In May 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) finalized ASC 606, Revenue from Contracts with Customers, a set of uniform guidelines for recognizing revenue. The guidance can be applied across multiple industries and multiple transactions. Conversely, prior to this convergence, guidance was inconsistent, with over 200 revenue recognition pronouncements under United States Generally Accepted Accounting Principles (U.S. GAAP) and only very few under comparable International accounting guidance. So, the convergence was meant to create consistency across the board, and was the result of much discussion and debate among standard setters.
The implementation of the new standard takes effect for annual reporting periods beginning on or after Dec. 15, 2017 for public companies and exactly one year later for private companies.
I have recently spoken to many of our clients that are in different phases of their implementation, including some who have not started and some who have created a road map for themselves. Rarely have I come across leaders who have fully realized the impact it will have on their business. I will use some of this knowledge, along with the results of my own research and expertise on the topic (due to my background in accounting) to highlight some key challenges facing the marketplace.
1. The “Scoping”
Before a company can truly realize the method they would like to adopt in changing their financial statements, they will undoubtedly need to determine the revenue streams that are higher risk than others. For example, a company may have 80 percent of its revenue that is consistent and only 20 percent that could be considered “dirty” revenue, comprising of items such as “bill and hold,” “variable consideration” or even “excessive returns.” A way to determine this early would be to utilize a questionnaire from your auditors or outside consulting firms. The larger accounting firms should have a meaningful questionnaire that can be “checked off” for scoping purposes and provide you a good idea of where you need to be in understanding how your revenue streams will be affected. Once revenue streams are assessed in a reasonable manner, companies can move on to understanding what the process gaps are that will impact implementation of the new revenue recognition guidelines.
2. The “Accounting”
There are 2 different methods a company can utilize under the new guidance, a “Full Retrospective” method and a “Modified Retrospective” method. The method chosen is a factor of not only the needs of the users of this information but also the availability of proper resources to implement it.
This choice of Accounting method is a challenging one because it may cause a short term spike in resource needs but may also become the cause of long lasting change within the processes of a company. Hence, before making this decision, a company should assess the following key factors:
A. Gaps in policies and processes
B. Stakeholder expectations (especially investor expectations for public companies)
C. Resources available and cost to procure them
While these items are not truly “Accounting” related, they are relevant in the decision to make a change because they may cause the largest change in the manner and duration in which the accounting information is obtained.
3. The “changes”
A certain level of education at all levels of the company is crucial when implementing the new guidance. All stakeholders should understand the key aspects of the guidance before moving on to their individual contributions within the process. Otherwise, unnecessary questions and discussions may bog down the process. One of these key aspects is the focus on contracts. The new guidance is so focused on contracts with customers that the considerations under the prior guidance need to be viewed from a different perspective. For example, collectability, while a significant factor in the older guidance, is not a large factor in the newer guidance because a high risk of collectability implies the potential lack of an executed contract in the first place. The importance of a strong contract policy cannot be emphasized enough, as it becomes the source of information that will determine the amount of revenue recognized as well as when it will be recognized. This will be especially relevant in “one-off” transactions such as those that involve unique transactions like “Bill and Hold” and those that can impact unique industries such as software in which multiple elements like product and service are delivered under one contract.
4. The “impacts”
The changes will essentially cause impacts to business departments including sales, legal and operations in addition to the known obvious departments such as Reporting and Investor relations. This operational impact can be minimized if they can be considered as a part of the gap analysis companies are performing. For example, if the sales process does not allow for a properly executed contract before commencing a sale, revenue recognition may be delayed or hindered in the initial stages of the implementation. This can be especially problematic at critical points of time such as quarter ends and year ends when cut off information regarding which period revenue belongs in is extremely crucial.
5. The External Auditor and Investor Relationship
Vincent Papa, CPA, CFA, PhD and Director of Reporting Policy at the CFA Institute wrote a paper called Watching the “Top Line”: Areas for Investor Scrutiny on Revenue Recognition Changes which outlines key considerations that investors should have when analyzing company financial information. Companies that have challenges in the Investor Relations area whether due to volatility in their business, market related or internal, or on the other hand organic impacts, should carefully consider managing communications to investors. This is why an early performance of a gap analysis is highly relevant since it will “grease the wheels” of that conversation and make it easier. One challenge will be sifting through the Accounting guidance and explaining the reasons and impacts that the chosen method will have to both transparency of information and the financial results. While the conversation around straight forward revenue transactions may be easy or even unnecessary for some, it may be a challenge for unique transactions or industries. Unique transactions include multiple-element revenue transactions, “Gross versus Net” issues and even “Licensing Revenue” among others.
Scrutiny by Investors is not the only scrutiny a company will face. The Audit firms will be highly focused on the impact and implementation of the guidance and associated changes within the Control Environment. Of course, the Public Company Oversight Board (PCAOB) of the Securities and Exchange Commission (SEC) will be watching these auditors closely as a “check and balance” for the investor community whether they are boards of directors or individual shareholders. Given this assumption, it cannot be overemphasized that accounting leaders should involve auditors in every step of the process, especially when it comes to decision making. A challenge from auditors at crucial moments can reduce re-work and delays during implementation. Invitation to key audit personnel in on-going meetings to create transparency will go a very long way.
Should your business be in need of a gap analysis of existing processes and policies or additional resources to assist in implementation for the new Revenue Recognition standard, Brilliant™ is just a phone call away! Call 312.582.1907 or email firstname.lastname@example.org and mention this blog.
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