Accounting

A Guide to ICFR by Preparers, for Preparers


A Q&A with CCR ICFR Working Group members Laura Phillips, Matt Janzaruk, and Craig Schmidt on what preparers can learn from the ICFR: Insights, Issues, and Practices documents and their biggest takeaways from the experience.

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FEI’s Committee on Corporate Reporting (CCR) recently released two ICFR: Insights, Issues, and Practices documents that address internal control considerations for preparers’ adoption of both the new leases standard and the new current expected credit loss (CECL) standard.

In this episode of the Financial Executive Podcast, FEI’s Managing Editor of FEI Daily Olivia Berkman spoke with Laura Phillips, Director, Finance Compliance, Google and CCR ICFR Working Group Leader, Matt Janzaruk, Director, Finance & Accounting, Procter & Gamble and CCR ICFR Leases Pilot Team Leader, and Craig Schmidt, Governance and Oversight Leader, Wells Fargo and CCR ICFR CECL Pilot Team Leader about what preparers can learn from these documents and their biggest takeaways from the experience.

An edited transcript of the discussion appears below the podcast player.

Olivia Berkman: Thank you all for joining me today. Let's start with Laura. What prompted you to draft these documents?

Laura Phillips: Thanks, Olivia. It's the latest high point in a multi-year journey for us. The Committee on Corporate Reporting (CCR) is composed of about 40 very large, public companies. The committee's been engaged for the past several years in a dialogue with the PCAOB, the SEC, and the largest audit firms, to try to sort out why many public companies have encountered what they've perceived as a misalignment between auditor and management understanding of how to assess and report on a company's system of internal control. 

Even within the CCR, there's been a lot of diversity and experience; some companies have had a good experience with their auditors, and have said they have no issues with how to evaluate internal control, and how auditors evaluate it. Other companies have been experiencing tension. They saw misalignment among what they think the SEC guidance to management instructs them to do, what the COSO internal control framework calls for, and what auditors have been expecting.

One of the issues that makes this area challenging, is that there's so much judgment and subjectivity involved. Context and fact patterns are very important to the analysis. This is a different space from the requirements contained in accounting standards. What does it mean to have effective internal control? How does management assess it? This has never been compliance for compliance sake. It's about managing and identifying risk, and how, in a pragmatic way, you adequately control risk.

The CCR has suggested for a while that our capital markets needed something akin to the EITF to deal with internal control and auditing issues, and address this diversity in experience with detailed practice guidance that would've been authoritative. Again, akin to the EITF.

We initially embarked on drafting these two documents as a type of proof of concept. We called them pilot documents to prove that it was possible to write meaningful, non-authoritative practice guidance addressing internal control over financial reporting.

Berkman: And what do you hope to achieve with the issuance of these documents?

Phillips: As our drafting progressed, our objectives evolved a bit. Where we've landed is that we hope to increase the quality of ICFR broadly. We hope to get in front of potential conflicts that might develop between public companies and their auditors as they adopt these two new accounting standards, hopefully minimize the disagreement about what's needed and what's considered good practice.  It's the first time CCR's done anything like this; in depth guidance on ICFR by preparers, for preparers.

One of the ways that our thinking evolved during the project is we quickly got away from a highly structured template, and instead allowed the documents to vary a bit in exact content and form to be responsive to the subject matter. In short, we hope to make things better, and after we see how these two documents are received, and what kind of feedback we get, then we'll make some decisions about whether to do more. 

At this point, we're really eager to get them out and hear feedback on whether people find them helpful.

Berkman: Absolutely. And I'm curious, Laura, how did you select CECL and Leases?

Phillips: We wanted to take on pieces that were manageable and bite sized, not something that would've been overly broad. The newness of, and the adoption of new accounting standards, was attractive to us, that we would have the opportunity to prevent, or at least reduce, conflict proactively versus try to resolve existing disagreements after they've been going on for a while.

We also liked that they're very different accounting standards with different stress points in terms of where the action is in adopting them. So we thought they'd make good companions with healthy diversity, again, that we wanted them to serve as a proof of concept that meaningful guidance can be developed by preparers, for preparers, on ICFR.

Berkman: Great. And I want to open that question up, to Craig and Matt as well. Do either of you have any thoughts on that?

Craig Schmidt: At least from a CECL perspective, it really came down to impact and time. I selfishly work at a very large bank and the impact of CECL on the financial services industry, and banks in particular, is going to be enormous. So this is definitely something that was exciting to be a challenge from that perspective, because we knew processes and controls were going to change as we moved from an “incurred loss” model to an “expected credit loss” model. 

And also from a timing perspective, we have enough runway to make this valuable for preparers, given that this is not being implemented for many preparers until 2020. Preparers, in particular, are thinking about implementing process …..thinking about the ICFR impact of CECL in 2019. So with this issuance happening here in 2018, this will hopefully be extremely beneficial for people that choose to use and leverage the document. 

Berkman: Right. And what was the process that you went through in drafting these documents? Laura, maybe we'll start with you.

Phillips: I've been chairing an ad hoc working group within the CCR for these past several years, focused on issues in ICFR. It's been a passion project of mine, because more than a decade ago I was on the staff of the PCOAB, and worked on their internal control standards. Now that I've been on the controllership side of things for a while, I continue to have strong views that good internal control is healthy for our capital markets and the right thing for public companies, when it's done well.

Although the CCR had this ICFR working group already in place, these two pilot documents demanded deep subject matter expertise in both ICFR and Leases and CECL. Early on we organized sub-teams dedicated to each document, and we're all fortunate to have had Matt lead the Leases team, and Craig lead the CECL team.

Berkman: Great. Matt, do you want to talk a little bit about what the process was like for you leading the Leases team?

Matt Janzaruk: Sure. For Leases, the approach was fairly simple. We designed a working team across a number of companies as well as input from the accounting firms. We kind of rallied around two key concepts. We wanted to prepare a document that was concise and practical. We recognized the guidance is very, very long, and rightly so, over 300 pages, and there's a lot of accounting firm guidance that's very, very detailed.

We thought we could be a little bit different in making sure that we could provide a really concise, actionable feedback. So a lot of our perspective is more about tips and tricks, and practical experience from these companies.

Berkman: And Craig, what about your experience in leading the CECL team?

Schmidt: We also wanted to keep it concise. The guidance around CECL is expansive. The ultimate process that we went through was research, draft, review, and repeat. And, honestly, I lost track of how many times we went through that exact process, but ultimately with the crowdsourcing of knowledge effort across various players within the financial services industry …… I reached out to several other banks and folks that were responsible for SOX and ICFR at those particular banks, and really sought their guidance and assistance to help make this a valuable document, and they were instrumental in the reviews. 

There were a lot of reviews that did take place, and we ultimately involved regulators, accounting firms, and industry groups. So I feel pretty confident with the end product that we've pulled together.

Berkman: Laura mentioned earlier that this was the first time that CCR had done anything like this, an in depth guidance on ICFR for preparers, by preparers. Matt, what do you hope other preparers will learn from these documents, and what are your thoughts on who the audience is for these documents?

Janzaruk: We did our best to make sure this document was inclusive for all preparers across the spectrum of Leasing. That intent was really inspired by our experience on revenue recognition. We recognized a lot of companies spent a lot of effort going through contracts, revising operating processes to adopt to the revenue recognition standard, and now Leasing is coming up next. We recognized Leasing also requires a significant effort for all companies to work through those contracts.

But Leasing's a little bit different, because Leasing is primarily a corporate effort. There's less focus of a company to operationalize Leasing by individual scorecard or sales budget tool. In that respect, what we did is we created three tiers for our controlled activities. The tiers were: Insignificant, Significant, and Material. In many ways the approach for Insignificant and Material was fairly intuitive, but we had to also address situations where companies may have a large amount of leases, but the overall balance sheet recognition is not material taken as whole.

And we think this scale is important and very helpful, and it will address all potential preparers. If some control activities are relevant for companies where Leasing is Insignificant, Significant or Material, conversely other control activities are more relevant when you go further down that spectrum. We think the stratification of controls will help companies guide how to right size an implementation plan for ICFR.

Berkman: Great. And Craig, on the CECL document, who do you see as the audience for that one?

Schmidt: Simple answer is everyone. Yes, it's mainly focused on financial services, institutions, and mainly banks within that realm, but we do have an appendix within the CECL document to analyze the impacts to non-financial institutions, and how to think about CECL, because CECL wasn't a standard developed just for financial services institutions. It was developed for everybody, with all preparers with regards to thinking about expected credit losses. Any preparer that has [held-to-maturity and] available for sale debt securities, for instance, is going to be impacted by this new standard, which is a bigger group than just financial services institutions.

Berkman: And Craig, can you give us an example of an insight that's included in the CECL document?

Schmidt: I'll give you two. What we wanted to do was put real life risk and control examples within the document. What we've seen in the past by others, whether it's accounting firms or regulators, we've seen people use generic risk and controls. That has been helpful to some extent, but we thought that maybe putting in real life examples, taking controls that other banks are using or considering as they develop CECL, that that would be more beneficial for preparers to leverage. 

Again, this document is not meant or intended to be a “one size fits all” document. It’s going to depend on the size of the firm, the capabilities, industry, so on and so forth. But we thought that having the real risk and control examples would be something that preparers would like to see and that they haven't seen before. 

The second example, and Laura touched on this during her introduction, is that ICFR can be complex and judgmental. One of the hardest parts about ICFR, I think, is around management review controls, and the type of documentation and evidence needed around management review controls, especially those around complex areas or higher level management review controls. So we have an appendix within the document to tackle that particular subject matter, and hopefully that will be of significant benefit for preparers as they leverage this document.

Berkman: And Matt, maybe you can give us an example of an insight that’s included in the Leases document.

Janzaruk: Sure, so one of the dilemmas of Leasing is that the hardest part is the first step, which can be frustrating and aggravating. The first step for Leasing is to collect all the contracts in a company. I think everyone can quickly realize that that's a very daunting task. So we provided some tips and tricks to think about ways to slice and dice that effort to make it a little bit more manageable. 

For example, for many companies, there's a centralized process to manage real estate. If you have the benefit of that fact pattern, you can develop a really clear, intuitive set of control processes to build a strong process for the accounting for leasing for real estate.

For many other companies, equipment leases are very pervasive across operating divisions, locations, and multiple sites. That might require a very different set of control processes and approaches to address the overall standard. And from pulling together those different characteristics, you might build a better and smarter plan in totality, without driving a one size fits all solution.

Berkman: Matt, what was one of the biggest takeaways from your experience?

Janzaruk: It's been a pleasure to go through this process to learn how much smarter and more aware I am of the leasing process. Going through this effort has made my company's approach stronger based on the exchange of ideas. And we're hopeful that this benefit will bleed over to others as well. So, hopefully as companies go through this document and have a chance to take a benefit of our suggestions and our model, it may mean some benefits for others as well.

Berkman: And Craig, any big takeaways for you?

Schmidt: Yes, I would say what's become abundantly clear to me is that preparers, and not just preparers, but industry groups, are thirsty for this type of guidance, by preparers, for preparers. When we were in the formulation of this idea and what it was going to look like ... we had reached out to industry groups, and others, to garner feedback, asking, ‘Is this something that you think would be valuable?’

Overwhelmingly, ‘Yes,’ was the answer, but I'll share one of the quotes that I thought really enunciated that yes was from a prominent industry group within financial services, and what this individual said was that this document was “an answer to his prayers!” And when I heard that, I knew we were on the right path. 

This document will be something that industry groups, preparers, and others, will be able to leverage, and that's what makes it so exciting to be part of this process.

Berkman: Definitely. And finally, Laura, I'd love for you to tell FEI members and other listeners how they can actually access the documents.

Phillips: You bet. For folks accessing the podcast recording, you can see a link right above the recording. Others can go to FEI's website. The documents are free to anyone. Simply search on ICFR Insights, and they should come up. 

In the postings and in the documents themselves, there's an open invitation for readers to provide us with feedback or to get involved going forward. You can reach the core team that's been involved developing these documents by emailing: techacct@financialexecutives.org.

Berkman: Great. Thank you, Laura. It was great speaking with you all today, and I want to thank you again for your time.