Seven revenue recognition considerations

The prospect of preparing for a historic, game-changing revenue recognition standard at a huge, global public company is a bit daunting for GE Technical Controller Russell Hodge, CPA.

“I’ll admit to it being a little bit overwhelming to us,” Hodge said. “We have $150 billion of revenue and so many diverse, different business models. It’s a tough question. It’s a tough thing to think about.”

The new, converged revenue recognition standard that’s in the final stages of development by FASB and the International Accounting Standards Board is expected to lead to at least some changes in financial reporting for virtually all entities that use U.S. GAAP or IFRS.

When this issue of the JofA went to press, the boards were scheduled to release the standard in the first quarter of 2014. In December, Hodge and other panelists at the AICPA Conference on Current SEC and PCAOB Developments described in detail some of the changes companies may face in moving from the industry-specific guidance in U.S. GAAP to one principles-based standard.

Christopher Bolash, CPA, a partner in EY’s Financial Accounting Advisory Services practice, encouraged CPAs to start thinking about the standard even before it is issued. He urged companies to build a project team and a plan, and to take inventory of major revenue streams so they will be ready to begin implementation when the final standard is issued.

Here are some of the changes the panelists said companies may need to wrestle with under the new standard:

1. Updated Criteria for Contract Determination

For a contract to exist under the new guidance, Bolash explained, an arrangement must have:

• Commercial substance, which means changes in cash flows would be expected as a result of the arrangement.
• Approval and commitment to perform obligations from both parties.
• Identification of rights and responsibilities—and payment terms—by both parties.

This is a bit different from the “persuasive evidence of arrangement” criteria some companies use in U.S. GAAP today, Bolash said. Companies will need to examine whether their arrangements meet the new criteria to be considered a contract. They may need to change their accounting policies if previously they relied only on the persuasive evidence of arrangement to determine whether a contract existed.

2. New Depictions of Contract Modifications

The standard will include a new framework for reporting on contract modifications that could cause challenges and be a huge undertaking for some companies. Companies that retrospectively adopt the new standard will need to consider past contract modifications in determining contract balances.

GE has many 15- and 20-year contracts that have changed over the years, and that could lead to implementation difficulties, Hodge said.

“That’s going to be a huge change,” he said. “Having to go back and retrospectively restate those, thinking about all the modifications that have occurred in those contracts over the last 15 or 20 years, is overwhelming to think about.”

3. Identifying Different Performance Obligations

Companies that have followed long-term contract accounting under AICPA Statement of Position 81-1 typically think of the contract as the unit of account, Bolash said. But the new guidance may cause companies to find components of a contract that they would identify separately and think about differently, perhaps with a new recognition pattern for those components.

“We believe at Microsoft that we’ll be pulling forward a lot of revenue because we’re going to be separating our performance obligations, the license separated from the upgrades—when available—or other services,” said Stacy Harrington, Microsoft director of corporate revenue assurance.

4. Judgment in Selling Price Estimate

A lot of judgment will be involved in the estimation of the selling price, Hodge said. He said it will be important for management to establish and maintain sound policies, adjusting where necessary. Documenting the judgments also will be important.

Harrington said companies will have to build out an infrastructure to support their estimates. Identifying key credits such as rebates, price protections, and returns—and booking the reserves for them—will be important, Harrington said.

“I think this is going to be a change for a lot of companies because they can estimate,” Harrington said. “… They have the history of the refunds and returns, etc., so they are going to have to recognize revenue as a sell-in model.”

5. New Depiction of Transfer Over Time

Many companies—particularly in the aerospace and defense industry—use percentage of completion in a “units-of-delivery” method under U.S. GAAP to depict transfer of goods or services over time to a customer, Bolash said.

Under the new guidance, Bolash said, shifting to a “cost-to-cost” approach may provide a more accurate depiction of the transfer of goods over time. The cost-to-cost method presents the ratio of costs already incurred compared with the expected total cost of completing a project. But that might lead to operational challenges.

“Some companies like to use the output measures because you can objectively identify it, and it drives the right operational behavior, right?” Hodge said. “You get the unit done and out the door, and that’s your milestone. I think that’s going to create some challenges for [some] companies.”

6. Change in Performance Incentives

A switch from “units of delivery” to “cost-to-cost” may create a need for different performance incentives for operations, Bolash said.

That’s one of a handful of areas where it may be important to make sure employee incentives are changed, if necessary, to reward behavior that benefits the company under the new revenue standard, panelists said.

For instance, a company that is newly recognizing revenue upon sales to a reseller would want to make sure that commission policies do not incentivize the sales force to engage in channel stuffing, Harrington said.

“If the nature of your revenue recognition is changing, maybe you need to revisit your commission structures,” Bolash said. “And there are all kinds of different approaches in terms of a commission on booking, a commission on collecting cash, or revenue recognition.”

7. New Disclosures

Even companies that do not anticipate recognition or measurement differences are likely to have significant changes in the disclosures they need to make under the new standard, Bolash said.

Disclosures will include disaggregation of reported revenue, narrative explanations of changes in balances, and information about performance obligations, according to the panelists. Significant judgments will need to be explained, particularly those regarding the timing of satisfaction of performance obligations, and the determination of transaction price and allocation to performance obligations, the panelists said.

“Start thinking about, what are those disclosure requirements?” Bolash said. “Take an inventory of those disclosure requirements. Do you have the systems and processes in place today to capture that information? Otherwise, start thinking about what you need to do to build that out.”

Taken as a whole, Hodge said, the changes and implementation are going to require a lot of resources for some companies. The effort will require the attention of many functions across the organization, and the implementation landscape will develop over time as companies get answers to pressing questions from the boards’ transition resource group, he said.

“It’s going to be a significant implementation effort,” Hodge said. “Even if you look at it and you don’t expect there to be a significant financial statement impact … it’s still a huge undertaking because you’re looking at all of your contracts through a new lens.”

EXECUTIVE SUMMARY

Many companies will see changes in their financial reporting as a result of the converged revenue recognition standard under preparation by FASB and the International Accounting Standards Board.

Building a project team and a plan is an important early step in implementation of the standard. Companies also may want to take inventory of major revenue streams as they begin implementation.

Updated criteria for contract determination and new disclosure requirements are some of the changes companies may wrestle with as they implement the standard.

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, page50
• “A New System for Recognizing Revenue,” Jan. 2012, page 30

Websites

• JofA Revenue Recognition page
• AICPA Financial Reporting Center