Even after calendar-year companies have filed their first-quarter reports reflecting a new way to recognize revenue, work continues to adapt to the new rules.
As companies close the books on their second quarter, they’re studying peer company reporting, conversing with their auditors, and anticipating comments from the Securities and Exchange Commission about their first-ever filing under the massive new revenue recognition standard. For many, it may mean reconsidering disclosures or even adjusting the accounting, experts say.
“On the accounting side, we’re seeing some differences in terms of how companies have accounted for things,” says Eric Knachel, senior consultation partner at Deloitte & Touche. It’s too soon, however, to know whether those differences are appropriate because the reporting variances are even bigger in terms of what companies have disclosed under the new standard, he says.
Accounting Standard Codification Topic 606, or ASC 606, is a principles-based standard that took effect Jan. 1, 2018, for public companies about how companies should recognize revenue in financial statements. It doesn’t give companies strict, prescriptive rules to follow, but instead gives them direction on how to arrive at their own conclusions about how to recognize revenue. As such, it relies heavily on disclosure to enable users of financial statements to fully understand when and how companies are recognizing revenue.
In a May Webcast poll, KPMG found only 26 percent of companies indicated they anticipated no further work on revenue recognition following their first-quarter reporting under the new standard; 32 percent said they expect further refinements to processes and systems, and 18 percent said they expect to make further refinements to their accounting conclusions and disclosures. Another 24 percent said they expected to make minor updates of some kind.
When it comes to disclosure, Knachel says, companies fell along a wide spectrum in terms of how much or how little they disclosed. Deloitte has said disclosure in general has roughly tripled under the new standard, but some companies disclosed much more detail than others.
“The disclosure varied quite a bit,” says Knachel. “On balance, the trend is for companies to disclose a lot more. But even within that, the spectrum from one company to another is varying quite a bit. Some seems very robust and detailed, but others didn’t seem as detailed or informative.”
Meredith Canady, a partner at KPMG, says most companies adopted the standard using the modified retrospective method, which doesn’t require companies to restate historic periods in financial statements, but relies on opening balance sheet adjustments and disclosure to explain the impact of adoption. “That means companies are going to continue providing disclosures in 2018 about what their financials would have been under old GAAP [Generally Accepted Accounting Principles],” she says.
“There are disclosures companies might have been hesitant to make because that can contain competitive information. We may see some pressure on companies to disclose more than they already have.”
Meredith Canady, Partner, KPMG
Companies are also busy comparing their disclosures to peer companies, she says. Where they see differences, companies are pondering why there are differences. “Are there different facts and circumstances that drove different accounting conclusions or different judgments that are both reasonable and acceptable?” she says. “That’s the ongoing analysis.”
No doubt the SEC will be doing that kind of analysis as well, asking companies to parse out more disclosure where it’s necessary to enable investors to understand the different approaches. Where the SEC issued comment letters to the handful of companies that adopted the standard even earlier than required, disclosure was a common focus, says Canady.
“We saw many that early adopted making changes to disclosure prospectively as a result of comments,” she says. “As a natural part of the audit process, auditors will start sharpening their pencils, and we may see them identify where companies will need to build out disclosures more.”
As an example, says Canady, some companies may have been cautious about disaggregating revenue, or breaking revenue down into categories as required under the standard. Logical categories might include product types, service types, or geographic regions, for example, and companies need to use judgment to determine what disaggregation makes most sense for them.
“There are disclosures companies might have been hesitant to make because they can contain competitive information,” says Canady. “We may see some pressure on companies to disclose more than they already have.”
Cullen Walsh, a partner at Grant Thornton, says companies may even look to the Financial Accounting Standards Board for more guidance on the standard, especially in a few specific areas, like determining whether a company is a principal or an agent to a contract, or how to treat payments companies make to customers, like rebates. The principal versus agent question is important because it determines whether a company recognized revenue on a gross or net basis, which can produce big differences in reported revenue.
“These are areas where there’s been difficulty in practice for years, and some of those challenges continue even under the new guidance,” says Walsh. He’s predicting, however, that consideration of new guidance probably wouldn’t begin until all companies are accounting for revenue under the new standard.
So far, only public companies have adopted the standard, and that’s a small fraction of the total number of companies that ultimately must transition to the new method. The American Institute of Certified Public Accountants recently indicated it’s seeing a big spike in requests for technical assistance on new accounting standards, particularly as private companies prepare for their adoption of ASC 606 effective Jan. 1, 2019.
In addition to reconsidering any accounting or disclosures, companies are also taking up or considering measures to make the process more streamlined or more sustainable over time, says Walsh. Many companies adopted the standard using manual methods or manual controls in certain respects while technology solutions still developed, whether that’s software to crunch the numbers or artificial intelligence tools to refine the process.
“A lot of companies will be looking for ways to make the process more effective and more efficient,” says Walsh. “And all of that is happening at a time when companies are looking to better leverage technology to decrease the cost of finance organizations.”
In terms of near-term disclosure considerations, Knachel says he expects companies to focus on some specific areas that are likely to require more attention in upcoming quarters. The most critical, he says, is disclosure to explain the significant judgments and estimates companies make to comply with the new accounting requirements.
“In order for this to be useful, you have to say what those judgments and estimates were and how you made those,” says Knachel. “That’s an area that I think is a bit short.” Companies will probably be tasked to say more, for example, about their judgments around variable consideration, or amounts where revenue will vary as a result of factors like bonuses or penalties.
Similarly, companies are likely to face questions about their disclosures regarding performance obligations, like where they are combined or separated, and why, says Knachel. They’ll also likely be asked to better explain revenue recognized over time by some measure of progress, which is common on longer-term projects like construction.
Knachel also concurs that disclosures regarding different revenue streams will probably face some scrutiny that will lead to more disclosure. “What are your different revenue streams and how does it work?” he says.
The next six to 12 months will involve a great deal of benchmarking, says Knachel. Companies are comparing their reporting to other companies to consider whether changes are warranted, and the SEC will issue comment letters that prompt reconsiderations. “The story is not over,” he says.