Who has authority, and where do you research it?

Use this lesson when you need to distinguish an accounting rule from an explanation of that rule, or when you have found a paragraph but are unsure whether it applies. The research example supplies its own facts.

Who prepares the statements and who sets the rules?

Management is responsible for a company's financial statements, including its accounting policies and estimates. The board of directors oversees management. An independent auditor examines evidence and expresses an opinion on the statements; the audit does not transfer management's responsibility to the auditor.

For US nongovernmental entities, generally accepted accounting principles (GAAP) are the accounting standards used to prepare the financial statements. The Financial Accounting Standards Board (FASB) establishes these standards. Its Accounting Standards Codification (ASC) organizes the authoritative guidance by subject. Governmental accounting uses other standards and is outside this lesson.

Two other organizations have different responsibilities:

• The Securities and Exchange Commission (SEC) regulates US securities markets and requires disclosures from companies subject to its reporting rules.
• The Public Company Accounting Oversight Board (PCAOB) oversees audits of public companies and SEC-registered brokers and dealers. Brokers and dealers are firms that conduct securities transactions for customers or for themselves. Audit oversight is different from preparing a company's statements.

These roles explain why an auditor's agreement does not make a policy GAAP. An auditor may have carefully considered the policy, but management still needs to identify the applicable guidance and show how the company's facts satisfy it.

Which source governs the accounting?

Begin with the Codification for an ordinary nongovernmental US GAAP question. For a company subject to SEC reporting requirements, also check the applicable SEC rules. The Codification includes some SEC material for reference, but does not replace the SEC's own requirements.

A textbook or an accounting firm's guide can explain a difficult issue and help you find relevant paragraphs. It cannot override the applicable rule. FASB Concepts Statements explain the ideas behind financial reporting but do not establish GAAP. A conceptual argument that another answer would be more useful does not give a company permission to disregard a Codification requirement.

An Accounting Standards Update (ASU) communicates changes to the Codification. An update is not itself authoritative GAAP. It can help you understand what changed and when the change takes effect; the accounting requirement belongs in the applicable Codification paragraphs.

How do you read a Codification citation?

The citation ASC 606-10-25-1 identifies one paragraph:

Recognition means including an item in the financial statements, with an amount and an appropriate label. The citation above points to guidance about when to account for a contract with a customer under Topic 606. Reading the address is a navigation task; deciding whether the paragraph applies requires the contract facts and the surrounding guidance.

Section numbers help you find the kind of guidance you need. Not every subtopic contains every section.

Section 55 guidance is part of the Codification, not a lower-authority source. It may contain specific requirements as well as examples. Read it together with the relevant scope, definitions, and other paragraphs. An example does not apply merely because one sentence resembles your question.

The FASB Codification guide explains the structure. Use the Codification itself to check current accounting guidance.

Work from a question to a supported answer

Linden Peak, a company that manufactures sensors, sells a device with a separately described support service. Its accountant is researching whether the device and support should be accounted for separately. A search finds the words "customer option" in a Topic 606 example.

The search has found a possible lead, not an answer. The facts describe a device and support; they do not yet establish that the customer has an option to buy anything else. Applying an option example before reading the contract could answer a different question.

Use this sequence:

1. Write the question without assuming the answer: "Should the device and support be accounted for separately?"
2. Identify the relevant topic and read its scope. Confirm that the transaction is covered before applying its requirements.
3. Read the relevant definitions and paragraphs. Follow references that explain how to identify the promised goods and services.
4. Compare the contract with the guidance. Identify what the customer receives, what the company promises, and any facts still missing.
5. Check which version applies to the company's reporting period, including effective dates and any permitted early adoption of a change.
6. Record the conclusion, supporting facts, exact paragraph references, and date accessed. If a needed contract term is missing, name it instead of making up an answer.

This example teaches the research process, not the revenue conclusion. It intentionally leaves the detailed contract terms unspecified. A research note should state that limitation so another reader can see what remains unresolved.

Check your understanding

A private manufacturing company's accountant has an audit-firm article, a Concepts Statement, and a Codification paragraph that appear to address its question. The auditor agrees with the article. Which source should the accountant use to support the accounting, and what remains to be checked?

Check your reasoning

Use the applicable Codification guidance to support the accounting conclusion. The article can explain it, the Concepts Statement can clarify the underlying ideas, and the auditor's agreement can inform the review. None replaces the company's responsibility to apply the guidance correctly. Check the transaction's scope, relevant definitions and related paragraphs, missing facts, and the requirements effective for the reporting period before reaching a conclusion.

More practice

Practice identifying accounting authority on the grouped Chapter 4 practice page. Each question includes its own facts and an explanation or worked answer.