Board Matters Quarterly, January 2014

Convergence projects on revenue, leases and insurance

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Revenue recognition standard

The FASB and the IASB (collectively, the Boards) addressed several outstanding issues on their joint revenue recognition standard that were identified in the drafting of a final standard. They plan to issue this final standard in the first quarter of 2014.

In October, the Boards reached tentative decisions on the proposed constraint on estimates of variable consideration and how assessments of a customer’s credit risk should be reflected in the accounting for contracts with customers. The Boards also decided to have their staffs draft clarifications for determining when revenue from a license of intellectual property would be recognized at a point in time and when license revenue would be recognized over time.

The new guidance will be effective in 2017 for public companies.

The Boards tentatively decided to allow either full retrospective application (i.e., all periods presented would be restated to follow the new guidance) or a modified retrospective approach for both public and nonpublic companies.

Under the modified approach, entities would:

  • Present comparative periods under today’s guidance
  • Apply the standard to new and existing contracts as of the effective date
  • Recognize a cumulative catch-up adjustment to the opening balance of retained earnings at the effective date for existing contracts that still require performance by the entity
  • Disclose all line items in the year of adoption as if they were prepared under today’s revenue guidance

The new standard may significantly increase the volume of required disclosures that companies applying US GAAP will have to include in both their annual and interim financial statements. During the transition period, entities will need to determine that their systems can properly capture the data needed to comply with these requirements.

In addition, companies will have to evaluate their revenue arrangements to determine any significant differences in the timing of revenue recognition. Even if there are no significant differences to reported revenue, companies will need to understand the new judgments and estimates that may be required, as well as any related changes in systems or controls.

The Boards plan to redeliberate many key aspects of their May 2013 exposure draft in which they proposed a right-of-use model for leases that would require lessees to recognize most leases on their balance sheets.

Leases on the balance sheet

The Boards plan to redeliberate many key aspects of their May 2013 exposure draft in which they proposed a right-of-use model for leases that would require lessees to recognize most leases on their balance sheets. The plan was developed based on feedback the Boards received in more than 600 comment letters and in roundtable discussions.

While constituents generally support the goal of reporting leases on the balance sheet, many of them expressed concerns about the cost and complexity of the proposal and questioned whether such presentation would significantly improve the decision-useful information available to investors.

Effects of the FASB insurance proposal

The FASB has proposed a new accounting model that would apply to all contracts that meet the definition of an insurance contract, not just those contracts issued by insurance entities. Entities that issue certain financial guarantees, performance bonds, warranties and indemnities would have to follow the guidance in accounting for those contracts.

Many noninsurance companies that issue contracts that would fall into the proposed scope said in comment letters that they don’t believe the guidance should apply to them. In their view, requiring them to follow the guidance would be costly. It would make their accounting more complex and confuse investors.

The proposal is aimed at giving users of the financial statements better information about an entity’s insurance liabilities and promoting comparability by treating arrangements with attributes, risk transfer and cash flows similar to those of insurance contracts as insurance contracts.

Entities would have to consider various outcomes to measure the expected cash flows for obligations resulting from contracts in the scope of the proposal on a discounted basis for each reporting period. Revenue would be recognized as coverage is provided. Claims expense would be recognized when incurred.

The FASB and the IASB issued separate insurance proposals after deliberating jointly and disagreeing on certain key issues.

Questions for the audit committee to consider

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Questions for the audit committee to consider

  • Have management and the audit committee discussed which transition alternative the company will select with respect to the new revenue recognition standard and why?
  • Does the company have all of the lease data necessary to comply with the Boards’ proposal?
  • Has the company performed a preliminary assessment of the effects of these proposals on its financial statements, processes and internal controls and presented the assessment to the audit committee?
  • Has management determined what planned or ongoing IT system initiatives could be affected by these accounting changes?