Revenue recognition: full retrospective, modified retrospective, or somewhere in-between

Those at the forefront of implementing the new revenue recognition accounting standard are starting to favor the idea of presenting three complete years of historical data under the new rules, but many companies are still lagging in the assessments necessary to make any determination at all.

Experts who are in the battle grounds helping companies wade through the massive new requirements and determine how they will comply with them say those furthest along are seeing the benefits of a full retrospective adoption. That means presenting 2016 and 2017 financial statement data in 2018, the year of adoption, as if the standard had been in effect all along.

A recent poll by Deloitte, for example, found 38 percent of 170 people representing primarily technology, media, and telecommunications companies said they were leaning toward or firmly decided on following the full retrospective method of adoption. Only 25 percent said they were leaning toward or firmly decided on the modified retrospective method, where historical data is presented using cumulative-effect adjustments and lots of disclosure. About a third remained in middle ground—uncertain.

“There does appear to be a shift in the thinking by companies,” say Eric Knachel, an audit partner at Deloitte & Touche. “It is still early in the evaluation stage, but this is a significant shift. A year ago, many were thinking they would follow the modified retrospective approach. Now more are leaning toward the full retrospective approach.”

Dusty Stallings, a partner with PwC, said she is seeing some “gravitation” toward the full retrospective method as well. “As companies go through the process of assessing the effect of the standard, some are finding yes, they are going to have a large effect, so they need to do the full retrospective method to get good comparable information,” she says.

John McGaw, a partner at EY, isn’t seeing the same shift in his interaction with companies. “It is not clear to me that a large number of companies have sufficient information to make an educated decision around this right now,” he says.

The decision of whether to adopt under the full or modified retrospective approach hinges on the magnitude of change not only to financial statements, but also systems and processes required to gather and process the necessary information, says McGaw. “That really requires a robust diagnostic to be substantially complete to reach part of those conclusions,” he says. “A lot of companies just aren’t there right now.”

Companies might also consider other factors in deciding which method to adopt, such as analyst expectations and industry peers’ plans, says Knachel. Stallings says she hears the analyst community stating a preference, even an expectation, for the full retrospective approach.

Kazim Razvi, a director in accounting research and policy for Fitch Ratings, says needs may differ between equity analysts and credit risk analysts. Analysts are aware that the full retrospective method may be difficult for companies in certain sectors with long-term contracts. “The full retrospective method will provide better historical data, and improve comparability but is not essential for our analysis,” he says.

While the full retrospective method sounds daunting enough, some companies are discovering the modified approach presents challenges of its own, says Brian Christie, managing director at FTI Consulting. Under the modified approach, companies can continue to reflect historic, settled contracts under existing rules. Any ongoing contracts that would overlap the historic and adoption date periods would be presented with an adjustment to transition them to the new standard.

“If you’re a company that does a lot of longer-term contracts, you can quickly see where just the disclosure of how you recognize revenue before and after will be difficult,” says Christie. “What is the impact of the transition adjustment? And how should investors think about that going forward? That could quickly become a very difficult message to explain.”

Companies also are coming to grips with the line item adjustments that are necessary, says Stallings. “You’ve got to figure out not only how revenue would have been different, but also taxes, compensation,” she says. “You have to go line by line through the income statement and say: Is there anything else in here that would have changed because revenue would have changed?”

Where companies are considering the full retrospective method, in some cases it stems from a concern about revenue that might get lost in transition if the standard is adopted using the modified approach, says Mark Winiarski, a shareholder with audit firm Mayer Hoffman McCann.

PICK A METHOD

During various seminars on the new revenue standard, Deloitte asked participants, “Which Method Will You Use to Adopt the New Revenue Standard?” A ranking of their choices is below.

Only 14 percent of respondents indicated an affirmative decision on a method of adoption, with 10 percent noting they would adopt the new revenue standard on a full retrospective basis. Overwhelmingly, respondents had not reached a definitive conclusion regarding selection of a transition method. Of the 86 percent that had not affirmatively responded on which method they would use for adoption, 49 percent indicated a “preliminary leaning” to one of the new revenue standard’s transition methods.
Editor’s Note: Like Deloitte’s above survey results, informal polling during the 2015 AICPA Conference indicated that most preparers had still not decided which transition method to use and that the percentages of those with a preliminary leaning toward the full retrospective method and those with a preliminary leaning toward the modified retrospective method were now relatively even.
In deciding which transition method to use, companies should confer with key stakeholders and gain an understanding of the methods used by peer companies. The greater the differences expected between a company’s legacy revenue accounting and accounting for revenue under the new standard, the more the company may want to consider using the full retrospective transition method. Under this method, the company would reflect revenue consistently for all years presented in its financial statements rather than for only the latest year presented, as is permitted under the modified transition method.
Source: Deloitte

Software companies, for example, may have deferred revenue that they cannot yet recognize following existing rules. Under the new rules, they will not be bound to the same deferral requirements, but the catch-up adjustments upon transition will push that deferred revenue directly to retained earnings. “If you don’t do the full retrospective approach, that deferred revenue goes to retained earnings, and it never goes to revenue,” he says.

McGaw says he sees companies discussing not just want they want to do in terms of an adoption method, but also what they are able to do. Companies that elect the full retrospective method would ideally be collecting and processing revenue data with the opening of the 2016 year under the new standard.

“As you start to look at the full retrospective method, how much accounting change you have, what resources you have internally and externally, what’s the timeline available to you, what are the competing priorities, the change management effect inside the company,” he says. “It’s fair to say companies that have done meaningful work have a greater appreciation for the challenge at hand.”

Experts working with smaller companies say many are still just beginning to grasp the changes that are coming. “The consensus I’m getting is most people we’re talking with aren’t sure what they’re going to do yet,” says Winiarski.

Diana Gilbert, senior consultant at RoseRyan, says many of her clients are not hearing any clamor from analysts or investors to provide a full retrospective set of data. “They are just going to try to deal with the change in as simplistic a way as possible,” she says.

Jordan Scheiderer, senior manager at consulting firm MorganFranklin, says she’s troubled by the state of implementation. “As a consultant, it stresses me out that we haven’t made more progress,” she says. “We’re just now starting to see a pick-up in companies asking questions. For the life of me, it is very perplexing. A lot of companies don’t know where to start. That’s one of the challenges we’re seeing.”