New that companies and audit firms have had time to digest the new accounting standard for revenue recognition, some common questions have emerged, including what are the first steps for adopting the standard, and how much time will companies have to get up to speed? We talked to audit firms, issuers, and others and compiled answers to these frequently asked questions.
When is this standard effective?
Public companies are required to adopt the standard for annual periods beginning after Dec. 15, 2016. For calendar-year companies, that means 2017 financial statements will reflect the new standard. Private organizations will have an extra year to prepare for the new standard. Early adoption is not permitted in the United States, although companies reporting under International Financial Reporting Standards will have that option.
U.S. companies will have some elections to make around how they want to adopt the standard. They can choose a retrospective approach, presenting all periods in the financial statements as if the standard had been in effect all along, or a cumulative approach, where earlier periods are not presented under the new standard but are accompanied by disclosures to explain how they would have looked under the new standard. “Publicly traded companies are largely going to choose retrospective adoption,” says James Comito, a shareholder with audit firm Mayer Hoffman McCann. “Most publicly traded companies will find that their investors want that comparability.”
For large publicly traded companies that present three years of results in financial statements, that means presenting 2015 results under the new standard when it takes effect in 2017. Companies that choose to prepare for the standard by running parallel systems under the new standard and the old standard will need to be up and running soon to facilitate this.
Where do we begin to prepare to adopt this standard?
Study the standard to determine how it compares with the company’s current accounting practices and disclosures, says Prabhakar Kalavacherla, a partner at KPMG. “Until you have done that, it will be really difficult to have a meeting with the CFO and say here’s what I need,” he says.
Publicly traded companies are largely going to choose retrospective adoption. Most publicly traded companies will find that their investors want that comparability.
James Comito, Shareholder, Mayer Hoffman McCann
Stephen Thompson, another KPMG partner, says a core team can begin the process, but the team will get broader as the impact begins to unfold. Depending on the effect for any given company, the adoption might be planned by a small group beginning in finance, or it might require a large cross-section of the organization, including sales, IT, human resources, tax, legal, and possibly others. The adoption will naturally be driven by the extent of change that any given company might be facing.
Regardless of the nature of the company or extent of expected change, companies will want to dive into this exercise sooner rather than later so they can determine their adoption plan and begin disclosing it to investors. Under Staff Accounting Bulletin No. 74, companies are required to disclose in their next interim or annual report that they are preparing to adopt the new standard and what effect they anticipate, says Adam Brown, a partner with BDO USA. “For the first few quarters, companies will probably say they are evaluating the impact,” he says. “But the Securities and Exchange Commission will be looking for more detail in those disclosures over time.”
What are the key changes in the standard that might affect how we recognize revenue?
The standard does away with industry-specific exceptions and constraints that had accumulated in accounting rules, and it places greater emphasis on using judgment to determine when it is appropriate to recognize revenue. Companies will be required to assess their contractual arrangements with customers, identify their performance obligations under those arrangements, allocate a transaction price to each of those obligations, and recognize revenue when they determine they have satisfied those obligations.
For the typical operating company that buys and sells a product in a straight-forward arrangement, the new approach is not likely to cause significant changes in accounting, says Chad Kokenge, a partner with PwC. Even those kinds of companies, however, will have to look carefully at how the accounting affects things like tiered discounts or volume rebates. “Those arrangements will be more subject to estimation than we have had in the past,” he says.
Companies most affected by the historical constraints on recognizing revenue likely will accelerate their recognition of revenue under the new standard. That might include software or telecommunications companies, which often bundle goods and services into a single package for customers or sell licensing. Existing standards have made it difficult for companies to recognize revenue until late in the contract cycle. Changes are most significant in areas where there was industry-specific guidance to follow, as well as allocating a purchase price to performance obligations, assessing collectibility, assessing variable consideration, licensing, and long-term contracts. “It’s safe to say the more complex your company and your contracts are, the more difficult this will be,” says Anne-Lise Vivier, a manager in the tax and accounting business of Thomson Reuters.
Who Wins, Who Loses, as Revenue Standards Change
Below is a compilation of winners and losers in the world of revenue recognition.
Every business organization—whether a public or private company, global or domestic, small or large, for profit or not-for-profit, and in every possible sector—will be affected by the new standard. Along the continuum of possible outcomes, the effect is expected to be greatest according to the industry sector in which a given company operates.
“We’re going away from decades of industry-specific, rules-based guidance,” says James Comito a shareholder with audit firm Mayer Hoffman McCann. “Now we have a single standard that cuts across all industries based on a set of principles.” For some, that will mean a great deal more change than for others.
Companies that will be less affected by the new standard include those that have a relatively simple revenue cycle, says Diana Gilbert, a senior consultant at accounting and finance consulting firm RoseRyan. “I go to the store and buy a dress,” she says. “I pay the money and walk out with the dress. That’s revenue. That’s not going to change much.”
Retail operations, including those in the hospitality sector, such as restaurants and hotels, will likely feel minimal effect. Manufacturers with a relatively simple sales and distribution cycle also will be less affected. If a company offers tiered discounts, volume rebates, or warranties, or has a customer loyalty program, those will need to be considered under the new analysis of when revenue would be recognized.
However, accounting experts say companies in that situation likely will be able to arrive at relatively straightforward answers under the new standard, making adoption for them a bit simpler. “A pure product company may not be as impacted, but to some extent everyone’s going to have to take a look at this,” says Les Stone, managing director at Accenture.
Companies that operate in industry sectors where accounting rules have long provided industry-specific guidance will have the most work ahead of them. That includes companies in software, telecommunications, aerospace and defense, real estate, asset management, some pharmaceuticals, and some aspects of construction and automotive.
Companies in the high-tech sectors will see big changes because they often “bundle” products and services, or they generate revenue under licensing agreements, and the standard around both of those practices has changed. Bundling is the practice of selling a product with services attached—like a cell phone that comes with service and data plans, a software package that includes upgrades or technical support, an equipment purchase that includes delivery and installation, or even a new car that comes with free maintenance for some period of time. “Any company that bundles products and services is going to see the biggest impact,” says Stone.
Accounting rules around multiple-element arrangements have tended to delay the recognition of revenue until the entire transaction or earnings cycle was complete, even if that meant years into the future when a service agreement might expire. Some provisions in more recent years have given companies more room to recognize revenue at stages along the way, such as after a product has been delivered, when they could show good evidence of the value attached to individual elements as they were delivered along the way.
What accounting policies will be affected?
Essentially every accounting policy tied to revenue recognition will be affected by the new standard. There are a number of other policies that must be assessed for change as well.
“Revenue is one of those areas that always touches something else,” says Doug Reynolds, a partner with Grant Thornton. “Every time you book revenue, the other half of that transaction is something else.” It could be cash, inventory, receivables … “You’ll have to look at the other side of all revenue transactions to make sure your policies are consistent.”
Can our auditor help us?
Auditors are barred by independence rules from assisting companies in adopting new accounting standards. However, companies will want to confer with their auditors early in the adoption process to assure the auditor is onboard with the changes the company is considering, says Dusty Stallings, a partner with PwC. “It’s early to have a good clear picture of what the audit will look like, but if you involve auditors early it will help smooth the road when the first audits are performed,” she says.
What about tagging? Do we need to present this in XBRL too?
Normally, FASB would include XBRL elements to reflect a new accounting standard in the GAAP Taxonomy release that covers the year the standard takes effect. In the case of revenue recognition, that would mean the 2017 Taxonomy, which would be released in draft form in mid-2016. However, FASB has said it is considering including tags related to the new revenue recognition standard in its 2016 release to give companies more time to consider and prepare for changes to the tagging process. The draft of the 2016 release is expected in late August 2015.
If standard setters spent more than a decade writing this standard, why did they give companies a more limited timeline to adopt it?
FASB and IASB set an expected implementation date of 2017 and then faced delays of about a full year in producing the final standard. They deliberated openly, and many accounting experts followed the deliberations and warned companies of the significant changes ahead. “We knew this was coming,” says Comito. “So now that we finally have the actual words, it’s time to roll up the sleeves.”
We’re bound to run into problems or concerns as we dig into this. Will we get any breaks on implementing the entire standard?
Despite more than 10 years of study and deliberation before issuing the final standard, FASB and IASB recognize that implementation issues are bound to arise. That’s why they formed the Joint Transition Group for Revenue Recognition. The 19-member panel, made up of experts from around the globe and across capital markets, will field questions or concerns that arise as companies study the standard and prepare to put it into practice. The panel will meet regularly to sort through issues that are presented and determine if any action should be recommended to FASB or the IASB.
“They’re just waiting for companies to digest the standard and start providing feedback,” says Diana Gilbert, a senior consultant at accounting and finance consulting firm RoseRyan. She expects early on the group is likely to hear concerns that the timeline for adoption is too ambitious. Public companies that elect a retrospective adoption ideally would have a parallel system set up with the start of 2015 to capture 2015 data and compare it to the new standard. “This is going to be a lot of work,” she says.