The new standard on revenue recognition means plenty of new judgments to make, and judgments to disclose. It also means plenty of data companies will need to collect to put both of those chores into context for investors.
Exactly how the new standard will affect a company's collection of financial data isn't fully understood yet. Software vendors have been watching the new standard's development for years, but many have also waited until the final standard was here before investing in new products or features to meet its demands, says Tracy McBride, vice president of Financial Executives International. “Everyone was on standby, anxiously awaiting the release,” she says.
Here is what we do know so far: The new standard fundamentally changes how companies track business transactions and decide that, yes, a certain amount of revenue can now be recorded. That means significant new disclosure about how a company generates and books revenue, says Alex Wodka, a partner with Crowe Horwath. “Depending on the nature of the business, the disclosures could be extensive,” he says. “It will be a lot more than now required.”
New judgments about how a company arrives at revenue numbers will command new frameworks for how judgments are reached, not to mention new methods of capturing necessary data. The necessary overhaul to comply with the standard is potentially extensive for those companies that have the most work to do to adopt it.
The Financial Accounting Standards Board and the International Accounting Standards Board adopted a standard that represents a blank-sheet-of-paper approach to calculating revenue. It abolishes hundreds of historical pronouncements in U.S. GAAP and a smattering of guidance in international rules to provide a single, comparable, global method.
Historically GAAP tended to impose prescriptive, restrictive requirements on companies, meant to take a conservative view on when revenue was sure enough to report it in financial statements. When the new standard takes effect in 2017, such constraints will largely be gone, giving companies new latitude to use their own well-reasoned judgment about when to recognize revenue.
That's where the disclosures come in. Companies will be required to provide disclosures that allow users of financial statements to understand the nature, amount, timing, and uncertainty around revenue and cash flow. Current disclosures about revenue are more limited and lack cohesion, FASB says. Investors have told FASB they can't always comprehend, even with careful parsing of existing disclosure, what's happening with revenue.
The new disclosure requirements are meant to tell a story about how a company generates its revenue and how it makes judgments on that point along the way. “The ongoing disclosures will have to be fairly extensive about how you are recording revenue,” says Les Stone, managing director at Accenture. “The timing of it, the amount, how you are dealing with uncertainty of future revenues and cash flow, how you have allocated different costs to a bundled program—all of these things are going to have to be thought through.”
“Depending on the nature of the business, the disclosures could be extensive. It will be a lot more than now required.”
—Alex Wodka,
Partner,
Crowe Horwath
Companies will need to develop a framework for reaching the numerous judgments that the new standard requires, says Bryan Anderson, a partner with Deloitte & Touche. The new standard will require companies to identify individual performance obligations under their contracts and allocate the price across those obligations; then to recognize revenue as each obligation is met. Numerous judgments will be made along that road, and companies will have to be able to explain them to auditors and investors.
“This is pushing everyone to think through and make decisions,” Anderson says. “When it comes to judgment, you might have two views that are pretty convincing, so you're going to have to pick the one that makes the most sense for the fact pattern.” Companies will need a framework that guides that decision-making process, he says.
And Think Through Even More
As a result of those judgments and the implications for revenue recognition, some companies might even decide to revisit how they do business and revise their practices going forward, says James Comito, a shareholder with audit firm Mayer Hoffman McCann. “With the guidance that has built up over years, clearly the way results are reported has affected the way business is done,” he says. “The new standard really puts the economics at the heart of the accounting, so this is an opportunity to think about the business processes and whether they can change.”
From a systems perspective, companies will have diverse needs, and in some cases those needs will be extensive, says Chris Smith, a partner with PwC. “Everyone will have something specific they will need, and some of it will come from concepts in the new standard that we don't deal with extensively today,” he says.
REV-REC FRAUD RISKS
Below, CW's Tammy Whitehouse asks the experts why judgments under the new revenue recognition rule carry fraud risk.
If principles-based standards, with their room for judgment, can be a cause for heightened fraud risk, the new standard on revenue recognition must look positively terrifying to compliance officers.
“One might title this standard ‘Pick a Number, Any Number,'” wrote Lynn Turner, former chief accountant for the Securities and Exchange Commission, about the newly issued standard. In 700 pages of guidance—not only the rules themselves but also the conforming amendments, background, and basis for conclusions—the term “judgment” or some variation of it appears nearly 50 times. Its close cousin, the term “estimate” or some variation of it, appears more than 500 times.
The list of required or permitted judgments and estimates along with the disclosures necessary to explain them is daunting. In a complex business environment—where a contract with a customer includes multiple separate performance obligations, delivered at different intervals over time, under variable or various different pricing arrangements—the list of judgments and estimates to determine the proper timing and amounts of revenue recognition is extensive.
While revenue recognition is a common target for would-be fraudsters, and while Turner is known for his call-it-as-he-sees-it candor, not all accounting experts are prepared to say the new standard carries increased fraud risk. “There's always a risk of fraud,” says Doug Reynolds, a partner with Grant Thornton. “I can't say if there's more or less risk with this standard.”
Bryan Anderson, a partner with Deloitte & Touche, says companies can begin with their current fraud risk analysis and ad more scrutiny around where there will be new or increased judgments around revenue. “The rules and bright lines from U.S. GAAP have been removed, but I don't think that should in and of itself create massive amounts of new fraud risk.”
Tracy McBride, vice president at Financial Executives International, says companies will need to turn to their internal controls. “Senior executives will have to be really diligent in setting policies on how those judgments will be made,” she says. “So long as you set policies that everyone will be held accountable to and you have documentation, as with any standard, that will definitely negate any additional risk.”
With the standard taking effect in 2017, Reynolds says companies have a long runway to adopt strong controls. “I would suggest companies avail themselves of the time and bake in appropriate safeguards,” he says. “They've got time to go back and look at every little thing.”
Alex Wodka, a partner with Crowe Horwath, says companies should be equally or even more concerned about the variability of interpretation that is inherent with areas where judgment is involved. “That will create challenges both in interpreting and for auditors in ascertaining whether the accounting is consistent with the standard,” he says.
Experts say companies will be wise to involve their auditors early in the process to assure they buy in to the judgment framework and controls put in place to mitigate risks of fraud or any other cause for mis-statement. Lorraine Malonza, a director with FEI, says companies can certainly anticipate thorough audits in their first year of adopting the new standard. “There's always extra rigor in that first year,” she says.
—Tammy Whitehouse
The time value of money, for example, features more prominently in the new revenue standard than in existing GAAP, Smith says. Companies likely will pursue a wide variety of system changes depending on their need: new releases of existing software, leveraging an enterprise resource planning system, bolt-on solutions, and various types of customization. “For more complex companies and business models, there isn't going to be a single out-of-the-box solution that will work,” he says.
Heaped on top, Smith says, is the pace of change in the technology sector and in business environments generally. Companies will spend the next few years adapting to the new standard while technology and business environments around them will continue to change and evolve. “Is there a silver bullet solution that we're aware of?” he asks. “No, there isn't.”
Tom Zauli, vice president at technology provider Softrax, says he's seen a “massive uptick in concern” since FASB issued the final standard in May, but nobody could do much substantive planning before that final language was published. “Companies out there are now thinking about it, but don't necessarily have an idea yet of what they need,” he says.
Anderson says companies need to complete their accounting analysis soon so they can begin to plan for their IT needs. “There are so many deviations that exist,” he says. “It's hard to say if you're on SAP or Oracle, if you're big or small, a simple or complex organization, if you're already going through a technology upgrade. There are a ton of questions.”
As the new standard brings an overhaul to how the accounting is done, companies do have an opportunity to rethink their financial systems from the ground up, Zauli says. “You have a heavy percentage of companies that are still doing a lot of their revenue recognition on spreadsheets with data in multiple systems,” he says. “The critical factor now is the systemization of data.”
Virtually all accounting experts are warning companies to decide how they will adopt the standard soon: either retrospectively, presenting three years of data when the standard takes effect in 2017; or cumulatively, providing disclosures to help explain differences. In Zuali's view, those looking for a retrospective approach in particular will need to be in position with the opening of the 2015 year—meaning service providers will soon be overrun with demands.
“If companies want to be able to gather data under the new guidance, six months is not enough time,” Zauli says. “A lot of implementations can take six months. You're not going to have enough people or solution providers out there.”
Companies that are planning a cumulative approach will have more time, but making that determination is time sensitive, he says. “The big thing is to start taking action now. If you wait, it will quickly be too late.”
No comments yet