Question

1. Two issues that the FASB has dealt with in the past include the following:

1. Capitalization vs. Expensing of certain costs
2. Off-Balance Sheet Financing
3. Discuss the potential ramifications of the alternatives auditors should be aware of depending on how management chooses to account for transactions in these areas.   

Answer 1

1. Capitalisation vs Expense of certain costs

Expensing of costs means including the cost in the income statement. Capitalisation means cost is taken to balance sheet. Few examples are Research and Development costs, Interest capitalisation, Repairs and Maintenance expense etc.

Auditors should consider whether these amounts are appropriately recorded in places as suggested by the GAAP and all the creative accounting is avoided. Moreover, substance over form is to be considered while considering whether an expense is to be capitalised or taken to income statement. Rationale of management and industry practices should also be taken into account. He should also consider whether such action would be an implication of Management Fraud.

2. Off- Balance sheet financing

Off balance sheet financing is a method in which company does not include liability in its balance sheet. One of the best examples to understand off balance sheet financing are operating leases. In this case, to take a new asset without owning a liability, a company must just enter into an operating lease and show rent expenses in its income statement. This will not create a liability on the asset side and the debt equity ratio shall remain unaltered.
Auditors should thoroughly check whether the lease is an operating lease or a finance lease by understanding the principles as given in ASC 840. It is pertinent to note that the new guidance on leases i.e. ASC 842 will hinder the off balance sheet financing of operating leases by bringing the assets and corresponding liability in the books (right of use assets and lease liability). Kindly refer ASC 842.