Preparing Financial Statements in Codification Era

With the adoption of the Accounting Standards Codification structure for accounting rules, financial reporting executives have a new job in front of them: simply assuring they refer to accounting rules correctly.

After years of preparation by the Financial Accounting Standards Board, the Codification will take effect July 1. It completely reorganizes U.S. accounting principles into an online compendium of rules grouped by topic, rather than the mess of paper-based pronouncements that has accumulated over decades.

Pounder

While accountants are learning how to use the Codification, anyone in financial reporting who refers to accounting rules by name should prepare for the “ripple effects,” says Bruce Pounder, president of accounting education firm Leveraged Logic.

Most notably, financial statements that refer to historical accounting pronouncements after July 1 will no longer be referring to Generally Accepted Accounting Principles—and that will raise a serious question about internal control over financial reporting, Pounder warns. “If you refer to historical pronouncements after July 1, you might as well be referring to the owner’s manual for an ’87 Toyota Camry,” he quips.

Preparers will need to comb through any financial statement that will be issued after July 1, search for historical references to accounting pronouncements, and then update those references to reflect where those rules have been slotted into the Codification, financial reporting experts says.

“If the company were to attempt to continue to refer to historical references, then management would be asserting we specifically have not referred to authoritative GAAP,” Pounder explains. “That’s not going to hold up with auditors or in court if you’re sued by shareholders. If, as of July 1, your company can’t tell what’s authoritative GAAP and what’s not, you’ve got a big issue.”

Ben Neuhausen, national director of accounting for BDO Seidman, says that for some filers, the process could be as simple as starting with the most recent 10-K or 10-Q, searching it for references to accounting rules, and replacing those historical references with the new Codification references. Codification does provide a cross-referencing tool, so finding historical pronouncements and seeing how they’ve been re-numbered in the new system should be straightforward.

Elder

For the lucky ones, that updating may be easy enough to accomplish in a day or two, Neuhausen says. But Randy Elder, accounting professor at Syracuse University, warns that larger businesses with complicated financial statements will face “a fairly substantial undertaking … There’s a lot of information out there that needs to be updated to be consistent with the new codification.”

“There’s a lot of information out there that needs to be updated to be consistent with the new codification.”

—Ben Neuhausen,

National Director of Accounting,

BDO Seidman

And the updating could become tedious if the reference in existing financial statements doesn’t cite a specific line or paragraph in an old accounting pronouncement, Pounder says. The Codification has chopped all those historical pronouncements into small bits and regrouped them all according to topic, so knowing the title of a historical pronouncement alone may not provide enough detail to find it in the Codification.

For example, say you have a disclosure related to a fair-value measurement that must explain an adjustment to a Level 2 input. (Level 2 sits in the middle of fair-value estimates, based partly on models and partly on prices of real-world transactions.) An historical reference might simply cite Financial Accounting Standard No. 157, Fair-Value Measurements. Diligent accounting executives might even note the adjustment was made in accordance with guidance in Paragraph 29 of FAS 157.

In the Codification, however, Paragraph 29 of FAS 157 has been carved into five different pieces. They all exist in the same location—Topic 820, Subtopic 10, Section 35—but it could take five clicks of the computer mouse to find the specific reference in the Codification that correlates to the historical reference in an existing disclosure. And if the historical reference to FAS 157 doesn’t include a paragraph number, the Codification will display more than 400 references to FAS 157 where the historical literature might be found.

Once you do find the appropriate reference in the Codification, financial statements must still cite that reference properly so users can find the rule quickly. FASB has developed a suggested format for that chore; in the fair-value example from above, FASB recommends citing it as “FASB ASC 820-10-35-X” where X is the paragraph you want to cite. In our specific scenario, X is the specific line in GAAP you want to cite that originated from Paragraph 29.

FASB has also published a 50-page “Notice to Constituents” that provides detailed instructions on how to cite old GAAP rules according to their location in the Codification.

CITATION IN CODIFICATION

The following excerpt from Deloitte’s “Heads Up” newsletter gives readers an overview of what to look for while combing through financial statements:

What documents will entities most likely have to update for the Codification?

Financial statements and research memos will most likely require updating to reflect Codification references. For example, entities should consider updating memos documenting accounting conclusions that are carried forward to periods beyond the effective date of the Codification. Entities may also have specific references to GAAP in their accounting policy manuals and may want to make sure users of the manuals refer to the appropriate authoritative source. Specific references to pre-Codification GAAP citations in an entity’s financial statements may need to be updated.

Are entities required to refer to specific GAAP in their financial statements?

No. Although it may be difficult for entities to avoid references to specific GAAP in certain disclosures (e.g., the impact of the adoption of a new standard), the Codification may provide an opportunity for them to make financial statements more useful

to users by redrafting language in their financial statements to avoid specific references and to more clearly explain accounting concepts. For example, instead of specifically referring to FASB Statement No. 131, Disclosures About Segments of an Enterprise

and Related Information, or ASC 280, Segment Reporting, an entity may choose to simply refer to general accounting principles for segment reporting or describe its reason for providing segment information.

Should references to specific GAAP in financial statements for periods ending June 30, 2009 (or earlier), that are issued after the effective date of the Codification continue to refer to pre-Codification GAAP or be updated to reflect the Codification reference?

The Codification is expected to be effective on July 1, 2009. In financial statements for periods ending before but issued after the effective date of the Codification, entities may continue to refer exclusively to pre-Codification GAAP (if they use specific references

to GAAP). Entities may also elect to provide references to both current GAAP and the Codification (perhaps parenthetically) in their financial statements, but are not required to do so. If entities use only Codification references in financial statements for periods

ending before the effective date, they should consider whether that presentation would be appropriate because the basis for preparing the financial statements would be pre-Codification GAAP.

For example, in its financial statements, an entity may refer to the recognition of revenue in accordance with AICPA Statement of Position SOP 81-1, Accounting for Performance of Construction-Type and Certain Product-Type Contracts. In the entity’s June 30, 2009, interim financial statements, it may continue to refer to SOP 81-1 or it may elect to refer to both SOP 81-1 and Accounting Standards Codification subtopic 605-35, Revenue Recognition: Construction-Type and Production-Type Contracts (or ASC 605-35).

Should references to specific GAAP in financial statements for periods ending (and issued) after the effective date of the Codification (e.g., September 30, 2009, interim or year-end financial statements) continue to be to pre-Codification GAAP for prior periods included in those financial statements or be updated to reflect the Codification?

Because the Codification is expected to be effective on July 1, 2009, if entities refer to specific GAAP in their financial statements for periods ending after the effective date (e.g., September 30, 2009), the references should be updated to refer to the Codification.

Since the Codification is not expected to change GAAP, the consistent use of references only to the Codification for all periods presented (including periods before the effective date of the Codification) would be most appropriate. Entities may also elect to provide references to both the Codification and pre-Codification GAAP (perhaps parenthetically) since the financial statements include periods before the effective date of the Codification, but they are not required to do so. The use of only pre-Codification GAAP references in financial statements for periods that include or are after the effective date of the Codification would not be appropriate.

Source

Deloitte Heads Up on FASB Codification (May 20, 2009).

Overlooked Updates

Aside from updating the accounting references in all financial statements and disclosures (including the Management Discussion & Analysis in annual reports), companies will also need to do a sweep of other documents that need updates, Pounder warns—say, any accounting policy manual you might use.

“If your company has an accounting policy manual—and it should if it has good internal control over financial reporting—then there are various policies that tie back to some authoritative GAAP,” he says. Those policies, too, will no longer be authoritative once Codification becomes the sole authority for GAAP as anticipated on July 1.

Mark Crowley, a partner with Deloitte & Touche, says companies might use this transition period to consider whether their references to GAAP are essential. After all, he says, companies aren’t required to refer to GAAP in financial statements.

“Sometimes it’s difficult not to refer to GAAP, but a lot of times you could just put it in plain English,” he says. “One idea now is to rethink how you word the disclosures in financial statements to not refer to specific GAAP but just describe the accounting concepts in plain English.”

Cosper

Susan Cosper, a partner at PricewaterhouseCoopers, agrees that now is the time for companies to reconsider their detailed references to GAAP. “Companies should reassess whether there was a need for that reference to begin with, or whether they can describe the nature of the transaction instead of just giving the numerical reference,” she says.

Updating the financial statements themselves will be the most time-sensitive issue, Cosper says, but companies should also examine every document they create and assure they reference rules according to the new Codification, including accounting memoranda and correspondence with regulators.

Some accounting experts are hearing gripes from the trenches that the Codification seems too late to be a helpful tool in applying GAAP, since the United States is (ostensibly) preparing to adopt International Financial Reporting Standards.

Crowley

Crowley, however, says the Codification will help in convergence with IFRS. It organizes rules much more akin to how IFRS does, and that should help rulemakers see differences between GAAP and IFRS that still need to be resolved and help financial reporting executives as they make a transition to IFRS, he says. There are no plans to codify IFRS in the same way as GAAP is now codified, but Crowley says it’s a likely future endeavor.

The Securities and Exchange Commission does have a proposal to adopt IFRS by 2016, with large filers starting as soon as 2012. But new leadership at the SEC has been cool to the idea of IFRS adoption, so that timeline may change or otherwise go in the deep freeze.