In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) for public business entities, certain not-for-profit entities, and certain employee benefit plans. It becomes effective for public entities for annual reporting periods beginning after December 15, 2017. In addition to changing things dramatically in the accounting and financial realms, this new revenue recognition standard which may significantly impact the compliance profession, compliance programs and compliance practitioners going forward. In this episode, we provide an introduction to the new revenue recognition standard.
Matt Kelly and I have put together a five-part podcast series where we explore implications of this new revenue recognition standard. Each podcast is short, 11-13 minutes and deals with one topic on the new revenue recognition standard. The schedule for this week is:
Part 1: Introduction
Part 2: What the logic of your transaction price?
Part 3: Shaking up software revenue recognition.
Part 4: Auditors need to pay attention.
Part 5: What does it all mean for compliance (and everyone else)?
This standard has been a long time in coming but the go live date is here; it becomes effective on December 15, 2017. This means the financial reports your company will submit which will come out sometime in February or March will be under the new revenue recognition standard. Kelly noted that “upwards of 80 percent of filers in the United States have a year end of December 31 as their fiscal year end. For most companies, this new revenue recognition standard is here you are going to have to start worrying about it now. You are going to have to start reporting under the new standard early in the spring.” While some companies, such as Google, General Motors and Microsoft adopted the standard early, most will be doing so on the fly in Q1 2018.
The prior revenue recognition standard was rules-based, while this new revenue recognition standard is principles-based. This was done deliberately as FASB is coordinating this rollout with how revenue is recognized in other parts of the world, specifically International Financial Reporting Standards (IFRS) which are put forth by the International Accounting Standards Board. This was a joint effort to have a one global approach to how companies recognize revenue and the process involves a lot more judgment. Kelly noted, “The good news is that you can exercise a lot more judgment and if you have good judgment you can finesse things to be much more reflective of what's the economics of the deal.”
The new revenue recognition standard is really about a series of performance obligations; what a company is committing to do in delivering a good, delivering a service, or both. Next, has a company fulfilled those performance obligations. Finally, is do these actions give that obligation to a company beyond the contract language? Kelly said, “It's a sweeping standard. The philosophy of when you have a transaction and when you do not, has changed. Different types of industries will be hit by this quite a bit by this new revenue recognition standard but others will not.”
Kelly said this use of more judgment, than rules cuts, both ways. “If your judgment is not sound or if your judgment could be called into question because you have not properly documented your logic and your chain of thought, your organization is opened itself to questioning your judgment much more than might have happened under the old standard. This means a key will be the logic in determining the transaction price.” In addition to the process aspect, there is the document, document, document process which should warm the heart of every compliance practitioner. As the prior revenue recognition standard was rules based, “you went through all the contortions you come to a number that's the number.” Now, as Kelly noted, “it's down to this is our judgment and if our judgment is good and we can document it.”
Kelly also noted the Securities and Exchange Commission (SEC) has gone to great lengths over the past two years at least about this new revenue recognition standard, giving what he termed “gentle nudges and sometimes not gentle nudges to companies that you've got to get on board with this new revenue recognition standard.” The good thing is that while the SEC may well provide a few comment letters, as companies are reporting under the new revenue recognition standards, they will probably not sanction companies for reporting errors for some period of time. Kelly believes, “as long as you are actually trying to embrace the spirit of the new revenue recognition standard” the SEC will not sanction your organization. However, if an organization is “committing accounting fraud you are still going to get nailed.”
Kelly concluding by raising the very interesting question of whether the investor community is ready for this new revenue recognition standard. This may be truer for private equity companies investing in the tech space are the rules around revenue recognition for software companies could be more greatly impacted than other organizations. (We will take up the new revenue recognition standards for software companies in Part 3.) The bottom line is that a wide variety of interests, in a multitude of organizations will be impacted by this new revenue recognition standard; including the compliance profession.
I hope you will join us for our exploration this week. Tomorrow we will ask, and hopefully answer, the question: What is the logic of your transaction price?