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. The amendments become effective for public entities for annual reporting periods beginning after December 15, 2017. In other words, we are now less than six months away from a new Revenue Recognition (“new rev rec”) standard which may significantly impact the compliance profession, compliance programs and compliance practitioners going forward. Joe Howell, Executive Vice President (EVP) at Workiva Inc. spoke with me on some of the key changes and how it might impact compliance going forward.
FASB recognized that its revenue recognition requirements around U.S. generally accepted accounting principles (GAAP) differed from those in the International Financial Reporting Standards (IFRS) and that both sets of requirements needed improvement. This led to a project by FASB and the International Accounting Standards Board to jointly clarify the principles for recognizing revenue and to develop a common converged revenue standard for GAAP and IFRS. Hence the new rev rec standard.
The implementation will be a massive undertaking. According to Howell, “The accounting standard itself is 700 pages long and in the US accounting literature it replaces over 200 other pieces of accounting guidance on revenue.” The official name is “Revenue from Contracts with Customers” and Howell noted there are “lot of surprises, and the things that are true for almost everybody is that they are going to be facing some level of change in the way they account and report revenue. They will most certainly have to change the way they disclose things related to their revenue. There are, included in the revenue standards, over six pages worth of new disclosure requirements.”
One of the key differences in this new rev rec standard is that it requires companies to disclose new information beyond data a company might have been required to release in the past. Howell thinks this will put pressure on auditors “to get comfortable with what the company provided them and which they incorporated into their decision- making process in forming an opinion. For disclosure controls, this is something quite different, because the auditor’s typically not relying on those.” This will create risks for auditors adjusting to the new rev rec standard because as they learn more about the new standard and apply it going forward into 2018, they may have to revisit it prior reporting and revise some of it.
The reason this is important to the compliance profession and the compliance practitioner is internal controls over financial reporting involved in implementing this new standard are critical to the effective use of implementation and how you implement. 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. Howell believes “The SEC is making it perfectly clear that this is a real compliance issue.”
Moreover, the SEC has indicated that these disclosures are central to the new rev rec standard. Howell said, “typically, if a company has some sort of failure in their disclosures for an accounting standard, they’re 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 rev rec standard, they may now do so.
Howell articulated that usually when performing a financial audit, an auditor would not rely on a disclosure control in the past. However under the new rev rec standard, if there is a change during the year in how an auditor views a disclosure control, it could require them “to go back and either figure out if the audit work that they did is tainted and they need to go back and do that work in the form of a substantive testing, or they need to go back to see if there were mitigating controls that were in place that still allowed them to rely on the internal control processes to get comfortable with what the company provided them and which they incorporated into their decision making process in forming an opinion. For disclosure control this is something quite different, because the auditor’s typically not relying on those.”
Of course, this is overlaid on the requirements of effective internal controls under the Foreign Corrupt Practices Act (FCPA) and the lack of any materiality standard. One only need to consider the Wells Fargo fraudulent accounts scandal to see how a lack of materiality does not prevent the types of risk from moving forward to become huge public relations disasters, hundreds of millions of dollars in fines and costs estimated at over $1bn for failures of internal controls.
Yet there are other tie-ins into compliance which the compliance practitioner needs to understand and prepare for going forward. The prior rev rec standard was rules based. As a lawyer, that was an approach I was quite comfortable with both from a learning stand point and communicating to business folks. But now the standard is much more judgment based and when a standard is more judgment based, there can be more room for manipulation. Howell explained the response by compliance is “making sure that you have changes in the business processes necessary to gather the information that has not previously been required to continue to monitor; how that information is factoring into the judgements that managers must make as they report their revenue under the new standard; and that those judgements themselves are properly documented.”
This final point demonstrates the convergence and overlap between the compliance profession, compliance programs and compliance practitioners going forward. Compliance internal controls are in place to both detect and prevent. Now they can also be used to gather the information which will be presented to auditors under the new rev rec standard. Many professional are focused on the new rev rec 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.
Three Key Takeaways
- We are less than six months away from a new revenue recognition standard. Are you ready?
- This new revenue recognition standard is standard is much more judgment based and when a standard is more judgment based, there can be more room for manipulation.
- Compliance internal controls now can also be used to gather the information which will be presented to auditors under the new rev rec standard.
For more information on how to improve your internal controls management process, visit this month’s sponsor Workiva at workiva.com.