Demystifying Accounting Policies and Standard Operating Procedures: Understanding the Differences and Making Informed Choices
At The Alliance Group, the Client Advisory technical accounting team takes on the crucial task of assisting clients in writing comprehensive accounting policies and standard operating procedures (SOP). However, it is essential to understand that these two documents serve distinct purposes.
Accounting policies are high-level documents that outline a company’s position and compliance with specific accounting standards issued by the Financial Accounting Standards Board (FASB). They serve as the foundation of financial reporting, ensuring consistency and accuracy across a range of transactions.
On the other hand, SOPs are meticulously detailed, step-by-step procedures that illustrate the flow and accounting of transactions within a business cycle and are specific to the company’s routine operations.
For instance, a company could make a policy election that the assets acquired during a merger could be accounted for as asset acquisition versus business combination if it meets the criteria under ASC 805 (“Accounting for Business Combination”). This is different from the company setting up the SOPs for mergers, which could include engagement of valuation and technical accounting experts, performing the purchase accounting valuation, recording opening balance sheet entries, and disclosing within the financial statements.
Confusion often arises when clients mistakenly assume that SOPs and accounting policies can be used interchangeably. This is a critical misunderstanding, as the purpose and considerations for each document are entirely different. To make informed decisions, clients must recognize the distinctions and choose the appropriate document(s) that align with their specific needs.
One of the most common pitfalls in accounting policy drafting is initiating the process without a deep understanding of the accounting standard or the company’s business operations. The accounting policies should showcase how current accounting procedures conform to generally accepted accounting principles (GAAP).
Best practices indicate that an accounting policy should be prepared by a team consisting of the preparer, who is familiar with the business process, applicable accounting standards, and industry practices, and a reviewer, who can make an informed decision about policy elections and application. The policy should be approved and communicated across the organization. If not applied consistently with the standard, it could lead to improper financial reporting and ultimately audit qualification or regulatory scrutiny.
Here are some of the key steps involved in preparing an accounting policy:
Deep Understanding of Accounting Standards:
- The team should gain a deep understanding of the accounting standards applicable to the client’s industry. A well-drafted accounting policy will reflect diligent research and industry-specific experience to provide informed guidance. We recommend involving a technical accounting expert in this task.
Communication and Analysis:
- Effective communication with management at all levels and knowledge of the client’s financial reporting practices are necessary to ensure that the accounting policy is comprehensive and addresses all material aspects of the transaction or the business process.
Considerations and Elections:
- The preparer may need to consult with the technical accounting expert to ensure that the accounting policy captures and lists all the considerations within the accounting standard. Through in-depth discussions, management needs to make practical elections based on their experience, industry norms, and adherence to the accounting standard. If necessary, the team suggests modifications to the accounting procedures to ensure conformity.
Accounting Policy Review:
- The accounting policy draft should be reviewed and approved by the appropriate levels of management. More complex situations may need to be discussed with the external auditors in advance to ensure that the policy adheres to the accounting standard(s). The final document should outline management’s considerations and choices, providing a clear roadmap for consistent financial reporting.
Standard Operating Procedure (SOP):
- Once the accounting policy is finalized and approved, an SOP could be established to provide specific guidance, instruction, and necessary approvals required to elucidate the flow and accounting of transactions within a business cycle. It is important to incorporate the end users’ inputs into the development of the SOP document to capture all potential nuances within the business process.
The Alliance Group’s client advisory practice provides a dedicated technical accounting team that understands the nuanced differences between accounting policies and standard operating procedures. So, the next time you find yourself grappling with the question of whether you require an accounting policy, an SOP, or both, remember the importance of clearly defining your objectives and assembling the team capable of creating the necessary documentation.
Reach out to The Alliance Group, and let their expertise guide you towards optimal accounting practices that align with your business objectives.