Item 2: Addressing regulatory issues and accounting changes

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Audit committee outlook

Audit committees must ensure their organizations are prepared to comply with domestic and foreign regulations and professional standards related to financial reporting. This requires a governance infrastructure with mechanisms that ascertain that the organization has documented policies and procedures for adhering to regulatory mandates, and that it can demonstrate compliance. Proper training and controls are also required, as are methods of monitoring regulatory change.

For example, U.S. organizations with international operations may be subject to provisions of the Foreign Corrupt Practices Act and similar legislation in other countries, such as the UK Bribery Act. In addition to regulatory issues, private companies can, like their publicly held peers, risk operational disruption or reputational damage over labor practices or product content issues.

Regarding accounting changes, requirements in two areas — revenue recognition and accounting for leases — will affect all companies in the next two to three years.

Changes in the revenue recognition standard go into effect for nonpublic companies on Jan. 1, 2019. The experience to date indicates that many companies that initially did not think they would be affected (other than through some additional disclosures) are now determining that their recognition practices are not consistent with the new standard. It is imperative for audit committees to ascertain whether the company is preparing for adoption of the standard.

Given that the new standard will affect organizations differently, the audit committee should:

  • Understand management’s assessment of the impact of the standard on policies, procedures, operations and financial statements; specifically, the new standard may affect debt covenants, compensation programs and sales contracts as well as other areas.
  • Ascertain that the right people are included in the implementation effort; Grant Thornton recommends a cross-functional team with representatives from accounting, tax, IT, legal, sales and compensation. Internal audit should be party to these discussions as well.
  • Provide oversight on management’s accounting judgments, particularly where management will be increasing the use of estimates, which may be the case given the more principles-based approach of the new standard.
  • Support requests for required additional resources, such as new or enhanced accounting processes or increased internal audit resources.

Well before adoption, the audit committee should understand the implications of the new revenue recognition standard, management’s plans for implementation and likely required resources.

Considerations regarding leases will arise in the run-up to 2020, when the new lease accounting standard takes effect. That standard will bring most leases onto the balance sheet of most lessees, and generate impacts for lessees and lessors. Key considerations for most companies will include management, centralization and policy changes regarding leases. In addition, loan ratios may be affected and potentially have an impact on debt covenants.

As with the changes to the revenue recognition standard, the sooner the organization begins to understand the effects and prepare to address them, the better.

Related content: Revenue Recognition Take 2
FASB issues new lease accounting standard