As companies get closer to their first annual disclosures under new revenue recognition rules, staff members at the Securities and Exchange Commission are stocking up on red pens.
“If we encounter material items that appear to conflict with the standard or material disclosures that are missing, you can expect a comment from the staff,” said Kyle Moffatt, chief accountant in corporation finance at the SEC, speaking at a Financial Executives International conference. “Over the course of the next few months, you will start to see comment letters released, and you’ll see we’re really focused on material items.”
Accounting Standards Codification Topic 606 took effect Jan. 1, 2018, requiring companies to follow a new, five-step method for determining when and in what amounts to recognize revenue in financial statements. Calendar-year companies have completed three quarterly filings following the new rules, so their first annual filing is a few months away.
SEC staff has been reviewing quarterly filings, but staff members have indicated they planned to give companies time to get acclimated to the new accounting before picking apart their filings. Moffatt indicated the staff plans to take a hard look at the first annual reports under the new standard, but it will be focused on material issues.
At the same time, Moffatt said, the staff is expecting disclosure to evolve. “As you prepare your 10-K, revisit your disclosures each quarter, and reassess or update those disclosures,” he said. “We do expect companies will continue to refine their revenue recognition disclosures.”
The staff is especially focused on some of the more subjective areas of the standard, where companies are relying on estimates and judgments that play a critical role in determining the amount and timing of revenue recognition. “In many situations, the focus is on how a company identified its performance obligations,” said Moffatt. “We will take a closer look, and we may issue a comment if disclosures are missing or are unclear.”
Preparers should assure they have provided clear disclosure regarding the nature of performance obligations, especially when they are combining goods or services into individual obligations, said Moffatt. If a particular performance obligation involves a license, for example, that will get attention, he said. That’s a common scenario in the technology sector where services might be included with access to software.
If an arrangement involves significant payment terms, that will also get the staff’s attention, said Moffatt. The staff is also scrutinizing how companies disaggregate revenue, or break revenue into different categories as required under the standard. Companies may not have seen a lot of comments from the staff on disaggregation so far, he said, “however, I can imagine the staff will look at these in upcoming filings.”
The staff will also explore information companies provide outside their filings to look for consistencies, said Moffatt. That might include earnings releases, slide presentations, and materials posted on Websites, he said.
All that being said, Moffatt also praised what companies have achieved so far. “Companies have done a pretty good job of addressing the disclosure requirements,” he said. “The real message out there is keep up the good work.”