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 concluding episode, we consider what does it all mean.
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 2: What the logic of your transaction price?;
Part 3: Shaking up software revenue recognition;
Part 4: Auditors need to pay attention; and
Part 5: What does it all mean for compliance (and everyone else)?
As you might expect from the Compliance Evangelist, I see most issues through the lens of compliance practitioner. A key reason this is so important in the compliance area is because the internal controls over financial reporting involved in implementing this new standard are critical to effective implementation. The Securities and Exchange Commission (SEC) has said explicitly in several public statements, and through their early comment letters on disclosures made in advance of implementation, that companies must inform the SEC about the accounting policies that they are changing, and how this new standard will affect a company’s accounting processes, and finally how those effects are going to be managed. This makes it clear to me that this is a really a compliance issue.
Moreover, the SEC has indicated that these disclosures are central to the new revenue recognition standard. This is because if a company has some sort of failure in their disclosures for an accounting standard, they are treated under section Sarbanes-Oxley (SOX) Section 302 of the SEC rules, and that has a level of significance or liability, which is much lower than the liability that a company might face under SOX Section 404, which has to do with the actual internal controls over financial reporting. While disclosure of internal controls might not typically bring Section 404 scrutiny, under the new revenue recognition standard, they may now do so. Kelly stated, the SEC has made it “clear that it will be watching this first year of financial statements under the new standard closely.”
This new revenue recognition standards intertwines two concepts. This first is the convergence and overlap between the compliance profession, compliance programs and compliance practitioners with internal controls. While largely seen as financial in nature, compliance internal controls are in place to both detect and prevent. Now compliance internal controls can also be used to gather the information which will be presented to auditors under the new revenue recognition standard. Many professionals are focused on the new revenue recognition from the auditing and implementation perspective. However, if you are a Chief Compliance Officer (CCO), you might want to go down the hall and have a cup of coffee with your Chief Financial Officer (CFO) and find out what internal controls might be changing or that they might be adding and consider how that will impact compliance in your organization.
The second concept is the continued operationalization of compliance. During my tenure in compliance, you rarely heard a CCO consider revenue recognition as a compliance related issue. By going into detail, we have shown how this new revenue recognition standard can change the manner in which a company might recognize revenue, leading to a greater risk of the obfuscation of payments for bribery by corrupt employees. This means as a CCO you must not only be aware of the risk to manage it but you also must take active steps to mitigate against it.
Kelly believes this new revenue recognition standard means a lot of work for probably the next 12 months; particularly in the next six months or so, from the end of this year until about May or June 2018. This is when most large companies publish their first annual reports, under the new revenue recognition rule. It is difficult to say how many companies will go through all of this to find that actually their numbers will not change to any material amount. However, for many companies, they may not be able to quantify it but their internal mechanisms are going to get a lot more scrutiny. There will be pressure on the internal financial controls and processes to determine how a business is justifying what is being audited and reported to investors.
Kelly concluded by adding that, at the end of the day, “revenue recognition is a financial process. It is a financial issue. This standard really gets to how are you justifying the process of putting forth these numbers. It is about documenting your judgment. It is about making sure the processes you use are full and complete and sound. Who is the one who makes sure that people understand what the process is the process is well thought out and correct and sturdy.”
Matt and I are preparing a white paper based upon our writings on revenue recognition and this podcast series. It will be available through JDSupra when released.