By: George M. Wilson & Carol A. Stacey
As you have undoubtedly heard from a variety of sources (including this post we made last December), the new revenue recognition, financial instruments impairment and lease standards all involve many new and sometimes complex accounting judgments and estimates.
Issues ranging from how to estimate current expected credit losses to what is stand-alone selling price confront us with new, difficult, and subjective judgment calls.
“Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and
Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.”
To help us all deal with these challenges the Anti-Fraud Collaboration, a group made up of the Center For Audit Quality, FEI, NACD and IIA, has issued a report titled “Addressing Challenges for Highly Subjective and Complex Accounting Areas”.
This report is built on a foundation of detailed analysis of several SEC and PCAOB enforcement cases, a webcast and two workshops. The report has a robust discussion of several of the issues underlying these enforcement cases. One important conclusion drawn from this work is that a lack of controls surrounding subjective and complex accounting judgments is frequently a root cause underlying reporting problems. Based on this conclusion, the report includes a discussion of ways to help establish appropriate controls for such estimates and judgments. In fact, one of the enumerated objectives of the report is to:
“Facilitate a robust discussion about accounting policy, centering on highly subjective and complex accounting areas, and the design and operating effectiveness of ICFR”
In the report, there are several insights into ICFR issues surrounding complex judgments. For example:
Difficult Accounting Issues
Three accounting issues were problematic for companies under investigation: revenue recognition, loan impairment, and valuation. Both highly subjective and complex, these three areas were under stress during the financial crisis and therefore more prone to manipulation or error. The analysis of the AAERs also highlighted issues with the accounting policies pertaining to these areas. In the enforcement actions studied, the SEC cited that the companies either did not have an adequate accounting policy or procedure for the issue being investigated; the company was non-compliant with their existing policy or procedure; or that management acted to override the company’s accounting policy.
The report goes on to state:
For all members of the financial reporting supply chain, the importance of tone at the top cannot be overstated. In most cases of alleged financial fraud, the SEC names the CEO and/or the CFO in the complaint. Commission staff noted that the driver of earnings management—the catalyst for most fraud cases—is often top management, such that the focus on the CEO and CFO is not surprising. In cases the PCAOB has brought against individual auditors, it is usually the lead audit engagement partner or other senior members of an audit engagement team who are disciplined.
Hopefully, as you think about the design of ICFR over the new estimates and judgments required to implement the revenue recognition, lease and financial instrument impairment standards, you will find some helpful ideas in this report.
As always, your thoughts and comments are welcome!