The critical data-path for the Record to Report cycle is always “Posting journal entries to the G/L.” (e.g., ASC 842 Lease)

People tend to think that there are so many complicated topics and issues to “control,” under accounting standards, to ensure that related accounting treatments are put in place and to achieve financial reporting compliance under those standards.

The reality is, however, we should not be overwhelmed with any of the complication related to any of the accounting standard topics/issues when it comes to the Record to Report cycle because there is only one critical data-path, or Likely Source of Potential Misstatements (LSPM) as in Auditing Standard No. 5 guided by PCAOB/SEC, within the RtR cycle; i.e., posting journal entries to the general ledger (G/L).

There are only two types of the journal entries posted to the G/L; i.e., either simply transferring the subledger journal entries to the G/L or manual journal entries directly posted to the G/L.

And a control over each of those two types (of journal entry posting the G/L) is:

1. ERP automatically posts the journal entries on the subledger to the G/L or
2. An authorized manager (whose duty should be segregated from the personnel who created/posted the journal entries to the G/L) reviews each manual journal entry for appropriateness under applicable accounting standards.

So, where do all those complicated factors for the accounting standard compliance go?

They are NOT controls but control attributes, or control objectives.

Let’s take Lease Accounting (ASC 842) for example.

Such a process as “G/L Accountant ensures that lease expense are adequately ‘measured’ (as in the Valuation/Measurement assertion) in light of the related accounting standard or ASC 842.” is NOT a control.

That is because

1. the G/L Accountant is not a manager; i.e., his/her competence has not been approved; thus, the control authority is not delegated to him/her and s/he cannot be the control owner, or accountable, and that
2. the competence to “ensure that lease accrual ….. are adequately valued (under) ASC 842″ is a control Design Attribute (and it’s not the control itself).

The control over the LSPM (say, “G/L Accountant could accrue for the lease expenses inadequately (assertion: Valuation/Measurement) under ASC 842 in creating related manual journal entries posted to the G/L as of the balance sheet date.”, etc.) should be simply;

“Accounting Manager reviews the lease expense for adequate measurement.”, etc.

The example control above satisfies that

1. the proper authority must have been delegated to the Accounting Manager (because s/he must be competent enough to review the adequacy of the lease expense measurement; thus, s/he is the manager and accountable; with her/his duty being segregated from the G/L Accountant) and that
2. the control should mitigate the Valuation/Measurement risk and prevent the potential misstatement that could have a non-compliance against ASC 842.

The key here is the competence.

The competence Attribute must be thoroughly considered in delegating the control authority to the control owner manager.

In this example, the control owner, the “Accounting Manager,” must be competent enough to conclude and defend the company’s position as to why not only the lease expense but also the lease liability (as well as the ROU (Right Of Use) asset) is deemed properly measured/valued under ASC 842.

The competency attribute must be tested as part of the control test of design (ToD), or Walkthrough, to conclude that the control Design Attribute of the competence is satisfied to such an extent that the Accounting Manager’s sign off, to approve the lease expense and accrual (e.g., deferred rent) journal entries, can sufficiently evidence (as properly authorized by Policies and Procedures) the compliance with ASC 842. (Note that, once the Design Attribute has been concluded to be satisfied through the Walkthrough (ToD), the test of operation effectiveness (TOE) on the review control would be to vouch to the Manager’s sign off.)

Here, such a comment as “The Accounting Manager has a CPA license and long history of being Lease Accounting Manager at the company.”, etc. would NOT suffice as such an “assessment” is too discretionary and does not assess the competence to specially address the subject matter: i.e., discussion points under ASC 842 such as

1) whether the lease is operating or finance, and

2) how much the ROU asset is (in addition to the lease liability on the balance sheet).

One (or more) of the testing method(s) can be a tester’s

• inquiry (of the Manager specifically about the accounting topic),
• observation (of the Manager’s review extent, criteria, etc.), and/or
• reperformance (of the Manager’s review to see if the tester can reach the same conclusion as the Manager’s, to approve the journal entries to be reasonable).

Typically, the Manager would use a kind of checklist, template, etc. to validate that the construction of the journal entries (e.g., to determine the balance of the ROU asset, etc.) was compliant with the relevant with GAAP (ASC 842):

1. What is the lease term?
2. What are the lease payments?
3. What is the discount rate?/How is the rate is determined?
4. What is the fair value (of the underlying asset)?

To reiterate,

“to ensure the compliance with an accounting standard” can NOT be a financial control but a control Design Attribute.

And the specific “attribute” must be “the control owner’s competence” which must be tested through Walkthrough (ToD) for the control design effectiveness.