Starting Your Company’s Accounting Policy Library

Background

An accounting policy library is essential for ensuring consistent processes and is a critical requirement for financial statement audits. A robust accounting policy library also serves as a crucial part of the COSO framework implementation for internal controls as this represents the communication of your US GAAP accounting compliance guidelines. As this is such a critical part of the control environment, it can be daunting starting the task of documenting all the key accounting policies. In order to help, this article provides:

• A list of accounting policies which will normally always be required regardless of materiality of the recorded amounts the policy guides
• A method for evaluating additional policies required
• An easy-to-implement framework for writing policies

Although accounting policies are required for many audit purposes, you will likely find that having strong accounting policies will also create process efficiencies as it increases consistency in accounting practice across teams and reduces ambiguity in order to empower teams to make decisions locally regarding accounting treatment of transactions.

Accounting Policies to Always Include

Revenue Recognition

Even if revenue is small, for example for early start-up companies with a small customer base, a revenue recognition policy will always be required for two main reasons:

1. Revenue is complex under US GAAP. Even simple revenue transactions have the same 5-step process to follow for concluding on revenue recognition, so this needs to be thoroughly documented
2. Revenue is an important metric to investors, which makes it a material measure, even when amounts are small.

As revenue is complex and always considered material, this should be one of your first policies and will end up likely being the most thorough.

Expense policy

This does not refer to employee expense and travel guidelines, but rather when are total company expenses recognized. Total company expense is normally also considered material, even if the amounts are small. As such, the Company should document its basis for recognizing expenses. This can normally be as simple as wording such as “The Company recognizes expenses in the period in which the expense is occurred and matching the revenue generated by that expense where appropriate according to the matching principle in US GAAP.”

Capitalization policy

As a compliment to the expense policy, the company should list when amounts are capitalized rather than expensed. This normally also includes discussion on when amounts are expensed instead of capitalized in order to recognize efficiencies from not tracking or counting certain small items. This kind of conclusion should leverage a materiality policy.

Financial Statement Presentation Method

Amounts disclosed in financial statement captions are going to be the main information which investors can analyze. Accordingly, there should always be a policy which explains what is disclosed in each caption and the basis for deciding on the captions included.

Determination of Materiality

The basis for a lot of internal decision making is going to be materiality, so this should be clearly outlined for the company and re-evaluated each year. Materiality definitions should include the point at which the Company would require

• Restatement of prior period financials
• Disclosure to auditors of adjustments to the financials which were identified but not made

This is, in other words, a SAB 108 analysis for US GAAP. In addition, the policy can contain threshold for the following:

• Amounts that can be left unaddressed in account reconciliations
• Amounts that can be left unaddressed in financial fluctuation analyses
• Accounts that can be reconciled monthly rather than quarterly

Segment Definition Memo

The segments you define are the areas of business which need to be disclosed separately. This can be product segments, regional segments, or anything else which your company views as important for determining results. A common mistake among companies is that if there is only one segment, this policy is not required, but as the analysis is more complex and the determination of segment information can be material to investors, it is important to document the conclusion on why there is only one segment if this is the conclusion.

How to Determine When to Write Additional Policies

As demonstrated in the section above, the determination of when to write a policy is based on

1. Materiality
2. Complexity

This is another way of saying that the decision on when to implement a policy is based on risk. If a transaction cycle is material or complex, it should have an accounting policy.

For example, as each caption of the financials is likely material as it is disclosed separately, there should likely be a policy for the accounting of each caption and the relevant guidance. Additionally, any policy disclosed in the notes of the financials should also have its own internal document as this was determined to be either material or complex (e.g. required disclosure per US GAAP) for the Company.

Some additional examples are

• Goodwill
• Fixed Asset, Intangible or Investment Impairment
• Accounts Receivable and accounting for doubtful accounts
• Stock-based Compensation (normally required even if amounts are small due to complexity)
• Foreign Currency Accounting
• Business Combinations
• Financing Arrangements (debt)
• Hedging
• Leases

For more ideas, check the policy disclosure in your company’s competitors’ 10-K filing. This is also normally a good indicator of what is expected of your company.

Recommendation for Policy Structure

Most policies can be organized in the following way:

• Background or Purpose
• Guidance
• Policy
• Controls

Background or Purpose

Start off by describing the types of transactions that are occurring which cause the requirement for analysis. In other words, this is the “why” section of the policy. This can include the transaction amount per year, the number of transactions, an explanation of the complexity of the transactions. For example, if the company is documenting a policy on investments, the background might state something like:

The Company recognized 10 million USD in investments in cost-method investments in the current year financials. Entities in which the company is invested are ABC, Inc. for 19%, XYZ, LLP. for 5%, and Investment Entity, Inc. for 6%. The purpose of this policy is to support the Company’s conclusion that the risk associate with the investments allows the company to recognize the entities as cost-method investments.

This represents a more detailed policy. It is also an acceptable method to document a high-level policy such as:

The Company periodically invests in other entities as a way to create synergies with strategic partners or in order to use what would otherwise be idle cash. The purpose of this memo is to document when such investments are classified as cost-method investments. Please see the separate annual memo regarding whether any impairment exists on these investments as well as an assessment of the individual risk characteristics which allow the company to conclude on cost-method classification of investments.

Both methods are perfectly acceptable.

Guidance

This section should contain the guidance on which your company is relying to determine the accounting policy. This can be copy-paste from the FASB guidance on which you are relying. For a really strong policy, you can also reference guidance which you are not using and why the guidance is not in use. This helps avoid questions on why some guidance was used and other parts of the guidance which could seem relevant are not used. An example might be discussion of refunds in a revenue recognition policy. If the company has a history of refusing refunds, then there is no need to discuss refund guidance in depth; however, it’s helpful to state that refund guidance is not included because it is irrelevant due to the company’s operating policy.

Policy

Use this section to describe exactly what the company does and the conclusion on accounting policy. This should be where you explain most of your process and company-specific facts.

Controls

Although this is not necessary, a strong policy document will also include discussion of the controls in place to ensure the policy is followed, as controls are required at all US publicly traded companies. The controls discussed should match the company’s risk control matrix, so if controls discussion is included in the policy, it will need to be reviewed annually with internal audit.

Final Thoughts

Although it can feel like a huge task to put together accounting policies, some of the policies can be quite quick document. The main requirement of policies is that they address questions that a team member or auditor might have, not that the policy is long. As you might have observed from the discussion above, there are many different methods of compiling policies, so you should balance detail included in each policy with efficiency of maintaining each policy. Make this judgment based on internal resources available and overall complexity of your financials.