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10 More Things Related to Revenue Recognition

Scott Taub | July 28, 2015

One year ago, my column in this space covered 10 initial thoughts on the then-just-issued new standard for revenue recognition. I was pretty upbeat about what is now ASC Topic 606, Revenue From Contracts With Customers, and I’m happy to say that after a year of working with companies, participating in the Joint Transaction Resource Group for Revenue Recognition (TRG), and thinking about how I will update my revenue recognition book to deal with Topic 606 next year, I’m still upbeat.

Of course, in the past year I’ve also learned a lot about the new standard and how it will likely be implemented. So, while 9 of my 10 thoughts from last year are still true, here are 10 more thoughts about Topic 606.

Topic 606 provides more guidance than Topic 605, Revenue Recognition. This point deserves repetition from my column in 2014. The new standard, despite being around 50 percent of the size of the existing guidance in ASC Topic 605, covers more transactions and issues. In the past year, I’ve been reminded of that many times. I look forward to the day I no longer need to start my explanations of revenue recognition with something along the lines of “Well, this isn’t really addressed, but here’s the way practice has developed …”

In addition, preparers and auditors should look forward to the day when they can look to the ASC to provide a coherent model that walks through revenue recognition from reading a contract to making the journal entries. There are very few transactions where that can be done today.

U.S. and international experts think alike. In a year of TRG meetings, I haven’t run across situations where the U.S. members of the group saw things differently than the non-U.S. members. In most areas, we have all concluded that the standard had sufficient guidance to determine what principles to apply in resolving issues. And in those areas we’ve believed the standard was unclear or difficult to apply, both the U.S. and non-U.S. members see the same difficulty or lack of clarity. These discussions leave me optimistic that the converged standard will lead to converged accounting.

Some are looking hard to find potential problems. A handful of issues have come to the TRG where the standard can be applied both to support a reasonable answer as well as an illogical one. I believe those submitting the issues are worried that practitioners will be expected to apply the illogical answer.

This is discouraging, but understandable to a point as well. Given the way revenue recognition literature has been written and interpreted over the years, I can understand why people might be worried that regulators will require the illogical application, particularly if the tortured reading would result in slower revenue recognition.

We still have more than two years before Topic 606 will be adopted widely, and there is a lot more to learn. But I’m encouraged by what I’ve seen so far. It still seems to me that the adoption of Topic 606 is likely to be a significant improvement to financial reporting.

While I’m discouraged by the fear that seems to be behind these questions, I’m encouraged that: (1) the TRG has uniformly agreed that applying the illogical answer isn’t what’s required; (2) members of the Financial Accounting Standards Board and the International Accounting Standards Board have uniformly agreed with the TRG’s consensus; and (3) Securities and Exchange Commission staff have agreed as well.

FASB is very willing to help. At first, nobody knew to what extent FASB would be willing to change the standard if the TRG identified problems. The answer is that FASB has shown great willingness to modify the standard to address issues raised to or by the TRG. To a lesser extent, IASB has also been willing to modify the standard to address issues. As a result, we should have guidance that, by the time of the standard’s required adoption, is well-understood and as clear (at a principles level) as is reasonably possible.

FASB is so keen to help, it’s willing to go too far to do so. In several areas, FASB is so intent on ensuring a smooth implementation that it’s willing to sacrifice principles in the interests of operationality, and it is trying to fix problems not caused by the accounting literature.

Example: The proposal to base license accounting on the nature of the licensed property rather than the licensor’s activities, while easier to apply, deviates from the principles that underlie the rest of Topic 606. Similarly, the proposal to allow transportation of a customer’s goods always to be treated as a fulfillment activity, rather than requiring analysis to determine if it is a significant promised service, undercuts the principles as well.

And the proposal to allow promises that are “immaterial in the context of the contract” to be ignored is attempting to solve a problem that constituents believe will arise not because the standard is flawed, but because of the way auditing practice has developed to require the effect of almost any accounting convention that deviates from GAAP to be quantified.

In my view, all of these proposals are well-intentioned, but ill-advised. Still, if they are finalized as proposed, the standard will be easier to apply.

The SEC is looking for reasonableness, not uniformity. Initially, SEC Chief Accountant Jim Schnurr made some comments that had me concerned. For example, he said, “I want to assure you that the implementation of the standard in the United States in a timely and consistent manner will continue to be a priority for me and my staff.” That kind of statement had many, including me, fearing that the SEC staff was looking for rules-based implementation of a principles-based standard, and it might enforce its own views of proper judgment calls.

More recent comments from Schnurr and other key staff members at the SEC have set a different tone, making clear that the staff understands that not everybody will reach the same judgments, even when acting in good faith. And the staff has been clear that it expects registrants will apply the standard in a reasonable, practical manner, and has confirmed, through public statements, that interpretations in that direction are appropriate.

Of course, the staff would never say that it expects “unreasonable, impractical” application, but the message is that the SEC staff is not intending to impose strict or uniform application out of the box.

You might need retrospective numbers even if you don’t adopt retrospectively. The new standard can be adopted retrospectively or by recording a cumulative catch-up adjustment in the year of adoption. I’ve begun to understand, however, that if a public company adopts the standard through a cumulative catch-up adjustment, analysts following the company are highly likely to expect the company to provide retrospective numbers in earnings releases and in the Management Discussion and Analysis section of periodic reports.

Because revenue is key to evaluating a company’s future earnings and cash flows, analysts need information about trends in revenue and related costs. While the footnote disclosures required for companies that adopt by way of a cumulative catch-up adjustment are intended to help in those areas, it seems that analysts don’t believe that information will be sufficient.

As such, public companies that intend to adopt the new standard by a cumulative catch-up adjustment may well find themselves providing pro forma retrospective figures anyway.

Convergence is at risk. The standards issued by FASB and IASB were virtually identical. And as I’ve said, accounting experts seem to be interpreting the standard similarly, leading to my optimism that converged accounting will result. But FASB and IASB have had different reactions to TRG discussions, with FASB generally proposing more changes to the standard than IASB. Given how hard the boards worked to issue a truly converged standard, it would be disappointing to lose that convergence in any substantive way during the implementation period. In addition, diverging at this point will discourage any further attempts at converged standards—not ideal in an increasingly global marketplace.

Large audit firms are working hard to help. The large audit firms have published large amounts of interpretive guidance already and are dedicating a huge amount of resources to building knowledge and expertise, in both the interpretation of Topic 606 and in understanding the systems needed to apply the new requirements. While there’s always a concern among preparers that auditors might act like a secret standard setter through their books and publications, the amount of analysis that is already available is impressive.

The delay in the effective date is probably a good thing. I said last year that calls for a delay in the effective date were premature. This is my one point that no longer holds true. Given the areas where the boards decided clarification is necessary, the depth of analysis necessary to get this right, and the fact that analysts want retrospective figures even from companies that adopt via cumulative catch-up adjustment, pushing the effective date back one year is a good thing.

We still have more than two years before Topic 606 will be adopted widely, and there is a lot more to learn. But I’m encouraged by what I’ve seen so far. It still seems to me that the adoption of Topic 606 is likely to be a significant improvement to financial reporting.