With 18 months remaining until all companies are required to report revenue following hundreds of pages of new accounting guidance, accounting leaders are a little stumped on why companies aren’t taking more action to prepare.
At Compliance Week’s recent annual conference, a session on the massive new revenue recognition standard was perhaps the most sparsely attended. In an onsite poll of those in the room, more than half said they came from companies that hadn’t yet decided how they would adopt the new standard. That’s a troubling sign that those companies probably hadn’t yet completed even a high-level assessment to determine how they will be affected by the new requirements.
“The results are somewhat—I wouldn’t say surprising—maybe alarming,” said Chris Chiriatti, managing director at Deloitte & Touche.
“It’s an indicator that many companies view this as 18 months from now,” said Eric Knachel, senior consultation partner also with Deloitte. They have other more time-sensitive priorities, perhaps, or limited resources to devote to the effort.
Or worse, companies may not appreciate the magnitude of the exercise. “The next three to nine months will be critical,” said Knachel.
Staff members at the Securities and Exchange Commission have been saying for months that they would expect to see companies moving through their assessments, deciding on a method of adoption, and giving investors some forewarning of how their financial statements will change when they begin following the new accounting rules. “This is evidence of a departure from what the SEC might be expecting with the adoption of this standard,” said Chiriatti.
Jan Hauser, vice president, controller, and chief accounting officer for GE, said the company has eight separate industrial segments working through the new accounting requirements to determine how to apply them to their specific businesses. “We’ve been at this game a long time and we thought we started early, but it still feels like we have a lot of heavy lifting yet to do,” she said during a keynote panel discussion at the conference.
To understand why the transition is difficult, consider the change that’s occurring. Today’s rules around revenue recognition mushroomed over decades through hundreds of separate accounting pronouncements. Many of them were written to address narrow issues, sometimes specific to only a single industry sector.
“We’ve been at this game a long time and we thought we started early, but it still feels like we have a lot of heavy lifting yet to do.”
Jan Hauser, VP, Controller, and Chief Accounting Officer, GE
The new rules sweep all that away to provide a single method by which all companies will recognize revenue, regardless of the transaction, the business, or the sector. And with companies following international accounting rules embarking on the same exercise, the new rules will even wipe out geographic differences in how revenue is recognized.
To establish a single model where companies historically have followed many different approaches, the rules rely on principles rather than prescriptive bright lines. That requires companies to exercise plenty of judgment in interpreting them and applying them to their own transactions.
The idea behind a single model, says the Financial Accounting Standards Board, which wrote the new rule in collaboration with the International Accounting Standards Board, is to get everyone reporting revenue in a more consistent way. That should put all companies on a level plane to make comparability a breeze for investors.
For companies like GE with its eight separate industrial divisions, that’s a massive funneling exercise. “They all have some different form of revenue recognition, and yet some is the same among and between,” said Hauser. “We need to make sure that the judgments they are making and how they are reading and applying the standard is being done consistently—with the same judgments and internal controls.”
Even further, GE is reaching out to industry peers to compare notes, said Hauser. No one wants to see their financial statements published only to learn they are an outlier in terms of how they applied the rules and how it affected their numbers.
REVENUE GUIDANCE OBJECTIVES
Below FASB details what the new revenue guidance hopes to achieve.
The objective of the new guidance is to establish the principles to report useful information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers. It will:
Provide a more robust framework for addressing revenue issues as they arise
Increase comparability across industries and capital markets
Require better disclosure so investors and other users of financial statements better understand the economics behind the numbers.
The new guidance establishes the following core principle:
Recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
A company or other organization will apply the following five steps to achieve the core principle:
Identify the contract with a customer
Identify the performance obligations (promises) in the contract
Determine the transaction price
Allocate the transaction price to the performance obligations in the contract
Recognize revenue when (or as) the reporting organization satisfies a performance obligation
The enormity of the task before all companies is not lost on Wes Bricker, a deputy chief accountant at the SEC, nor is the importance. Revenue is the top line, he said, but it’s also prominent throughout financial reporting because of how it factors into so many critical metrics that matter to investors—volumes, margins, values, and trends. “To give you a sense of the magnitude of revenue across markets, for all of the S&P 1500 companies—and that captures about 90 percent of U.S. market cap—revenue is over $12 trillion,” he said. “This is a real step forward for a really significant number,” he said.
That being said, Bricker had some advice for companies on applying the new rules. Establish a good process for understanding the requirements and determining how you will interpret them and apply them to your business. Recognize that your systems may not be up to the task. Don’t overlook the many ways revenue might cut across your business, like in establishing compensation or calculating taxes. “Revenue is one of the primary processes through nearly any company,” Bricker said. “It deserves an appropriate level of attention.”
The new rule takes effect in 2018, and the Financial Accounting Standards Board has already extended the original effective date of 2017 by one year. FASB is operating a Transition Resource Group to help companies sort through questions, and it has issued guidance to help clarify questions the TRG couldn’t resolve through discussion. The SEC is not giving any indication it will entertain appeals for more time. Instead, Bricker advised companies to move forward.
“As with any good change management exercise, it’s really important to have a strong implementation plan,” said Bricker. “And not just a plan, but a really robust conversation that occurs at the highest levels within your organization.”
That means the board and audit committee need to be involved, and the resulting effort should produce compliance with not just the letter but the spirit of the new standard. “The opportunity for enhancement is really significant,” Bricker said. “Given the magnitude, the opportunity for defects in implementation shouldn’t be minimized. It should be managed and appropriately resolved before information gets reported to investors.”