Preparers issue self-driven guides on ICFR over leases, CECL

Like most financial institutions, Wells Fargo is deep into its efforts to adopt the new “current expected credit losses” model for recognizing loan losses in financial statements. While the CECL accounting requirements are spelled out explicitly enough in Accounting Standards Codification Topic 326, the requirement to have strong internal control around the accounting is, by comparison, a little more nebulous.

Sure, the Securities and Exchange Commission published guidance for preparers more than a decade ago about management’s responsibility under Sarbanes-Oxley to establish and maintain strong internal control over financial reporting. And yes, the Committee of Sponsoring Organizations, or COSO, has published and updated its Internal Control — Integrated Framework, which the SEC favors as a means of complying with Sarbanes-Oxley.

Yet, the biggest regulatory driver over internal control for the past decade has been the audit inspection process at the Public Company Accounting Oversight Board. Delivering harsh findings to all the major audit firms the past several years, especially with respect to the audit of internal control in compliance with PCAOB standards, auditors have dished it back on preparers, demanding even more rigor in their procedures and documentation.

“This has been a constant area of discussion in the preparer community,” says Sarah Ovuka, a professional accounting fellow at FEI and a former auditor. Preparers are trying to work through “perceived misalignment between auditors and management about how to assess and report on ICFR.”

Ongoing discussions prompted the Corporate Reporting Committee at Financial Executives International to mobilize. Not every company or every auditor team clashes over internal controls, but enough do that CCR looked for a way to help iron out difficulties.

That prompted the committee to develop two new guides to help preparers in their preparation for two new accounting standards. ASC 326, or CECL, takes effect in 2020, requiring companies to adopt a more forward-looking approach to estimating and reporting loan losses in financial statements.

Even sooner, ASC 842 takes effect in just a few weeks, on Jan. 1, 2019, for calendar-year companies, requiring companies to reflect lease-related assets and liabilities in financial statements. FEI’s committee wanted to help preparers not with the accounting requirements, but with establishing internal controls that will be necessary to achieve compliance with the leases and CECL standards.

Describing the CECL guide at a recent FEI conference, Schmidt said he had a “selfish interest” in being involved in the project, viewing it as an opportunity to compare notes with others who were navigating the same challenges.

“We wanted to make guidance that was for preparers, by preparers,” said Schmidt. “Internal control is a judgment area. It takes reasonable judgment to implement good internal control over financial reporting.” Noting much of existing guidance addresses risks and risk management ideas with respect to internal control, “we wanted to create real-life risk and control examples.”

The CECL document, for example, outlines issues management is likely to consider to provide documentation and evidence of their processes and controls to support their CECL estimates and allowances. The idea is to give preparers some issues to consider and some examples of documentation that might help in the CECL adoption.

Similarly, the leases document provides insights, best practices, and recommendations on scaling controls to the company’s situation, on determining materiality-drive design of controls, examples of key risks and controls for specific accounting areas, and more.

Neither document is issued as authoritative guidance, and neither is intended to provide an all-inclusive roadmap or a one-size-fits-all approach to internal control. The insights provided are intended to provoke some deep thinking, FEI says.

The CECL document in particular is meant to help companies work through some of the more difficult internal control issues, like management review controls, said Ovuka. Those controls are steeped in judgment and have won some special attention from the PCAOB. Inspection reports often hammer on the extent to which auditors tested or obtained evidence about the effectiveness of management review controls, and that will be an important area for companies complying with CECL.

“The inherent judgments and estimates required in management review controls have the potential to create a lot of the tension we see because of the differences in how auditors or preparers may view an appropriate assessment of those controls,” says Ovuka.

In the leases document, the committee wanted to be sure to address scaling internal controls, said Ovuka. Some companies may have thousands of leases, but some may have only a handful. “How do you strike the right balance of having internal control but not expending an exorbitant amount of effort on something that maybe doesn’t have a significant financial statement impact?”

The resulting documents should strike a chord for preparers, says Katie Greehan, a partner in the national professional standards group at audit firm RSM. “I do think companies will find these guides to be quite useful,” she says. One of the challenges with internal control is taking high-level theory and principles and turning it into practice, a point raised in the FEI documents. “Having examples of identified risks and related control activities will provide a great starting point.”

“It’s helpful for preparers to have any guidance they can get,” says Marc Blythe, president at Blythe Global Advisors. Especially with respect to the leasing standard, which is bearing down on companies, “it’s so susceptible to error because of all the different factors,” he says. “Anything that people can put out there to raise the white flag is a good thing.”

Joseph Soviero, executive director in derivatives and financial instruments at EY, says auditors will be looking at many different things with respect to controls over accounting standards adoptions; as such, he says, preparers should not see the guides as all-inclusive. “These are not one-size-fits-all publications,” he said. “Every entity is going to have their own unique control environment.”

Timothy Tuan, senior manager at MorganFranklin Consulting, says companies tend to focus on controls adequacy deeper into the implementation process, which often raises concerns by auditors. A focus earlier in the process helps reduce the risk of control deficiencies, he says.

While companies still have some time to work out the control structure for CECL, the lease accounting standard takes effect in just a few weeks, suggesting companies should be nearing the end of their implementation activities. Still, the guide will be helpful even for companies at advanced stages of preparation, says Graham Dyer, a partner in Grant Thornton’s accounting principles group.

“At the very least, it can help serve as maybe a final source of comparison against your process,” says Dyer. “You still have time to make any last-minute tweaks to the process. It will be helpful in that regard, and of course, continuous process improvement is always helpful.”