We have seen lots of changes in U.S. GAAP over the years. What should we have in our workpapers to substantiate the changes? While a memo is not required, it is probably the best way to document the process. If a memo is not used, then this information should be somewhere in the workpapers. The best memos follow a four-section methodology:
• Facts: Describe the accounting method used by the company.
• Question: How will the new rule change the company’s accounting method?
• Discussion: Discuss the new rule, including references to accounting pronouncements. Lay out the changes and how they relate to the facts at the company.
• Conclusion: Conclude as to the changes required under the new GAAP rule.
This memo takes time and will not be a few sentences. You must show the thinking that went into the conclusion. Too often CPAs want to know the question and answer, but are not as interested in the documentation of the facts and the thinking that went into the answer.
Client Prepared Memo
If this is a client prepared memo, then the firm must review it and document that it agrees with the conclusion. Again, this would be a paragraph or two describing how the firm corroborated the facts and agreed with the client’s professional judgement.
CPA Prepared Memo
If this is a CPA prepared memo, you must document the review and acceptance by the client. This includes documentation of client skills and knowledge to confirm their ability to perform the review and accept responsibility so you remain independent. You might also want to add a confirmation in the client representation letter as well.
This memo should remain in the permanent file for several years since it may be requested by a peer reviewer at a later date.
Revenue Recognition—Helpful Hints
This documentation would have been in a prior year's file; however, here are some tips from peer review deficiencies.
Be certain to discuss the company’s revenue recognition under ASC 605 vs. ASC 606 and how it is different.
Address the five-step model and discuss how each one works with the fact pattern at the company:
1. Identify the contract with the customer.
2. Identify contractual performance obligations.
3. Determine the amount of consideration/price for the transaction.
4. Allocate the determined amount of consideration/price to the contractual obligations.
5. Recognize revenue when the performing party satisfies the performance obligation.
It’s key that documentation is specific to the facts and circumstances of your client.
Again, begin with a discussion of the old leasing method and the differences between the rules. Many will want to identify the less-than-one-year model for related party leases and how the company is using that to avoid the change. (See additional discussion in ASU 2023-01 for related party leases.)
One possible pitfall if the client converts to the one-year model, is the failure to rewrite the lease annually. This can have consequences, so it’s important to review annually to ensure the client has not blown this practical expedient.
FRF for SMEs and Other Options
Smaller clients are seeing the benefits of not using U.S. GAAP, and so are bonding companies and banks. Recently, a major bonding company said that small construction companies (e.g., unsophisticated smaller revenue and having smaller bonding needs) are using the Financial Reporting Framework for Small and Medium Sized Entities.
So, if you have a smaller company, have them ask the banks and bonding companies if they can use FRF for SMEs or cash basis or tax basis.
The tide has turned in this area. We are seeing a lot more usage, and many CPAs say they are using this on at least a few clients. The cost benefit is winning! It appears that we are segmenting accounting into three groups with three different needs and usage.
• PCAOB: Public regulated companies are required by the SEC to use U.S. GAAP.
• Medium to large companies required by investors, insurers and lenders to use U.S. GAAP.
• Small companies find U.S. GAAP onerous and unnecessary for their owners, insurers and lenders. These can easily be on FRF for SMEs, with all parties feeling good about the costs and needs. If the third-party user will accept it, tax basis and cash basis are other good options.
Find the method that is going to work best for your client!
Mark F. Wille, CPA is a director at JLK Rosenberger and a member of the CalCPA APAS Committee.
Daryl Luna, CPA is a partner at JLK Rosenberger and member of the CalCPA APAS Committee.