Board Matters Quarterly, June 2014

FASB and IASB issue new revenue standard

Planning for the transition

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The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) recently issued a long-awaited standard that will replace virtually all revenue recognition guidance in US GAAP and IFRS. Now is the time to begin planning for a smooth transition to the new model.

The new standard will supersede nearly all industry-specific and transaction-specific standards and interpretive guidance. Most companies will be affected in some manner. The new standard is effective for calendar year-end public entities for the first time in the first quarter of 2017, but companies may need to start tracking revenue under the new standard as early as 2015.

Companies should begin preparing now because the standard will likely affect their financial statements, business processes and personnel, and internal control over financial reporting. While some companies will be able to implement the new standard with minimal effort, others may find implementation to be a significant undertaking.

Companies with more work in front of them will need to move at a faster pace and may need to consider adding resources. An early assessment is key to managing implementation. Companies should begin taking a measured and thoughtful approach in preparing for adoption now because this may help keep costs down and ensure a successful implementation.

Overview of the new standard

The standard’s core principle is that a company will recognize revenue when it transfers goods or services to customers at an amount that reflects the consideration to which the company expects to be entitled to in exchange for those goods or services. In doing so, companies will need to make more estimates and use more judgment than under current US GAAP. These judgments may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.

With over two years until the effective date, it may appear that companies have ample time to prepare. However, the potential changes to revenue recognition and related policies, procedures and business practices for some companies may be significant, so it is important for companies to get started immediately. Here’s what boards need to be aware of as companies begin to implement the standard.

Transition method and disclosures

The new standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented, or “modified retrospective” adoption, under which the standard is applied only to the most current period presented in the financial statements.

A decision about which method to use will affect a company’s implementation plans.

Once they choose a transition method, public business entities will need to disclose it in registration statements and reports they file with the SEC. In addition, SEC Staff Accounting Bulletin (SAB) Topic 11.M requires companies to disclose in management’s discussion and analysis (MD&A) and the financial statements the potential effects of recently issued accounting standards, to the extent those effects are known. Calendar year-end public business entities will have to provide these disclosures for the quarter ending 30 June 2014.

The new standard also requires significantly more interim and annual disclosures. Companies should carefully consider whether they have the information needed to satisfy the new requirements or whether new processes and controls must be implemented to gather the information and ensure its accuracy.

Implementation considerations

The new standard will likely affect the measurement, recognition and disclosure of revenue, frequently an entity’s most important financial performance indicator, for all entities. Gaining an understanding of the effects of the new standard, providing early communication to stakeholders and planning ahead are crucial for a successful implementation.

Even those entities that do not expect significant changes in measurement and timing of revenue will need to validate that assumption, as well as identify any necessary changes to policies, procedures, internal controls and systems to ensure that revenue transactions are appropriately evaluated through the lens of the new model in future periods. In addition, entities have to plan for the significantly expanded disclosure requirements.

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Questions for the board to consider

  • Has the company developed an implementation plan?
    • Who will lead the implementation effort? Who will be an executive sponsor?
    • Will the effort be centralized or decentralized?
    • What functions (e.g., Accounting, FP&A, Sales, Legal, IT, Tax) will be represented on the project team?

    Consider developing a detailed project plan to coordinate the timing and effort across multiple business units and geographies. A cross-functional implementation effort with strong support from the C-suite will be essential to address the diverse implementation challenges that many companies will face.

  • How many different revenue streams does the company have?
    • Which streams are signigicant?
    • Are the transactions within the significant revenue streams structured similarly?
    • Do revenue streams involve long-term contracts?
    • Do revenue streams involve multiple goods and services in the same arrangement?

    Because the new standard will affect different revenue streams in various ways, it is important to begin the analysis by identifying significant revenue streams. If transactions within those revenue streams are not uniform, you may need to perform the analysis at a lower level. The accounting for some long-term contracts and multipleelement arrangements will change under the new model, due to new guidance on measuring performance over time and identifying separate performance obligations.

  • Which performance metrics will be affected?
    • What other metrics are tied to revenue? Is your company considering changing compensation packages or other areas of your business that are tied to revenue?
    • Will changes in revenue affect any contractual covenants of the business?

    Some affected metrics would include gross margin, net income, EBITDA, earnings per share and operating cash flow. Once you understand the effects on your signigicant revenue streams, you should examine any compensation programs tied to revenue (e.g., sales commissions, bonus programs) to determine whether any changes are appropriate, including effects on contracts in progress at the transition date.

  • Do systems have the ability to capture or aggregate the following information to support disclosures that may not have been previously required?
    • Disaggregated revenue information
    • Value of remaining performance obligations
    • Allocation of transaction price to performance obligations
    • Measurement of revenue using input methods for performance obligations satisfied over time

    Additional data will be needed to comply with the expanded revenue disclosure requirements, which may call for significant modifications to existing internal data-gathering efforts and processes. Companies with decentralized operations will be especially affected because they need to accumulate information from multiple locations.