Last September, US
Securities and Exchange Commission Chief Accountant Wesley Bricker observed that
“the audit committee plays a vital role in overseeing a company’s financial
reporting, including the implementation of new accounting standards.”
One hotspot on the implementation front is oversight of how companies are implementing a major new accounting standard that will significantly change estimating and accounting for credit losses. The new accounting standard requires companies to measure certain credit losses under a new model, commonly referred to as the current expected credit loss model.
The standard will
affect accounting for a wide range of financial assets, including loans,
held-to-maturity debt securities, receivables, net investments in leases, and
certain off-balance sheet credit exposures. For most calendar year-end public
companies, the new standard is effective on January 1, 2020.
With this oversight challenge looming, the Center for Audit Quality has developed a tool to aid audit committee members. In addition to providing a concise overview of the standard, the tool provides ideas for audit committees regarding important questions to ask in key areas.
Evaluating the Company’s Impact Assessment
Company to company, the impact of the credit losses standard may vary based on a wide range of factors. Given this complexity, management may be performing high-level assessments to gauge whether the new standard’s impact will be limited, moderate, or significant. This impact assessment can be useful to guide the implementation plan, including consideration of needed resources.
As audit committees evaluate
management’s impact assessment, they should consider the following questions,
among others. (See the CAQ’s tool for additional questions.)
- Were all relevant parties involved in assessing and understanding the potential impact of the standard? This pool could include the following departments and functions: accounting, tax, communications, financial reporting (including internal control over financial reporting), financial planning and analysis, investor relations, risk, credit, operations (data retention for forecasting), treasury, and information technology.
- What factors were considered in management’s impact assessment?
- How has management assessed the potential impact the new standard may have on key areas such as investor relations and communications, regulatory compliance, accounting for taxes, and the impact on financial statements of borrowers?
- When will management provide pro forma financial statements including disclosures and investor communications to the audit committee to demonstrate the expected impact of the new standard on the financial statements (including multiple scenarios based on potential economic environmental impacts)?
Evaluating the Implementation Plan
Companies should develop an
implementation plan and communicate it to the audit committee. As with the
impact assessment, audit committee members should have a number of questions in
mind as they evaluate the implementation plan.
- How are milestones established and monitored? Are the milestones appropriate?
- How will the audit committee be apprised of status? Audit committees may want to consider requesting a quarterly progress report from management.
- Does a strong tone at the top support the effort required to implement the new standard? Is implementation receiving the appropriate resources (in-house and third-party) and priority?
- How is management’s assessment of internal control over financial reporting impacted?
- Has management created thorough processes to develop the expected credit loss model? Has it performed validation controls to verify that the model is performing as expected?
- Have governance processes and controls been put in place to determine that the model is—and will remain—fit for purpose?
- Who is responsible for new accounting policy decisions, and how does the company plan to revise written accounting policies?
- How has an internal communication plan been established (such that key stakeholders are aware of how the new standard will impact the company)?
- What is the view of the external auditor as it relates to the implementation plan? Will it satisfy the auditor’s plan and timeline to complete the audit in a timely manner?
Other Important Implementation
The questions don’t
stop at impact assessment or implementation. One critical area for audit
committees is understanding how the new standard will affect disclosures.
Exploring the following questions and others in the CAQ tool can aid in
building that understanding.
- Has the company disclosed the potential effects of the future adoption of the new standard in interim and annual filings leading up to the effective date? If quantitative amounts are not known, has the company provided qualitative or directional disclosures?
- What is management’s strategy for identifying, drafting, and communicating to the audit committee any new disclosures required as a result of the standard?
- To the extent that information for new disclosures is not currently available, how will the company develop new processes and controls to obtain required information?
Naturally, the questions listed above are just starting points in what should be a robust dialogue. For more, I urge audit committee members to download our tool, which, like all CAQ resources for audit committees, is a complimentary resource to the public.
Julie Bell Lindsay became the executive director of the Center for Audit Quality in May 2019.