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 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.
On our podcast, Compliance into the Weeds, Matt Kelly and I have put together a five-part podcast series where we explore implications of the new revenue recognition standard. Each podcast is short, 11-13 minutes, and deals with one topic from the new revenue recognition standard. It will go live at noon on each day this week. The schedule for this week is:
Monday, Part 1: Introduction
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 (IASB). 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.”
Tuesday, Part 2: What’s the logic of your transaction price?
In this episode, Matt and I discuss how to make a contract determination and then how to come up with a logical transaction price to base your revenue recognition on. In the grand scheme of this new revenue recognition standard, what FASB wants to achieve with this new rule is to bring more transparency to what is the logic of the economic action being reviewed. There is a five-step process for making this determination and judgments play a role at each step. This requirement will mandate many more internal company discussions to make the determination, including groups who have not traditionally been a part of such discussions. Lawyers and compliance practitioners will need to go far beyond simply the art of reading a spreadsheet to add value, they must be able to articulate the contractual obligations (written or oral), opine if they have changed from the pattern of a business practice and if the obligations have been completed or are ongoing.
Wednesday, Part 3: Shaking up software revenue recognition
In this episode, Matt and I take a deep dive into how the new revenue recognition standard will impact the software business. We consider how the new revenue recognition rule will ultimately allow some portion of the software sector, and possibly quite a lot of firms, to recognize more of their long-term contract revenue immediately. Yet, this brings about bigger strategic questions on how a software company might need to think about revenue patterns as such calculations may be much more volatile going forward. For investors, it also has serious implications around volatility, especially if you are trying to figure out what is the value of the company you are considering an investment in or purchase of going forward. It even has implications for business development representatives as it can impact the timing of bonuses based upon revenue recognition.
Thursday, Part 4: Auditors need to pay attention
In this episode, we focus on corporate disclosures, IFCR, audits and the Public Company Accounting Oversight Board (PCAOB). The PCAOB has made clear that audit firms are going to respond to this revenue recognition standard and everybody should be under no illusions. As we note throughout this series, there will be much more judgment by companies in making definitions or defining what the transactions and the values are for them. This means more documentation on the logic of the transaction price. Additionally, auditors have their own new inspection standards and they are required to pay more attention to judgment across the board. And now there is going to be more judgment in some of the most important revenue or financial lines that auditors look at in companies. Finally, auditors will be looking more closely at fraud risk because as there will be some circumstances where sales commissions could be higher because of the new revenue standard that would let some firms recognize more of a transaction more quickly.
Friday, Part 5: What does it all mean for compliance (and everyone else)?
In this final episode, we discuss what it means going forward. As you might expect from the Compliance Evangelist, I tend to see things through the prism of the compliance profession. This new revenue recognition standard intertwines two concepts. This first is the convergence and overlap between the compliance profession, compliance programs, compliance practitioners and 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.
Matt tends to see things through his journalist’s vision, with a bigger picture in front of him. He believes it is about coming up with the numbers, what goes into the calculation and how you can justify it going forward. A company is not losing or gaining money. However, when, and how, you recognize it will change. If your business falls into a category, where significant volatility will erupt, such as the software industry, you need to think through what the consequences of this change are for your organization.
I hope every compliance professional and many listeners beyond, will take in the entire podcast series. Our exploration of this topic drives home once again the broad base that a compliance practitioner needs, not only in their academic training, but in their professional experience.
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© Thomas R. Fox, 2017