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Public Companies Urged to Focus on Effect of New Standards on Internal Controls

The SEC wants pay close attention to how the adoption of some of the FASB’s major standards may affect their financial reporting controls in 2018 and beyond. The new revenue standard becomes effective in 2018, and the lease accounting amendments have a 2019 compliance date. Because of the changes to the accounting requirements, public companies and their auditors are expected to face a number of challenges with testing internal controls and ensuring that they are sound.

SEC officials are urging public companies to pay close attention to how adoption of some of the FASB’s major standards may affect their financial reporting controls in 2018 and beyond.

“Internal control that is effective within one set of conditions may not necessarily be effective when those conditions change significantly,” said Michael Dusza, a professional accounting fellow with the SEC in a December 4, 2017, speech at the AICPA Conference on Current SEC and PCAOB Developments in Washington. “Adoption of the new accounting standards for revenue, leases, and credit losses may be akin to a significant, complex, or unusual transaction for many companies and, like those transactions, it will put the design of companies’ [internal control over financial reporting] ICFR to test.”

In Dusza’s view, some of the key guidance for ensuring that a company has internal controls that are working properly and effectively prepared for the FASB’s new standards can be found in

Principle No. 9 of the Internal Control—Integrated Framework from the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The principle says an organization “identifies and assesses changes that could significantly impact the system of internal control,” and it is part of the Internal Control Framework’sassessment of the risk to prevent accounting errors. The principle also directs companies to use the risk assessment to avoid making accounting errors in the future.

According to Dusza, the changes to U.S. GAAP from Accounting Standards Update (ASU) No. 2014-09, Revenue From Contracts With Customers (Topic 606), ASU No. 2016-02, Leases (Topic 842), and ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, can be used by companies and auditors to address underlying risks in the internal controls or financial reporting systems that had been lurking in the background without detection.

“Such deficiencies need to be evaluated as to their severity and communicated to the company’s investors or audit committee,” Dusza said. “Identifying relevant risks of material misstatement that may arise under the new accounting standards and designing appropriately responsive controls may not be an easy task. However, we believe that if done right, the foundation established will over time yield benefits of a more effective and efficient ICFR process.”

Dusza also said that while companies have to employ a substantial amount of judgment when designing and implementing their internal controls, they can take steps to increase the likelihood that the controls are implemented properly if they plan and document the design and implementation. The planning and documentation can heighten the confidence a company’s management, auditors, and audit committee have that the controls were well designed and implemented correctly.

In recent years, the PCAOB’s heightened attention to Auditing Standard (AS) 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements, formerly AS 5, during its inspection process has forced accounting firms to apply more rigorous evaluations to clients’ internal controls. Companies have also been forced to correct the weaknesses in their controls.

In addition SEC officials have made a priority of correcting internal control problems.

For in-depth analysis of the FASB’s revenue recognition and leases standards, please see Catalyst: US GAAP — Revenue Recognition, and Catalyst: US GAAP — Leasesalso on Checkpoint.

Additional analysis of the revenue standard can be found on Checkpoint in Accounting and Auditing Update Service [AAUS No. 2014-18] and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements. For the lease standard, additional analysis is available at AAUS No. 2016-15 and SARU No. 2016-13 (March 2016): Special Report: Accounting for Leases—An Explanation and Analysis of Accounting Standards Update No. 2016-02.

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