Audit committees should take note that the Securities and Exchange Commission is putting a lot of faith in them to set the tone for corporate adoption of some major changes about to take place in accounting requirements.
A recent staff speech makes it clear that audit committees are expected to take on a significant leadership role in the collaborative effort necessary for companies to transition to major new accounting standards, beginning with revenue recognition in 2018, followed by leases in 2019 and credit losses in 2020. “The importance of the audit committee in promoting an environment for management’s successful implementation of the new GAAP standards cannot be overstated,” said Sagar Teotia, deputy chief accountant at the SEC.
Audit committee oversight is expected to set the tone at the top, said Teotia, establishing the environment and culture in which financial reporting occurs to assure integrity of the process. Audit committees should continue to set the tone for the adoption of the new GAAP standards, he said, including monitoring the implementation efforts and “taking the time” to understand and assess the quality and status of implementation.
“Simply put, I believe the tone set by an audit committee can affect the quality of a company’s implementation, including judgments made by management and ultimately the quality of information provided to investors,” he said.
Teotia praised the work some companies have done so far to prepare for the new revenue recognition standard, although various indicators suggest the bulk of public companies facing the Jan. 1 start date have delayed the process and may face serious compliance problems as a result. The SEC has fielded many questions on how to apply the rules to specific fact patterns, he said, and the staff will continue to do so, but time is running short. “To avoid a massive backlog at the end of the year, which would potentially be a detriment to all stakeholders, the time for those questions is now,” he said.
The new five-step method for recognizing revenue requires companies in many cases to exercise a great deal of judgment, which take time to develop, Teotia warned. “We will accept well-reasoned judgments but as a cautionary note generally well-reasoned judgments frequently require the important element of time to make,” he said.
Disclosures also require some extra attention, Teotia said. The new standard requires some judgment with respect to the disclosures, both in how the information should be presented and in implementing systems and internal controls to gather and display the data required in disclosures. And all of that follows continued focus on disclosures leading up to the implementation to explain how the company will be affected. “It is critical for the transition disclosures to be as informative as possible to the users of the financial statements,” he said.
Although the new standard on leasing doesn’t take effect until 2019, Teotia urged companies to dig in. “Sequential implementation of the revenue recognition standard followed by the leases standard may leave a company in a situation where it finds that it has potentially limited its time to adopt the new leases standard,” he said.