the gap between the current and new Standards. CAEs and boards should consider leveraging external resources to help bridge any identified gaps and transition to an internal audit co-sourcing model. Adopting innovative and collaborative approaches will help elevate the value of your internal audit function, amplify the positive impact that Internal Audit has within the organization related to overall risk management activities, and create greater board and stakeholder confidence in strategic decision-making.
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This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
In August 2023, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2023-05 Business Combinations – Joint Venture Formations (Subtopic 805-60). Prior to this ASU, there was no specific accounting guidance on the accounting for the formation of a joint venture, which led to diversity in practice.
The amendments in this ASU are effective for all joint ventures formed on or after Jan. 1, 2025. Further, an election can be made for any joint venture formed before Jan. 1, 2025 to apply the provision of this update retrospectively, if the venture has sufficient information to do so.
Prior to this ASU, U.S. generally accepted accounting principles (GAAP) stated that transactions between a corporate joint venture and its owners were outside the scope of Topic 845, Nonmonetary Transactions and outside the scope of Topic 805, Business Combinations (Topic 805). Therefore, the lack of specific U.S. GAAP on the measurement of formation transactions led to some joint ventures accounting for their formation utilizing the fair value of the assets contributed by the members of the joint venture, analogizing to the accounting for a business combination under Topic 805.
Alternatively, other joint ventures utilized the historical carrying value of the contributed assets and liabilities of each of the members analogizing to the literature in Subtopic ASC 805-50 for common control transactions. The intent of the FASB in issuing this ASU was to reduce diversity in practice, as well as to provide decision-useful information to the users of a joint venture’s financial statements.
Key provisions of ASU 2023-05
This ASU requires a joint venture to account for its formation by applying a new basis of accounting to the assets contributed and liabilities assumed. This new basis of accounting is determined by applying aspects of the acquisition method utilized in accounting for business combinations (Topic 805), with certain adaptations specific to joint ventures. Although the guidance borrows measurement concepts from the acquisition method, a joint venture formation does not result in the identification of an accounting acquirer. Accounting for the formation of a joint venture follows a three-step process:
- Determination of the formation date;
- Recognizing and measuring the identifiable assets, the liabilities and any non-controlling interest in those net assets; and
- Recognizing and measuring goodwill, if any, using the fair value of the joint venture as a whole.
In the determination of the formation date, consider whether multiple arrangements should be accounted for as a single formation transaction. Factors utilized in this determination include:
- Whether multiple arrangements are entered into at the same time or in contemplation of one another;
- Whether such multiple arrangements form a single transaction designed to achieve an overall commercial effect;
- Whether the occurrence of one arrangement is dependent upon the occurrence of at least one other arrangement, and
- Whether one arrangement, considered on its own is not economically justified, but when combined with the other arrangement(s), the collective arrangements are economically justified.
Such consideration may be relatively straightforward while others involve significant complexity and/or judgment. Further, carefully consider and distinguish those transactions that constitute the formation of the joint venture from other transactions that may be completed or entered into that are not part of the formation of the venture itself (e.g., an agreement to provide future services to the joint venture by a member of the venture).
The recognition and measurement of the identifiable assets, liabilities, and any related non-controlling interest of the joint venture should be in accordance with Subtopic 805-20. The accounting under Subtopic 805-20 should be irrespective of whether the assets or group of assets constitute a business under Subtopic 805-10. For formation transactions for which the initial accounting is incomplete at the end of the reporting period, the same measurement period guidance provided in Subtopic 805-10-25-13 through 25-19 should be applied.
Goodwill is recognized at the formation date as the amount by which the fair value of the joint venture as a whole exceeds the net amount of identifiable assets acquired and liabilities assumed at that date. If the assets or group of assets recognized by the joint venture do not constitute a business, the amount of goodwill should be insignificant. Any excess of the amount of identifiable net assets over the fair value of the joint venture as a whole (negative goodwill) should be reflected as an adjustment to additional paid-in capital or members’ equity.
A joint venture that is a private company may elect to apply the private company accounting alternative to subsume certain customer-related intangible assets and non-competition agreements into goodwill. However, a joint venture that makes that election must also elect to apply the accounting alternative to amortize goodwill (Subtopic 350-20).
This ASU also amends the definition of Goodwill in the FASB Master Glossary to add to the definition those future economic benefits arising from other assets recognized by a joint venture upon its formation. It also adds the term “Formation Date” to the Master Glossary, defined as the date on which an entity meets the definition of a joint venture, which may be different than its legal formation date. This ASU does not, however, amend the definition of a joint venture or a corporate joint venture, nor does it change the accounting by the equity method investors in the joint venture or the accounting for subsequent contributions to the joint venture by the members. However, a venturer’s contribution of nonfinancial assets to a joint venture should be recognized by both the joint venture and venturer at fair value.
The ASU also includes the disclosure of information that enables users of its financial statement to understand the nature and effect of the joint venture formation in the period in which the formation date occurs. Specifically, the following information should be disclosed:
- formation date,
- a description of purpose for which the joint venture was formed
- the fair value of the joint venture as a whole as of the formation date;
- a description of the assets and liabilities recognized as of the formation date;
- the amounts of each major class of assets and liabilities recognized by the joint venture; and
- a qualitative description of the factors that make up any goodwill recognized, such as expected synergies from combining operations of the contributed assets or businesses.
If the initial accounting is incomplete as of the reporting date, the reasons why such accounting is incomplete are required, the identification of which assets, liabilities or non-controlling assets or the formation date fair value of the joint venture as a whole should be identified; as well as the nature an amount of any measurement period adjustments recognized during the reporting period, including the amount of adjustment to the current period income statement line items that would have been recognized in previous periods if the initial formation date accounting reflected the completed accounting.
Why this matters
U.S. GAAP exists to create a consistent framework for accounting for financial transactions such that investors, creditors, and regulators can be better positioned to make accurate assessments as to the financial position and results of operations of an entity. By providing a set of accounting standards specific to certain transactions or events, U.S. GAAP allows these users of financial statements to make more accurate comparisons to different entities. Prior to this ASU, the accounting for joint venture formation by two similar entities could have been inconsistent and therefore could result in materially different opening balance sheets and consequently materially different balance sheets and results of operations for what otherwise would have been two comparable entities. This ASU reduces the chances of such inconsistencies and serves to improve financial reporting.
What does CohnReznick think?
The accounting introduced in this ASU aims to eliminate previous diversity in practice in accounting for joint venture formation transactions and improve consistency and comparability in financial reporting. Additionally, the guidance in this ASU regarding required disclosures for these formation transactions provides additional insight and clarity into the business objectives and related accounting impacts of these transactions to the financial statement users. Reporting entities should take care to understand this ASU and its impact on their financial reporting. Begin by evaluating transactions involving variable interest entities (VIEs) occurring after the effective date to assess how the new guidance may impact your financial reporting.