Four years ago, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). Shortly after the initial standard was issued, the Transition Resource Group for Revenue Recognition (“TRG”), comprised of members of the FASB and the International Accounting Standards Board (“IASB”), began meeting to analyze and discuss stakeholder issues arising from implementation of the new guidance. The group also served to inform the FASB and IASB as to whether any action should be taken to address those issues and begin to formulate how they should be handled.
Low Early Adoption
Largely as a result, just over a year after the initial standard was issued, the initial effective date was deferred by a year. Throughout 2016, the FASB also issued various amendments to the initial standard, which both clarified certain identified implementation issues as well as provided relief from some aspects of initial requirements of the standard. Further complicating the matter, calendar year-end public business entities are required to adopt the standard in interim and annual periods beginning in 2018, a full year before private companies are required to adopt the standard in annual financial statements.
For all of these reasons, and more, it is easy to understand why private companies may have seen little benefit to tackling implementation efforts related to the new standard in their own companies early. Private companies expected that more clarity would continue to be borne out of efforts like those undertaken by the TRG, by public company early adopters, and even by public company adopters at the required transition date, and, as such, hesitated to undertake significant implementation efforts. Many private companies intentionally operate under a lean and mean organizational infrastructure in which spare resources to undertake daunting, technically complex accounting projects are not readily available. Leadership ranks of private companies often also believe that the majority of public company adopters and private entity early adopters within their peer groups determined that implementation did not have a material impact to their overall financial reporting. This theory, however, is largely debunked by statistics reported from the initial public company adoption date impacts, as cited recently by The Wall Street Journal
. Even when accounting impacts are not significant, what is often not apparent, are the significant resources expended on analysis to determine the impact (even if immaterial).
Various surveys of companies reporting U.S. GAAP financial statements continue to indicate that the overwhelming majority of private companies still have not undertaken significant efforts to implement the new standard. With calendar year-end public companies adopting the standard in their first-quarter 10-Qs in 2018, and the beginning of year effective date for calendar year-end private companies right around the corner, private companies should begin implementation efforts now. Companies that assess the impacts earlier will experience significant advantages over those that continue to delay the inevitable.
Benefits to Assessing the Impact Now
Some of these advantages include:
Flexibility in selection of adoption method.
The new standard allows companies to elect their transition method from two available options:
1) a full retrospective application in which all periods are presented as if the new standard were effective as of the beginning of the earliest period presented or
2) a modified retrospective method in which prior periods presented are not restated; however, disclosures that assist financial statement users with comparability are required.
The available transition methods may provide distinct advantages and disadvantages depending on the impacts that application of the standard has on any particular company’s financial statements and the company’s plans and anticipated needs (e.g., potential acquisition of the company by a public company or anticipated financing rounds requiring trend analysis). Companies that undertake implementation efforts early will generally have more flexibility in choosing the transition method that best fits their individual circumstances.
While the vast majority of public filers have utilized the modified retrospective transition method, that fact is not necessarily an indicator that the method is best in individual circumstances. Many public companies likely selected the modified retrospective method simply because it was easier to complete transition in a short time frame. Several large public filers initially disclosed that their companies would adopt utilizing a full retrospective transition method only to later change to a modified retrospective method. Companies that want to let strategic objectives drive their transition method rather than simply easing transition efforts will likely benefit from undertaking assessment efforts sooner rather than later.
The last time an accounting rules change had as pervasive an impact on companies and their accounting infrastructure was the passage of the Sarbanes Oxley Act of 2002 (“SOX”). For those in the industry who experienced the significant efforts that public companies undertook in order to meet SOX requirements, it is easy to expect that implementation efforts for the new revenue standard in many cases will be no less intense. Companies that dig into implementation efforts early will undoubtedly reap the benefits of having greater flexibility with the resources that they need to get the job done. While private companies often don’t have significant capacity in their accounting functions, many companies may find that if they dedicate partial resources to begin ownership of the implementation project while there is still runway, meaningful progress can be made on a timeline that can still allow for the involvement of other stakeholders well in advance of the required implementation date. Companies that choose to outsource some or all of their implementation efforts should find many firms with recent experience and expertise applying the new standard to public company clients. Those buyers that enter the marketplace first should benefit from broad access to available and skilled third-party resources. And finally, whether internal, external, or a combination of resources are utilized in the effort, private companies will need their auditors to be engaged in the process throughout. Those that initiate earlier should be able to work with their auditors and provide complete documented assessments, ensuring that timing of the audit is not delayed and additional costs are avoided.
Companies that determine impacts just prior to the required deadlines may find their accounting departments creating spreadsheets and other manual processes to calculate and/or estimate related impacts of the adoption. In many cases, such processes may ultimately create more work (and less transparency) than would the implementation of new processes that do it right the first time. Getting ahead of the curve will likely provide companies more flexibility in determining the best methods to implement required processes, including consideration of any potential systems upgrades or changes that could facilitate an implementation approach that is not heavily manual.
Knowledge sharing and process improvement.
Companies that have undertaken implementation efforts have undoubtedly seen some unanticipated benefits and identified opportunities through the process. The primary tenet of the new guidance is to better align revenue recognition with the underlying economics of the transaction. While prior guidance could often be applied in a narrow fashion that relied heavily on specific contract terms, the new guidance generally takes a broader view of the economics in a given arrangement. As a result, many companies find that the implementation of the standard results in more collaboration across functional areas within their organizations, fostering a better understanding of the business for those involved and general improved cross-functional communication. The process may also result in the identification of opportunities for companies to improve contracting practices and other processes within the organization that will support the accounting and finance infrastructures going forward.
Enhanced business planning capabilities.
With respect to the new standard, stakeholders often reach outside the internal functions of the business. Changes to the amounts or timing of revenue recognition that may result from implementation could impact employee compensation, bank covenant compliance, tax liabilities, regulatory compliance, and a company’s ability to clearly communicate trends and expectations to prospective investors. It is these critical functions that often are the most significant drivers to persuading companies to undertake serious implementation efforts now.
More useful disclosures.
In most cases, ultimate revenue recognition under the old and new standards will not be significantly different given that cash flows from the customer over the entire term of an arrangement are subject to application of either standard. However, even for companies that do not ultimately conclude that adoption of the standard results in a significant change to amounts or timing of revenue recognition, companies should expect to reflect significantly enhanced disclosures in their financial statements that allow users to better understand the economics of revenue arrangements, how the new standard was applied, and which areas require the application of significant judgments. Companies should expect their disclosures to be highly tailored to the specific nature of their revenue streams and agreements with customers. Although optional relief from several disclosure requirements is provided to private companies, companies should consider whether the optional disclosures are valuable to include in their financial statements, either due to enhanced user understanding or because the company expects that its financial statements may be included in a public filing in the future.
In conclusion, the final required adoption date of the new revenue standard for private businesses is fast approaching, and implementation will require resource investment by companies no matter the timing of those efforts. Those companies that wait to initiate implementation efforts may miss significant opportunities and benefits that are available to their peers that undertake serious efforts earlier.
EKS&H helps companies handle a wide range of technical accounting issues including accounting standards changes, financing arrangements, share-based compensation, businesses combinations, and more. To learn how we can help your organization handle these kinds of issues, please contact Nicole Howe at email@example.com, or call us today at 303-740-9400.