Some of the major accounting firms and the American Institute of CPAs are planning to publish materials to help accountants and companies deal with the new revenue recognition standards.
Last week, the Financial Accounting Standards Board and the International Accounting Standards Board released the long-awaited converged standards (see FASB and IASB Release Revenue Recognition Standard and Accountants Start Preparing for Newly Released Revenue Recognition Standard).
Nancy Salisbury, a partner in the national accounting group at Ernst & Young who serves as the lead on the revenue team, pointed out that the new standards supersede the industry-specific standards that applied in the past.
“This is a comprehensive revenue recognition standard that has never existed before in U.S. GAAP,” she said. “U.S. GAAP is a hodgepodge of different pieces of guidance coming from a variety of different sources. For U.S. GAAP users, what this essentially means is that we’re going to throw out all the different pieces of literature that we have for U.S. GAAP in a couple of years. Everybody, no matter what industry you’re in, is going to follow this new single standard and that can be a big change.”
She noted that U.S. GAAP has traditionally contained many different pieces of industry-specific guidance for sectors such as software, cable, media and entertainment, and construction companies.
“Right now a lot of the guidance is really industry driven,” said Salisbury. “There are some general pieces, but there is a lot more that’s industry specific.”
With a single standard now across different industries, it could be a big change for some companies and a minimal change for others. “It really depends on what their starting point is and what their current revenue policies are,” said Salisbury.
“In some sectors it will go beyond looking at the back-end accounting,” said Aftab Jamil, a partner and leader of the Technology and Life Sciences Practice at BDO USA. “It will have an impact on how these companies do business and how to view certain things that they do, for example, how the pricings are getting done. There’s a new conceptual framework that this new standard offers, as opposed to tweaking the groups here and there. In some industries the impact will be a lot more impactful than perhaps the others. I deal with the technology companies most of the time, and some of those companies do expect a fair amount of change in how their practices are, both from an accounting standpoint as well as business operations.”
Steve Thompson, KPMG’s accounting change services lead partner for revenue recognition, believes one particular trouble spot could be the area of variable consideration. “In the past when you had an arrangement that had contingent consideration or some other variable component, the rules made it pretty easy to account for those because in most cases you don’t recognize the revenue until the amount becomes known, or it becomes fixed and determinable, and that made it easy,” he said. “Under the new standard, it’s much more focused on the principles behind what we are trying to accomplish, and therefore there’s much more estimation that will be involved. In some cases you will have to put that estimate through a filter to make sure it’s sufficiently predictive to allow you to actually go ahead and recognize that revenue. But in many cases companies will be recognizing revenue earlier, even though they don’t yet know how it’s going to turn out exactly, and even though the contingency hasn’t been resolved yet or some other variability hasn’t been determined yet. That will be a big mindset shift. Not only is it harder for the accountants because there is more judgment involved, but you’ve got to worry if you have the right controls in place around that, to make sure that you’re dealing with that appropriately.”
Because the standard doesn’t take effect until 2017 for public companies and 2018 for private companies, Ernst & Young is advising clients to evaluate what the potential effect of the new standard could be. Retailers that generally have simple point-of-sale transactions generally won’t be affected by the new standard since the issue of when they recognize is relatively straightforward. Conversely, software and telecom companies could need the full transition period to get ready.
“They may have to put in new systems,” said Salisbury. “They may have to put in new controls and processes in order to be ready to apply this, so they’re going to need a ramp-up time frame, which is why the boards provided such a long time. We are really telling our clients to figure out where you are first, determine how much change is going to be necessary, and that’s really going to drive the rest of your preparation. If they have a lot of change, they’re going to have to start now because the sooner the better. If they have less change, they may be able to wait a year or two before they start to dive in and figure out what they need to do differently because it would just be one-offs. It won’t be their whole process.”
Ernst & Young intends to issue guidance to inform clients about the standard in general, along with industry-specific guidance.
“Ernst & Young definitely does plan on putting out some guidance,” said Salisbury. “We’re also going to try to help them both from both a general perspective and an industry perspective. We plan on putting out guidance that will tell people about the standard just generally speaking, but then we also intend to put out industry-specific publications to help people identify, for example, if you’re coming from the software industry, here is where you’re most likely to see changes because here is the difference between the software literature and the new standard.”
She noted that the old guidance on revenue recognition for the software industry was written at a time when the standard-setters were trying to prevent abuse. “There are a lot of bright lines and explicit rules in software, whereas this new standard is much more principles based, and it’s going to require more judgments,” she said. “Entities will probably need to have to do more work around those kinds of things. They’re going to need the internal controls in place in order to make these estimates.”
Licensing will be a major issue in the software sector, with different companies realizing revenue from perpetual licenses and constant licenses, including in Software as a Service providers. “The SaaS companies always have to look into that,” said Jamil. “Beyond that with technology companies, hardware companies that sell their products through a distributor network may need to change and challenge some of the accounting that has been followed over a long period of time. In some sectors, for example, the sell-through model may no longer be applicable. A number of these hardware technology products are sold through a distributor network, so there is certainly going to be an impact on the timing of when the revenue can be recognized and how much can be recognized.”
Many of the major firms plan to monitor the work of the transition resource group that FASB and the IASB are setting up to help companies make the transition to the new revenue recognition standards in the next few years.
“During the next two and half years, we’re going to see a lot of activity because we’re going to see the official transition resource group of the FASB and the IASB, and then we’re also going to see the industry groups that the AICPA has started,” said Salisbury. “There are 16 of those. They’re also going to be looking at putting out some sort of industry-specific guidance to help them. Certainly as a firm we’re going to be updating the publications we’ve put out, both to help our clients and also our internal teams so they are prepared when they have to audit these standards.”
The AICPA is working with the major firms on crafting non-GAAP guidance.
“The AICPA has been collaborating with large firms—my firm as well—to have more industry-specific guidelines on how to interpret those rules,” said Jamil of BDO. “They may not be GAAP as such, but they will be a good resource.”
Jamil sees an important role for the large firms, especially in helping clients decide how to go about making the transition. “I think the major firms, including BDO, will play a constructive role in terms of sharing our insights and guidance with our clients,” he said. “While the implementation date is 2017 or 2018, depending upon which transition method these companies adopt, there at least three choices available. If you apply it on a full retrospective basis, then for the analysis that needs to be done in the period in which you are not officially reporting under this new GAAP, there will be a requirement for you to keep that analysis going, so when you do adopt it, if you are on a retrospective basis you can adjust your historical financials under the new guidance. From that standpoint there’s not a lot of time left for those companies to start putting in place the new controls, practices, policies and training of their internal staff, not only from the accounting side, but within the business operations side as well. How you go about doing business and how you negotiate your contracts are going to be critical in implementing the new standards as the new rule is very much based on what the contractual rights and obligations are, and when you have the disposition of those rights and obligations.”
Prospective and retrospective issues will play a large role in how companies adjust to the new standards.
“Beyond the accounting, what I think is the gotcha of this standard is that there is no prospective transition method,” said Thompson of KPMG. “Historically when new revenue standards have come out, companies had the option of adopting them prospectively, which means even though the accounting might change, it was not so difficult because they were only going to apply it to new contracts that are entered into after the effective date. So the old contracts would continue to be accounted for under the new rules even if they bled over into the new period. Under this new standard, the boards have decided that there will be no prospective transition option. So companies may have to follow a cumulative effect approach. In that case, they would go back and for any arrangements that remained open as of the effective date, they would have to go back to the beginning of the arrangement and recalculate what revenue would have been recognized up through that effective date. Then whatever the difference is between when it was actually recognized historically in the financial statements versus this new amount you calculate has to get flushed through retained earnings. So if you’re a company and you have two-year-long contracts, then on the effective date, you’re going to have to reach back up to two years in your history and recalculate for whatever arrangements are still open to see what revenue would have been for the new standard and then take that difference and flush it through retained earnings.
“Then there’s also a second transition method in addition to cumulative effect,” Thompson added. “There is a retrospective adoption, which has a similar effort that will be involved, because in that case you will actually restate your prior two years when you adopt a standard so that all years in your income statement are presented under the new rules. So under both of those methods, there is this constant need to look back into history, go back into your records, and recalculate what revenue would have been and figure out what to do with that difference.”
Like BDO, EY and other firms, KPMG plans to provide guidance to its clients on such issues.
“We will have guidance coming out,” said Thompson. “We had a very brief summary come out Wednesday when the standard was issued. We’re going to have a more in-depth document [this] week, and there will be additional interpretive guidance coming out over time.”
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