With the clock winding down on the time remaining to prepare for a wholesale change to revenue recognition, accounting leaders are offering some last-minute insights and suggestions to help companies cross the finish line.
At a year-end national conference of the American Institute of Certified Public Accountants, members of the staff at the Securities and Exchange Commission said they plan to respect judgments companies reach in compliance with the new method for recognizing revenue when it takes effect Jan. 1, 2018—so long as the judgments are reached after thorough and thoughtful analysis.
While the new standard, contained in Accounting Standards Codification Topic 606, requires entities to exercise considerable judgment, that does not mean it permits optionality, said Barry Kanczuker, associate chief accountant at the SEC. To arrive at reasonable judgments that will pass muster with the SEC staff, “registrants need to roll up their leaves to understand the nuances of the transaction and faithfully apply the Topic 606 model to their specific set of facts and circumstances,” he said.
Scott Taub, managing director at Financial Reporting Advisors and a former acting chief accountant at the SEC, is all too familiar with the pushback preparers sometimes give when their judgments are questioned. “You can’t just point to the words in the standard and say: ‘The standard says use judgment; how can you disagree with me?’” said Taub at the same conference. “You’ve got to be able to provide the support that is necessary.”
Arriving at difficult judgments was not a small or straightforward task, said Stacy Harrington, senior director of revenue assurance at Microsoft, one of a handful of companies that elected to adopt the standard at the beginning of 2017. She participated in working groups at both the AICPA and Financial Executives International to vet various interpretations of the new standard, and observed a great deal of consternation over differences in accounting conclusions within the company’s industry sector.
“There were growing pains around: ‘I just don’t want to change.’” Harrington said. “It took years to work through issues.” It’s as if people were going through the various stages of grief—shock, denial, and anger, before coming to terms with the new requirements. Discussions were difficult, she said.
The working groups Harrington referenced—especially the industry task forces operated through the AICPA’s Financial Reporting Executive Committee—have produced some helpful guidance, said Taub. The groups are producing papers describing how companies in specific industry sectors have coalesced around some common views about how to apply the new requirements to their particular business models.
“They describe the issues in clean language,” said Taub. “They’re very understandable. They provide a good description of what the thought process should be and how the principles relate to specific fact patterns.”
Identifying performance obligations under the new standard has proven particularly difficult, said EY partner John Offenbacher, especially in sorting out where elements of a contract are interrelated or interdependent. That analysis is key to sorting out whether performance obligations are distinct within a contract, and therefore should be treated separately with respect to recognizing revenue.
“Getting to a place where there’s a thorough understanding of the facts such that there could be a determination of whether you have two-way interdependency or an interrelationship has proven to be a very difficult task,” said Offenbacher. He’s also spent a great deal of time in discussions on whether revenue should be recognized on a gross or net basis, depending on whether a company is acting as a principal or an agent in a given contract.
That’s been a topic of frequent consultation at the SEC, said Kanczuker. The analysis has been particularly difficult in sectors like technology and digital advertising, where goods or service can often be provided by multiple parties, and “transactions often take place within the blink of an eye,” he said.
The accounting guidance provides indicators to support a company’s assessment of whether it controls a specific good or service before it is transferred to a customer, which is important to the gross versus net analysis, but companies should be careful not to tally up indicators as if completing a checklist, said Kanczuker. Even that, he says, is a matter of judgment. Some indicators may be more relevant to certain transactions than others, he said.
You can’t just point to the words in the standard and say: ‘The standard says use judgment; how can you disagree with me? You’ve got to be able to provide the support that is necessary.
— Scott Taub, Financial Reporting Advisors
Registrants need to roll up their leaves to understand the nuances of the transaction and faithfully apply the Topic 60 model to their specific set of facts and circumstances.
—Barry Kanczuker, SEC
There were growing pains around: ‘I just don’t want to change.’ It took years to work through issues.
—Stacy Harrington, Microsoft
Getting to a place where there’s a thorough understanding of the facts such that there could be a determination of whether you have two-way interdependency or an interrelationship has proven to be a very difficult task.
—John Offenbacher, EY
Everyone should know at a qualitative level what needs to change and what policies need to change. You should be done or working out the final kinks in the system to make sure everything is recorded the way it’s supposed to. If you’re not at that point, you’re behind.
— Scott Taub, Financial Reporting Advisors
Drafting and finalizing disclosures proved to be a ton of work at the tail end of the project. That was a significant amount of work that I wasn’t anticipating
—Stacy Harrington, Microsoft
AICPA industry task force papers are helpful. They describe the issues in clean language. They’re very understandable. They provide a good description of what the thought process should be and how the principles relate to specific fact patterns.
—Scott Taub, Financial Reporting Advisors
Another area of common consultation, said Kanczuker, is in the treatment of shipping and handling expenses. The new standard treats shipping and handling expenses differently depending on whether they happen before or after a customer obtains control of a promised good. Where shipping and handling is accounted for as an activity to fulfill a promise to transfer a good, companies will have to exercise some judgment, he said.
In some cases, companies might classify those costs as an expense within the cost of sales; in others, the company might be able to make a case that the expense should be classified outside the cost of sales. SEC staff won’t object to either conclusions, so long as it’s supported, said Kanczuker, but companies may need to think hard about disclosing costs that are classified outside of sales.
Joseph Epstein, a professional accounting fellow at the SEC, said the office of the chief accountant has also done a number of consultations on how to treat costs associated with pre-production arrangements. That refers to activity a company undertakes to ready itself to meet a performance obligation within a contract, like research or set-up at the outset of a new arrangement.
Epstein described a scenario where a registrant reasoned design activity preceding a manufacturing arrangement constituted a research and development expense, and the staff did not object. The company determined the design work did not transfer any good or service to the customer, so any payments received in association with that activity could be accounted for as advance payment for a future sale.
Offenbacher said he expects to see a certain amount of diversity in the way companies implement the standard in its first year, just given the complexity of the analysis of individual facts and circumstances. “We’ll have to wait and see ultimately whether the regulator says that’s a reasonable amount of diversity or not,” he said.
By this point in the process, calendar year-end companies should have worked through most such technical accounting issues and should be well on their way to completing their implementation, said Taub. “I certainly hope everyone should know at a qualitative level what needs to change,” he said. “I hope you know what policies need to change and you’re done or working out the final kinks in the system to make sure everything is recorded the way it’s supposed to. If you’re not at that point, you’re behind.”
Harrington said the implementation at Microsoft led to a bevy of activity at the very end to address disclosures. The standard contains a heavy load of disclosure requirements, and Harrington said she was aware of that and was prepared. Yet it was still “a ton of work” at the tail end of the project.
In addition to knowing what to disclose, the effort included the actual drafting of disclosures, drawing in the right information, assuring the right controls, observing appropriate messaging to the investor relations team, and anticipating analyst questions. “That was a significant amount of work that I wasn’t anticipating,” she said.
Harrington and Taub both called special attention to the “backlog” disclosure that is required under the new standard, where entities are required to explain the transaction price that is allocated to performance obligations under existing contracts with customers that will be recognized in future periods. “There are some nuances around how you think about returns, credits, and rebates that factor into the transaction price but might not be factored into backlog,” said Harrington.
Companies are accustomed to working on disclosures late in the process, so it would normally be late March or early April when companies would begin working on disclosures. “There’s a good chance if you wait until then you will find out you do not have the information you need to make that disclosure,” said Taub. Especially with respect to certain quantitative disclosures, companies need to act now to be sure they will have the data they need, he said. “Look at them now, and look at them in depth.”