Could Codification Weaken Internal Controls?

Maybe. And here's what you can do to mitigate the effect on your accounting policies, disclosures, and error detection.

On July 1, 2009, the Financial Accounting Standards Board formally adopted its Accounting Standards CodificationTM (ASC) as the source of authoritative generally accepted accounting principles for nongovernmental entities in the United States. The codification profoundly changed the way U.S. GAAP is documented, updated, referenced, and accessed.

Shortly before its adoption, most financial executives weren’t even aware that the codification was coming (see “Will the New FASB Code Change Accounting?”). And even those who knew it was on the way often failed to recognize its potential to introduce new weaknesses in internal control over financial reporting (ICFR). In this article, I’ll describe the impact of the codification on ICFR, as well as what you can do to mitigate the impact.

Five Areas to Focus On

In a robust system of ICFR, a reporting entity’s accounting policies are defined in advance, documented, and cite the authoritative financial accounting and reporting standards on which they are based. In addition, significant policies and changes in policies must be disclosed in notes that accompany financial statements. These simple facts enable us to identify five areas in which the codification may have created new weaknesses in your organization’s ICFR:
• Accounting policies;
• Accounting policy disclosures;
• Accounting principle changes;
• Error detection and correction; and
• Competencies.
Let’s examine each of these areas in more detail.

Accounting Policies

Mitigating the impact of the codification on ICFR begins with your organization’s accounting policy manual. You should review each accounting policy and update (or add) GAAP references that point to the appropriate guidance in the codification. For example, accounting policies for leases often include language to the effect of “Leased equipment is capitalized if it meets the criteria outlined in FASB Statement of Financial Accounting Standards (SFAS) No. 13.” Because SFAS No. 13 is no longer authoritative GAAP, the wording should be changed to refer to FASB ASC Section 840-10-25. The more specific the reference (e.g., referring to a codification subtopic rather than a topic), the better.

BPounder2“The complicating factor in updating GAAP references is that historical pronouncements of GAAP don’t map neatly into the codification.” — Bruce Pounder

The complicating factor in updating GAAP references is that historical pronouncements of GAAP don’t map neatly into the codification. That’s because in developing the codification content, FASB essentially disassembled historical pronouncements down to the paragraph level and then reassembled the paragraphs without regard to the source or structure of the historical pronouncements. Fortunately, the FASB Codification Research System and most third-party GAAP research services offer a cross-reference feature that aids in the mapping of historical pronouncements to the codification and vice versa.

Accounting Policy Disclosures
Reporting entities have traditionally referred to specific pronouncements of GAAP in the notes that accompany financial statements and in narratives, such as the management’s discussion and analysis section of annual reports. For example, the 2008 annual report of General Electric Co. contained the following:
• Forty-seven references to 12 different Statements of Financial Accounting Standards;
• Three references to a FASB Technical Bulletin;
• Three references to two different FASB Interpretations;
• Seven references to four different FASB Staff Positions; and
• Three references to three different EITF Issues.


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