There are deadlines, and then there are drop-dead deadlines. In the transition to new accounting rules on revenue recognition, it appears some companies are aiming for the latter.
Yes, the massive new accounting requirements for when and in what amounts to recognize revenue in financial statements took effect Jan. 1, 2018—both for U.S. companies reporting under Generally Accepted Accounting Principles and for companies abroad following International Financial Reporting Standards. But calendar-year companies will not do any reporting based on those new accounting requirements until they file their first-quarter reports in April and May, depending on their specific filing deadlines.
That’s the deadline that really matters, says Eric Knachel, a senior consultation partner at Deloitte & Touche. “This is not like Y2K,” Knachel says, referring to the run-up to the new millennium when companies worried about whether computer technology could handle the date change. With respect to the revenue rules, “there wasn’t anything magical about midnight, Dec. 31, in terms of what a company needs to show or report or present.”
That gives them a little more time to prepare. And revenue recognition experts at major firms say a good number of companies are using it.
Cullen Walsh, an accounting advisory services partner at Grant Thornton, says he sees companies falling into one of three big groups when it comes to readiness to adopt the new rules under Accounting Standards Codification Topic 606, or ASC 606. Some companies are ready to go, he says, with processes and procedures in place to account for revenue under the new rules as transactions occur. A handful even adopted early, so they were up and running before Jan. 1.
“We’re a matter of weeks away from companies reporting under the new standard, so now investors are asking what does this mean? Companies will be getting a lot of questions from investors about the impact of the new standard on their specific organizations.”
Cullen Walsh, Accounting Advisory Services Partner, Grant Thornton
The second group, however, is still working on getting those processes and procedures in order, says Walsh. “My gut would tell me this middle category is probably the biggest category,” he says. “They have probably made key decisions on most things, but they’re trying to nail down issues on the periphery. They will be busy finalizing their implementations over the next few months.”
The third group, says Walsh, consists of companies that are still behind. “They’re in something like panic mode,” he says. “Realistically, it will be a small population of companies that will really struggle to meet the deadline, but they have a lot to get done to be able to have their earnings releases in a normal timeframe and have their 10Qs issued on time.”
Bill Watts, a partner at Crowe Horwath, says there are two big groups of companies that aren’t quite yet ready for the new standard. “First are those that felt it would not impact them much, so they did very little,” he says. As auditors started asking in 2017 to see what such companies had done to prepare, they began discovering missed revenue streams, differences in interpretations, and other issues that led to some scramble, he says.
The second group consists of companies that prepared diligently and thought they had covered all the necessary bases but learned in working with auditors or observing competitors that there were still additional areas to address, says Watts. “Auditors played a major role at the end of the year, maybe challenging some areas where companies weren’t prepared,” he says.
Dusty Stallings, a partner at PwC, says she observed a big push at the end of 2017 where companies did whatever was necessary to establish processes and procedures by Jan. 1, but continue to work on establishing more sustainable procedures that will be more effective or more efficient over time. “Companies are still working on that sustainable process that’s going to be the thing they do period on period as opposed to something created topside, maybe in a spreadsheet, that’s difficult to keep proper controls on,” she says.
Many companies will probably spend plenty of time in 2018 fighting for resources to come up with those more sustainable processes, says Stallings, but they may find it an uphill battle. “Companies would love to put in big-ticket revenue management systems where they have everything tracked in one place simplistically, but it just doesn’t happen that way,” she says. “Getting people higher up in the organization to respect the need to spend a bunch of money on accounting is tough enough. But when you’ve got a quick fix and it’s working, it’s tougher to say we need an overhaul.”
CFA Institute discussion starter for investors
Here are some questions the CFA Institute is advising investors to consider when evaluating whether there will be a significant change in how revenue is recognized for any particular company:
Multiple Deliverables: Do the entity’s arrangements with customers include multiple deliverables?
Long-Term Contracts: Are there long-term contracts in which revenue is recognized based on progress on the project?
Costs: Are significant costs associated with obtaining or fulfilling a contract with a customer, or a contract that may extend beyond one year?
Financing: Is financing an element of the arrangement with the customer?
Performance versus Cash Collection: Is there a significant difference in the timing of the completion of obligations under the contract and the collection of cash?
Variable or Uncertain Consideration: Are variable or uncertain considerations associated with contracts with customers?
Collectability: Has collectability been a significant consideration in the past? Is the basis of determining bad debt expense changing based on contract price?
Principal versus Agent and Gross versus Net: Does the company sell goods or services on behalf of others? Are they the principal or agent and is gross versus net presentation something that has been a consideration in the past?
Point in Time versus Over Time: Does the company have contracts where there might need to be consideration as to whether revenue should be recognized at a point in time or over time?
Degree of Estimation: Has there been a significant degree of estimation in the recognition of revenue in the past?
Evidence of Objective Selling Price: Has the company used vendor-specific objective evidence (VSOE) to determine selling price and revenue in the past?
Recent Change in Business Practices: Has there been an alteration in business practices or contracts in recent years in the lead-up to this change in revenue recognition?
Sale of Software: Does the company’s business involve the sale of software as a product or as a service?
Licensing: Does the company’s business involve intellectual property and licensing arrangements?
Source: CFA Institute
Plenty of companies are settling into the new accounting after successful implementations, says Knachel, but he also sees plenty that are scrambling. “For those that have not completed implementations, all the warnings we’ve been talking about implementations becoming a fire drill, those are coming true,” he says. Companies that procrastinated perhaps did not factor in the possible workload that would be associated with the Tax Cuts and Jobs Act, he says, which has produced a year-end reporting fire-drill of its own.
Like Stallings, Knachel sees many companies using “bandage” approaches for systematic, or more routine, transactions. “They’ve figured out how to deal with systematic transactions, even if with a temporary approach that’s less than ideal,” he says.
Then there are a lot of situations where companies are working on how to account for the “one-off” transactions, or those that Walsh described are on the periphery of everyday activity. “This is the one causing the most concern and anxiety for companies,” says Knachel. “This is the surprise, and it’s a big one.”
In many cases, these are transactions with unusual facts or circumstances that command heavy use of judgment or estimation under the new standard, says Knachel. “They can cover a wide, very wide range of issues,” he says.
One example, he says, is the determination of whether a company is the principal player in a particular contract, or whether the company is acting as agent for another entity, which determines whether companies record the gross amount on a contract, or a net amount. “It’s very sensitive because it drives margins and trends, and it’s important to analysts and investors as a result,” he says.
The accounting for upfront fees and for variable consideration is also proving vexing as companies approach the eleventh hour of their implementations, says Knachel. Companies are walking some very fine lines as they struggle with technical interpretations in the new standard and applying them to their own facts and circumstances, he says.
Companies are also working on their disclosures, says Knachel, but that one is less of a surprise. “There’s a tendency for disclosures to come at the end. To a certain degree, it’s inevitable.”
Investors and analysts are starting to take greater interest in the new accounting as well, says Sandra Peters, who is head of the financial reporting policy group at CFA Institute. Much of the year-end attention was focused on tax reform, she says, but more recent discussions over revenue recognition adoptions at companies like General Electric and Tesla have piqued investor attention. Inquiries by the Securities and Exchange Commission into some of the filings of early adopters of the new rules have also put a spotlight on the new accounting, she says.
The CFA Institute even released a discussion document for investors to help guide their questions. The paper explains the mechanics of the new accounting and gives investors some indication of where they might expect to find differences in corporate financial statements as a result of the new standard.
The major accounting firms also are getting questions from investors, says Walsh at Grant Thornton. “We’re a matter of weeks away from companies reporting under the new standard, so now investors are asking what does this mean?” he says. “Companies will be getting a lot of questions from investors about the impact of the new standard on their specific organizations.”