As discussed in this PubCo post, the SEC’s Office of the Chief Accountant has continued to beat the drums to encourage companies and their audit committees to hunker down and address the impending effectiveness in 2018 of the new revenue recognition standard, particularly with respect to assessment and implementation of the new standard and transition disclosures necessary to help investors assess the impact of the new standard. For some companies, the undertaking can be enormously challenging, which may explain why the SEC’s encouragement appears to be necessary. A 2016 PwC survey showed that 22% of respondents had not even started the assessment, 65% were in the assessment phase and only 13% were in the implementation phase. And for those in the assessment phase, 59% were not that far along — barely halfway or less. With regard to disclosures, according to the WSJ, only 15 companies in the S&P 100 have included transition disclosures in their most recent quarterly reports.
As former SEC Chief Accountant James Schnurr has previously observed, audit committees will play a key oversight role in implementation of the new standard, including understanding the planned transition method (full or modified retrospective) and anticipated disclosures. (See this PubCo post.) The new revenue recognition standard will require companies to develop detailed implementation plans, and Schnurr has advised audit committees to review and critically evaluate management’s implementation plan.
To assist audit committees in their oversight efforts, the Center for Audit Quality has just released a new publication, Preparing for the New Revenue Recognition Standard, a tool for audit committees. The publication is organized in four parts and provides important and sometimes quite specific and detailed questions for audit committees to ask management. The first section, Understanding the New Revenue Recognition Standard — What Is It?, is designed to help audit committees understand the new standard by providing a brief overview of its core principles. Generally, the new standard provides a five-step model for recognition of revenue “when the customer can use or benefit from the good(s) or service(s) provided.” The CAQ suggests that audit committee members ask management to explain the standard and how it affects (or does not affect) the company and encourages members to oversee the company’s decision regarding the appropriate transition method and consider the market impact.
SideBar: As the WSJ observes, the “new rules replace industry-specific practices with a unified five-step method to make revenue booking for similar transactions more comparable. It also is an effort to more accurately depict the timing, uncertainty and volatility of doing business.” The five steps required to apply the new standard are:
1. Identify the contract(s) 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.
5. Recognize the revenue when (or as) the entity satisfies a performance obligation.
In the second section, Evaluating the Company’s Impact Assessment — How Will Revenue Recognition Change?, the CAQ provides specific questions and general advice to help the audit committee discuss with management the impact of the new standard in light of the nature of the company’s business. Among other things, members will need to understand how the impact was assessed, who was involved in the assessment and how the outside auditor viewed the assessment, as well as specific aspects of the business that could affect the impact. For example, in a presentation to the 12th Annual Life Sciences Accounting and Reporting Congress, Schnurr singled out three areas — R&D arrangements, variable pricing terms (such as milestones) and rights of return — that are significant for life sciences companies. (See this PubCo post.) Similarly, the CAQ suggests that audit committee members ask management this question about the impact of the new standard on various revenue streams:
“3. What is the impact of the standard on the company’s revenue streams and related activities? Impacted revenue may include:
○ Simple point-of-sale transactions
○ Multiple goods or services as part of a sale (bundled goods or services)
○ Reward or loyalty programs
○ Vendor incentive programs or penalties
○ Rebate programs, return or refund provisions
○ Contingencies, warranties, or guarantees
○ Licenses or royalty agreements
○ Contracts that change throughout the term
○ Long-term (more than one year) contracts
○ Non-interest fees or other non-interest income
○ Long-term construction contracts
○ Variable or contingent consideration
○ Collaborative agreements”
The third section, Evaluating the Implementation Project Plan — How Do We Need to Prepare?, is designed to assist audit committees in understanding and evaluating management’s implementation project plan. Among the subjects that the CAQ recommends members ask management are plan milestones, progress reports to the committee, the views on the plan of the outside auditor and other third-party advisors, the experience level of the team, accounting judgments, adequacy of resources, systems and controls and tone at the top.
SideBar: In past remarks, Schnurr has suggested that, in reviewing the changes to be implemented, audit committee members should “ask management to identify and explain why the changes are occurring or in some cases why changes are not occurring. In particular, I would suggest that you inquire whether there are differing views within the industry on how to implement the new standard and if so how have management and the auditor concluded that the company’s approach was appropriate. I also suggest you challenge the auditors on conclusions that do not appear to reflect the core business of the company.”
The fourth section, Other Implementation Considerations — What Else Do We Need to Consider?, assists audit committees in overseeing various other considerations, such as transition decisions and new disclosure requirements, as well as key policy decisions to make in advance of adopting the new standard.