Whether you think your company is ready for the new accounting for revenue recognition or not, you’re probably not ready for the new disclosures. That’s what experts are saying as they witness the scrambling at many companies to prepare for the biggest change in corporate accounting since Sarbanes-Oxley.
“Many companies are largely ignoring the disclosure requirements,” says Eric Knachel, senior consultation partner at Deloitte & Touche. “They think it is a minor detail to be dealt with once the standard goes into effect, and that’s a mistake. A big mistake.”
Public companies are facing a Jan. 1, 2018, effective date for a massive change in how they will recognize revenue in financial statements, courtesy of the Financial Accounting Standards Board, which adopted the requirements in 2014 after spending more than a decade developing and writing the rules. A handful of companies have disclosed they will adopt the requirements early, but most companies have put off preparation for the new standard until this year.
“I think companies have always recognized there was going to be a need to accelerate their efforts, and I think that acceleration is taking place much more rapidly now than it did in the fourth quarter,” says Michael Stevenson, a partner at BDO USA. In terms of preparing for the disclosure requirements, however, he sees companies working through the recognition and measurement requirements of the standard first, saving disclosure issues for later. “For the projects we’re working on, it seems to me companies are employing a more linear approach,” he says.
It’s not uncommon for companies facing a new accounting requirement to begin by crunching the numbers, then sorting out what they need to disclose as a result. Knachel and others, however, are beginning to worry that companies have not completely digested the extensive scope of the new disclosure requirements, which includes information they may not be gathering as they prepare for the accounting requirements on the front end.
“Many companies are largely ignoring the disclosure requirements. They think it is a minor detail to be dealt with once the standard goes into effect, and that’s a mistake. A big mistake.”
Eric Knachel, Senior Consultation Partner, Deloitte & Touche
“Disclosure often is an afterthought,” says Knachel. “It’s like showing your work on a math problem. But here’s the difference. Some of the disclosure requirements include information that will need to be separately obtained or separately analyzed. It’s not a matter of showing your work. It’s a separate problem.”
The new approach to revenue recognition requires companies to identify their performance obligations to customers and allocate the purchase price under a given contract to each separate obligation. On the accounting side, they recognize revenue as they satisfy those obligations, and companies are working through ways to achieve that. They’re also required in disclosures, however, to explain when they expect to recognize revenue on remaining obligations. Some call it the “backlog” disclosure.
For long-term contracts with multiple performance obligations, that means some forward-thinking that companies may not be doing right now, says Knachel. “For disclosure purposes, you need to identify performance obligations you haven’t met and how much revenue you expect to recognize for each obligation in subsequent years,” he says. “So next year you expect to get X, in two years you expect to get Y, and in three years you expect Z. You have to go through that whole analysis.”
Below Deloitte discusses which disclosures might be difficult to implement.
Performance Obligations (Including Remaining Performance Obligations)
In contrast to current guidance, the new revenue standard introduces a series of quantitative and qualitative disclosure requirements related to performance obligations that will be partially or entirely new for many entities. Under these requirements, entities must disclose:
Qualitative information about the types of performance obligations, the nature of goods and services promised, and when the obligations are typically satisfied.
Qualitative information about significant payment terms, warranties, and refund obligations.
Quantitative and qualitative information about amounts allocated to remaining
performance obligations, and when such remaining amounts will be recognized as revenue.
Information about significant financing components and variable consideration.
Performance obligations for which the entity acts as an agent.
It may be difficult for companies to determine the level at which to present information about their performance obligations and the nature of goods or services. Complying with the requirements related to remaining performance obligations (commonly referred to as “backlog disclosures”) may be particularly challenging because of difficulties associated with identifying the remaining performance obligations. Further, determining when remaining performance
obligations are expected to be satisfied is a matter of judgment, and the information disclosed may therefore be subjective.
Other aspects of the disclosure requirements related to performance obligations that may pose difficulties in an entity’s implementation include:
Identifying amounts and related drivers of variable consideration associated with performance obligations (including information regarding the estimation of variable consideration and any related constraints on the variable consideration and their potential effects on future cash flows)
Assessing whether material rights exist, and the manner in which those rights would be disclosed within the context of other distinct performance obligations.
In addition to the backlog disclosure, companies are required to explain where they are recognizing revenue in a given period for performance obligations satisfied in an earlier period. That one is commonly called the out-of-period revenue adjustment. It can arise with performance bonuses, Knachel says, where a future payment may be promised in a contract if certain performance thresholds are met. “Companies are not focused on tracking that right now,” he says.
Another aspect of disclosure that is not top-of-mind for companies now is a concept many preparers already understand, but aren’t considering so far in the context of the new revenue standard, says Knachel. Filing rules with the Securities and Exchange Commission require companies, when they adopt new accounting, to effectively include all new disclosures required under the new accounting in the first period they adopt, not just the interim disclosures that might be required for an interim period. “This is not new, but it’s magnified here,” he says. “It’s probably lost in the enormity of what’s going on right now.”
In the case of revenue recognition, that will mean considerably more disclosure in the first quarter of 2018 than companies might expect, says Bill Tomazin, a partner at KPMG. “Companies are going to have to get their heads around that—not as they wander into calendar year 2018, but rather in preparation for the first quarter,” he says. “It’s a pretty extensive list of disclosures.”
Eloise Wagner, a partner at EY, sees a wide range of approaches to prepare for disclosure requirements. Some companies that are further through their implementation efforts are exploring what information they will need to gather and what IT implications that might present.
Those companies are working through, for example, how to meet the disaggregation requirements in the standard, which require plenty of judgment, and how to gather data necessary to disclose balances for contract assets and contract liabilities as required. “This is where I see companies starting to think through where they may have disclosure gaps,” she says.
Companies are also finding, particularly where disclosure requirements require judgement, accountants need to help of others, like legal consultation or investor relations, to determine what to disclose. “There’s always a balance of how much you want to disclose to the world and how much competitive information you put out there,” says Wagner. “Some of those decisions cannot be made by accountants alone.”
Doug Reynolds, a partner at Grant Thornton, sees “tremendous progress” being made at many companies to prepare for the new standard. He does, however, see companies moving more sequentially through the accounting and disclosure requirements, leaving disclosure preparation for the end. “Maybe a thought is for companies as they consider each accounting item is to have another sheet of paper where they are looking at other information they are going to have to gather and disclose,” he says. “It could run in parallel.”