Accounting: The Language of Business - Vol. 2 (Intermediate: Part 22)

When I hear health professionals suggesting that you shouldn't worry about the balance of calories in versus calories out, but rather eat clean and follow your hunger instincts, well, I really just want to pinch their heads off. That's like a millionaire suggesting that instead of worrying about what's in your bank account, just listen to your shopping instincts and buy high-quality goods . . . weight loss is not magic. To a great extent, it's accounting.

Chalene Johnson

Judgement and applied Financial Accounting research (part G)

by

Charles Lamson

Steps in the Applied Financial Accounting Research Process

If you have been following along (parts 15-21), you should be familiar with the form and content of the authoritative literature. We will now outline the six steps used in the financial reporting research process. These steps are presented in Exhibit 3.9 and discussed more extensively below. Financial statement preparers as well as auditors can use this process.

EXHIBIT 3.9 Steps in the Financial Accounting Research Process

Step 1: Establish and Understand the Facts

The first step in the research process is to understand the facts involved in the business transaction. What exactly does the business transaction look like? What parties are involved and how? What are the stipulations specified in any relevant contract? What is the timing of the transaction(s)? 

The way the facts are presented to the accountant will vary in practice. The facts may be conveyed to you in a concise and thorough manner. For example, your manager may explain the transaction to you at an audit team meeting or a client may email the information. Alternatively, you may need to spend a significant amount of time establishing the facts by talking to the parties involved or reading through documents.

Regardless of the manner in which the facts are initially presented, it is critical that the researcher thoroughly understand the business transaction. Misunderstood facts will often lead to incorrect conclusions.

Step 2: Identify the Issue: What is the Research Question?

After establishing the fact pattern associated with the business transaction, the researcher needs to identify the issue. That is, the researcher needs to determine the exact research question. For example, a research question might be, "Should ABC company recognize the revenue associated with this business transaction in the current fiscal year or the next fiscal year?" Typically, the research question (or issue) can be articulated in just a few sentences.

Step 3: Search the Authoritative Literature

Searching the authoritative literature can take a considerable amount of time, depending on the specific research question, even for experienced accountants. Understanding the structure of the Codification (Due to the large volume of diverse and complex standards, the body of U.S. GAAP became difficult to use. In response to this problem, the Financial Accounting Standards Board (FASB) developed the Financial Accounting Standards Board Accounting Standards Codification (ASC), often referred to as the Codification, which groups and summarizes all current standards by topic.) is invaluable for completing this step. Because the Codification is organized by topic, the research typically begins by identifying the appropriate topic to examine. For example, when researching an issue related to inventory, begin with Topic 330 – Inventory. It is sometimes possible to refine the search further, depending on the nature of the research question. If your question related to inventory was an issue as to how to initially record an item of inventory, you would most likely begin at ASC 330–10-30-10 - Inventory – Overall – Initial Measurement.

When searching the authoritative literature, you will often see cross references to other Codification topics. For example, if you were researching an issue related to disclosure requirements for inventory, you would start in ASC 330–10-50 Inventory - Overall – Disclosure. However, Paragraph 6 relates to disclosures of significant estimates and provides a cross reference to ASC 270 5-10–50 Risks and Uncertainties – Overall – Disclosure. Always check the applicability of cross references to be certain that you have done a thorough search of the literature.

You should also be aware that the Codification includes a search engine. Thus, if you are unsure where to start your research or you are unsure whether you have found all of the appropriate literature, you may want to search for various terms within the Codification using the search engine.

Step 4: Evaluate the Results of the Search

After you have found all the relevant authoritative literature, take the time to read it thoroughly, keeping in mind that much of the language used is highly technical and complex.

You may find that after reading through the authoritative literature, you need to change or refine the research question. Thus, these steps can be an iterative process [relating to or involving iteration (repetition of a mathematical or computational procedure applied to the result of a previous application, typically as a means of obtaining successively closer approximations to the solution of a problem)]. In fact, sometimes you will discover that you need to obtain additional facts related to the business transaction and return to Step 1.

Step 5: Develop Conclusions

After assimilating the relevant literature, decide on the best financial reporting treatment. Sometimes, there is only one correct answer. In other cases, the answer may not exist in the literature, particularly in Level 1 of the hierarchy. Accountants use judgment to work down the levels of the hierarchy and sometimes have to utilize a similar transaction that is covered in the authoritative literature. Other times, there are multiple legitimate treatments found in the accounting standards. Accountants compare the various treatments and identify the alternative that will result in the most faithful representation of the economic event.

Step 6: Communicate the Results of the Research

After finishing the first five steps, the accountant documents and communicates the results of the research process. This documentation may be done in a variety of forms such as a memo to the file or a client letter. The information included depends upon the audience, but it will most likely include documentation from all of the preceding steps:

• The facts of the business transaction.

• The research question.

• The analysis of the issue (i.e., a summary of the authoritative literature).

• The recommendation.

When articulating your research and recommendation in written form, write clearly and concisely to address the research question and communicate all relevant information. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 69-70*

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