Compensation arrangements are emerging as a big concern for companies as they implement the new revenue recognition standard.
Many companies have compensation plans for sales personnel, executives, or others that are tied to revenue metrics or trends. Companies that are working to implement the standard are encountering challenges with those kinds of compensation policies, Eric Knachel, CPA, a partner in the Professional Practice Group with Deloitte & Touche LLP, said in an interview.
FASB and the International Accounting Standards Board (IASB) issued the new, converged standard in May 2014 but delayed the effective date and have been working on clarifications to the standard. The effective date for public companies is annual reporting periods beginning after Dec. 15, 2017, for U.S. GAAP, and annual reporting periods beginning Jan. 1, 2018, for IFRS.
For some companies, the standard will change the timing of when revenue will be recognized and therefore may change the way compensation is awarded under existing arrangements.
“This has a direct dollar impact for the companies in terms of how much they are going to pay out,” Knachel said. “And, maybe more importantly, it has a direct impact on individuals, how much money the individuals at the company are going to get under these plans.”
‘Fire drill-type situation’
Existing compensation arrangements did not contemplate the new standard, he said. And the effects of the standard on compensation arrangements differ, depending on the industry and how the individual company structures its plan.
The new standard could result in earlier recognition of revenue, which could lead to higher commissions or bonuses—one reason companies may need to include human resources in their discussions as they implement the standard.
Companies that are discovering compensation concerns are likely far enough into their implementation to identify problems. Many companies have not gotten that far, Knachel said.
Some companies tend to view implementation as an issue for the future that doesn’t need to be addressed right away. Others lack the resources to devote to implementation and have competing priorities. Still others underestimate the effort required to implement the standard.
Often, companies don’t discover how challenging implementation will be until they start, Knachel said. That’s why he worries about companies that are late getting started. “Companies could find themselves in a fire drill-type situation with a lot of work to be done in a relatively short time frame, without the needed resources,” he said.
Building an implementation team
The first step in implementation is forming a team with representation from a broad range of functions, both at the corporate level and the business unit level, Knachel said. The finance and accounting function will take a leadership role. Other groups on the team could include:
- Human resources. The first issue for HR is making sure the organization possesses enough people and the appropriate training to handle implementation of the standard. HR also can address the standard’s effects on compensation.
- Information technology. Some companies are finding that their existing systems—with some add-ons—can handle the accounting changes. Others may need new systems. At any rate, accounting will need to cooperate with IT to accomplish the gathering and reporting of data, including disclosures, required by the new standard.
- Legal. A review of contractual obligations in the context of the standard almost certainly will be necessary. Contractual arrangements, particularly concerning items such as termination provisions, pricing, and enforceable obligations, may need to be reconsidered as a result of the accounting rules.
Sales personnel and those charged with establishing processes and internal controls also could play important roles on the implementation team. Once the team is in place, implementation may start with a technical assessment of the standard, said Knachel, who advises breaking it down into manageable components.
First, companies can take an inventory of their revenue streams, choosing sample contracts from each of them. Applying the guidance in the standard to those sample contracts, they can identify the accounting requirements, tension points, and open questions. “Once you’ve analyzed a particular revenue stream, not only can you evaluate and work through any technical issues, but then you can evaluate the impact on other aspects of the business,” Knachel said.
Considering a full retrospective
Many companies haven’t decided whether to make a full retrospective or modified retrospective transition to the new rules. But more companies are leaning toward the full retrospective method, Knachel said. The full retrospective method will give analysts more information and may not require significantly more work than the modified retrospective method, he said.
Companies that use the full retrospective method and file a registration statement with the SEC during the period of adoption could be required to restate an additional, fourth year under the new standard. “That’s a requirement that would not exist if a company had followed a modified retrospective method of adoption,” Knachel said. “We think it’s important for companies to consider that potential and the SEC rules as they consider their method of adoption. I think that’s a very significant point.”
The next three to nine months are expected to be a critical period for companies in terms of complying with the new standard, Knachel said. Because the implementation issues are complex, he said, it’s going to take much work and time for organizations to accomplish implementation.
It’s not just about accounting. It’s about examining contractual arrangements, IT systems, and even compensation policies, Knachel said. “It’s those broader implications that are not at the forefront of a company’s mind as they’re starting to implement the standard but rapidly become a very significant part of the exercise and maybe become even more of a focus point than the accounting initially.”
—Ken Tysiac (firstname.lastname@example.org) is a JofA editorial director.