Revenue recognition: No time to wait

It took more than 11 years for FASB and the International Accounting Standards Board (IASB) to develop a converged standard for revenue recognition, which first appeared on the boards’ technical agendas in 2002.

At first glance, it seems as though the implementation date provides companies with plenty of time to get their systems ready for the changes associated with the standard, which was approved by both boards in December and was released May 28.

The standard will take effect for reporting periods beginning after Dec. 15, 2016, for U.S. public companies, or reporting periods beginning on or after Jan. 1, 2017, for companies that use IFRS. That is more than two years away.

But companies may need to consider what the standard means for them much sooner in order to choose the appropriate transition method. Under the full retrospective method, public entities would be required to restate two comparative years prior to the implementation date. Companies may choose to take advantage of numerous practical expedients, including one that permits them not to restate contracts that begin and end within the same annual reporting period for contracts completed before the date of initial application.

Under an alternative method, the new standard would be applied only to contracts that are not completed under legacy IFRS or U.S. GAAP at the date of initial application. Entities would recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of retained earnings in the year of initial application. Comparative years would not be restated, but some detailed additional disclosures would be required.

The full retrospective method may be more complicated, but some companies plan to use it to give investors a full understanding of trends, according to Dusty Stallings, CPA, a member of PwC’s national professional services group. And that’s where things could get tricky. Using the full retrospective approach could be difficult because it may require systems to be ready to capture data to perform dual reporting as early as the beginning of 2015, according to Stallings, a member of an AICPA working group devoted to helping companies implement the standard correctly. That could mean a substantial overhaul in business processes, accounting systems, or both—as well as employee training—in a short time frame.

Each transition option has pros and cons. But companies may want to at least consider both options, and they won’t be able to do that without a focused, thorough inquiry that would have to start very soon. In addition to choosing a transition method, experts say other important implementation steps could include:

Building a team and a plan. Companies need to put a structure in place to analyze the change and follow it through the implementation process, Stallings said. She said the personnel involved will depend heavily on the organization’s structure and size, but the effects on systems, processes, and controls mean that personnel from many functions could be involved.

These could include finance—where someone high up in the organization may need to be involved—sales, legal, and IT.

“The importance of linkage and coordination between finance and IT becomes, in many cases, kind of the central risk area on these projects,” Nicholas Difazio, CPA, a partner with Deloitte & Touche LLP, said during a recent webcast. “And the sooner attention can be brought to that, the better.”

Once the team is built, a timeline with responsibilities and accountabilities can help the transition occur smoothly.

Making sure you understand the standard. This may be particularly difficult for U.S. companies that are accustomed to prescriptive, industry-specific guidance.

Getting direction on how to do something new may not be easy, though. One resource could be the transition resource group that FASB and the IASB created to help with implementation questions. The AICPA is updating various industry audit and accounting guides to reflect the changes, and comparing notes with peers in industry groups also is a good idea, Stallings said. SEC Deputy Chief Accountant Dan Murdock said at the AICPA Conference on Current SEC and PCAOB Developments in December that discussing views in industry groups is a good place to start in implementation, but he cautioned against making judgments without appropriate input.

“These groups may identify areas where extra guidance may be good, and even make an effort at developing that guidance themselves,” Murdock said. “I do not think it would be advisable to arrive at conclusions without first talking to us or the standard setter, as an objective of the project is that similar transactions across industries should be accounted for similarly.”

Analyzing contracts and revenue streams. Companies are going to have to review their contracts and understand the effects the standard will have, Stallings said.

“Do you need to review every contract? Not necessarily,” she said. “But you need to review all [different] types of contracts. If you’re in a company where every contract is unique, you probably have a bit more of a challenge on your hands than if you’re at a company where there are a lot of very similar contracts that you typically enter into.”

Considering systems, training, and education implications. Any company that is performing systems upgrades for other reasons will want to take into account the implications of the new standard, Stallings said.

She said it’s a bit too early to predict, though, whether companies will need widespread systems changes or overhauls just to accommodate the new revenue recognition standard. She said the finance department and anyone associated with accounting and the financial statements should be trained on the changes the new standard brings.

Education should go upward, too, according to Stallings. She said board members should be kept up to date on the changes and their implications.

SMOOTH TRANSITION CRITICAL

The importance of the whole project should not be underestimated.

“This is a major accomplishment that will greatly change how people think about perhaps the most important item in financial statements,” FASB member Tom Linsmeier said after board members indicated that they would approve the final standard.

Getting it right—and choosing the best transition method—will require quick, focused attention for many companies.

Revenue Recognition: The New, Five-Step Process

1. Identify the contract with a customer.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.

INDUSTRY FOCUS: Telecommunications

Did Boards Miss the Call?

Changes in the way cellphone sales and contracts will be reported are one of the reasons telecommunications companies were among the most vocal commenters on the new revenue standard.

Wireless telecommunications companies often offer cellphone handsets at steep discounts in exchange for contracts to provide services for those handsets. Under the new standard, they will be recognizing more revenue when they provide the handset and less revenue when they are billing for services, according to AT&T Director of Accounting Bill Schneider, CPA, CGMA.

Here are some other effects Schneider said the new standard may have in telecommunications:

More non-GAAP disclosures. Investors are interested in cash flow and historically have used average revenue per user (ARPU) metrics to gauge expectations for future cash flows. Moving revenue to the handset transaction will result in an ARPU number that no longer represents cash flow. As a result, Schneider said, companies in the industry may provide additional non-GAAP metrics to describe the amount of cash per user they are collecting.

Deferring incremental acquisition costs and upfront direct costs to fulfill contracts. “You can no longer choose to recognize them upfront,” Schneider said. “That’s going to require, first of all, making sure you understand what all those costs are, and which ones should and should not be deferred under the standard. And there’s going to be a lot of judgment there, because there are an awful lot of costs, and are they part of obtaining or directly fulfilling the contract, or are they something else?”

Expensive new systems. Under current GAAP, many telecommunications billing and payment systems feed directly into the ledger systems, Schneider said. The new standard is likely to require a layer of accounting between those systems, he said. “In the volume we’re talking about in this business, you can’t do that with a quick spreadsheet manual adjustment that takes 15 minutes,” Schneider said. “It just doesn’t work that way. If the industry can’t find a way to make the portfolio approach workable, we are going to need to develop new systems that may be quite pricey.”

INDUSTRY FOCUS: Real Estate

New Judgments Introduced

The addition of judgment into the determination of when to record a sale is one of many significant changes the new revenue recognition standard will have in the real estate industry.

Current GAAP calls for a sale to be recorded when the title of the underlying asset transfers. Although transfer of title is an indicator under the new guidance, it is not a hard-and-fast rule.

“The new model doesn’t really get into any bright lines, but it really makes people take a step back and figure out whether or not there is a sale based on passing of control to the purchaser,” said Christopher Drula, CPA, vice president for financial standards of the National Association of Real Estate Investment Trusts (NAREIT).

Other significant developments in real estate accounting identified by Drula and NAREIT Senior Vice President for Financial Standards George Yungmann, CPA, include:

New benchmarks for recognition over time. “We think that the revenue under a long-term development contract would be probably accounted for over time based on the output methods, which could mean surveys of work performed, a bit like the percentage of completion today,” Yungmann said. “The criteria to recognize revenue over time really depend on the reimbursement for the costs incurred, plus reasonable profit. And those criteria are really built into a development or a construction contract.”

Disaggregation of performance obligations. This is an area of judgment where guidance and practice may evolve over time. Take embedded services, for example. Can they be accounted for as one performance obligation, or does the window washing get accounted for separately from the carpet cleaning? “I think getting out ahead of this and asking the questions now would be most beneficial to members of our industry,” Drula said.

Nonrecourse seller financing. Current GAAP calls for a certain down payment before the seller proceeds to the next step of accounting for the loan. The new model won’t have any such bright lines, so the seller will be left to figure out if the purchaser has enough “skin in the game” to recognize a contract, according to Drula. “I think that’s going to be an area of judgment that management will have to evaluate as they apply this new model,” he said.

INDUSTRY FOCUS: Software

Point in Time … or Over Time?

The guidance on licenses of intellectual property in the new revenue recognition standard could make reporting extremely tricky for software companies, according to Intel Accounting Policy Controller Liesl Nebel, CPA.

Under the new standard, licenses that provide access to intellectual property will be recognized over time, while licenses that provide a right to use intellectual property will receive upfront recognition at a point in time. The boards have provided criteria that have to be met to qualify for recognition over time, and directed the staff in the late stages of the project to draft improvements in the criteria for distinguishing between the two types of licenses. As a result, there has been uncertainty in this area during the final drafting stages.

“It is not clear how different companies and auditors will interpret these criteria and, therefore, if a company will have upfront or ratable recognition,” Nebel said. “For some companies and some license arrangements, I think it is obvious. For others, it is not as obvious and not an area that is clear to us, even though the boards have made a final decision.”

It is expected that Intel subsidiary McAfee, which provides anti-virus software, will recognize revenue on delivery for perpetual licenses and ratably over time for licenses sold as subscriptions for a set number of years, Nebel said.

“You have to step back and say, first, what are the performance obligations, and then you determine the appropriate pattern of recognition,” she said. “Again, this is subject to final interpretations of the rules upon adoption.”

It also is unclear how companies and firms will interpret the guidance on determining separate performance obligations while adopting the standard. Nebel said there has been speculation that items such as free telephone customer support and covering risk of loss during shipment could be considered performance obligations that need to be accounted for separately.
 

EXECUTIVE SUMMARY

Virtually all companies are expected to experience some level of change as a result of the new, converged financial reporting standard for revenue recognition, which was released May 28.

The vast array of industry-specific guidance in U.S. GAAP will be replaced with a more principles-based approach as a result of this standard. The rules will require a five-step process for revenue recognition based on the principle of control.

Companies will need to move quickly to address change management related to the standard, despite a seemingly distant effective date of reporting periods beginning after Dec. 15, 2016 (U.S. public companies), or reporting periods beginning on or after Jan. 1, 2017 (IFRS companies). Many companies may choose a full retrospective method of transition, which experts say is likely to require systems to be ready to capture data for dual reporting as early as the beginning of 2015.

The first step in the transition for many companies will be to build a cross-functional team for implementation. It may take significant effort for companies to understand what the standard means for their financial reporting, and companies may have to devote many resources to analyzing contracts and revenue streams. Systems changes and employee training also may be needed.

Ken Tysiac is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at ktysiac@aicpa.org or 919-402-2112.

AICPA RESOURCES

JofA articles

• “What Have IASB and FASB Convergence Efforts Achieved?” Feb. 2013, page 50
• “A New System for Recognizing Revenue,” Jan. 2012, page 30

CPE Self-Study

Understanding the New Revenue Recognition Standard (audio webcast)

Website

• AICPA revenue recognition page

• JofA revenue recognition page