Accounting Policy or Accounting Convention

My staff and I had a interesting discussion recently.  Interesting at least if you are into geeky accounting esoteric discussions, but why deny who I am.  Many companies have a documented “accounting policy” that items under $X will simply be expensed.  It isn’t worth the time and effort to actually capitalize and track the item.  We have gotten so used to calling these types of materiality decisions “accounting policies” that we have lost track that they aren’t really policies but “accounting conventions” meant to make immaterial changes (or you could call them errors) that significantly enhance the efficiency of the accounting function.

The point is that an accounting policy is an election between allowed alternatives under GAAP.  For example, selecting the LFIO or FIFO method for inventory, or the FIFO or average cost method for treasury shares.  In  those cases you need to tell your financial statement users which allowed alternative under GAAP you selected and this is done through the accounting policies footnote (footnote 1 for almost every company). On the other hand GAAP just says you need to capitalize assets that have a useful life greater than a year.  No matter how hard you scour the codification, you will not find a reference to some minimum dollar amount that does not need to be capitalized.

Deciding not to follow GAAP because the result is not material is not really an accounting policy.  Instead it is an accounting convention.  So what is the big deal?  Well, an accounting convention is dependent on the immateriality of deciding not to follow GAAP.  When was the last time you checked to see if your minimum capitalization policy was only resulting in a immaterial amount of added expense?  Maybe you did such an analysis when you set or reset the threshold, but have you checked it since?  Are you even capable of checking it?

Of course its questions like these that can get you into real big trouble with your controller, or worse, she will tell you to go figure it out and report back to her.  So not bringing it up may be the wiser course of action, but that will only work as long as the auditors don’t ask too many questions.  Then again, auditors have been signing off on financial statements with these “policy” thresholds for years and I doubt you will find a work paper analyzing the immateriality of the threshold impact to support the audit conclusion that the financial statements are materially correct. So maybe auditors won’t be a problem. Now let’s just hope the PCAOB doesn’t get any bright ideas!

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