Revenue Recognition Update from the Chief Accountant of the SEC

On March 22, 2016 at the 12th Annual Life Sciences Accounting and Reporting Congress in Philadelphia, Pennsylvania, James V. Schnurr, Chief Accountant of the Securities and Exchange Commission gave an update on the new revenue recognition guidelines and the process of implementing them.  The following is a summary of hisspeech.

Revenue Recognition Policies

Mr. Schnurr began his speech by talking about the importance of revenue as a financial measure used by investors globally in assessing a company’s performance and prospects.  He also addressed the inconsistencies between IASB and FASB and the importance of a standards convergence.   The movement toward a converged standard culminated in May 2014 when the FASB and IASB issued the new standard on recognizing revenue (ASC 606 and IFRS 15 respectively). The new standard is designed to improve consistency by eliminating industry-specific guidance, providing a more robust framework for addressing revenue issues, and requiring additional disclosures to users of financial statements.  Mr. Schnurr went on to say:

“I consider the new converged revenue standard to be an important step forward in financial reporting for preparers and investors, both domestic and foreign. These changes will impact all companies and all industries, but the extent of the impact will differ from industry to industry.”

Mr. Schnurr also discussed the adoption method companies would use and how that would impact their reporting requirements.  For companies who elect the full-retrospective approach, they need to apply the standard to the prior years’ comparative revenue amounts.  He then went on to list out examples of areas impacted by the new standard specific to the life sciences industry.  Here is one example:

…rights of return are common in the life sciences industry, as are agreements to cover distributor carrying costs, guarantees of distributor profits, and other concessions. Under both the current guidance and the new revenue recognition standard, these types of agreements require close evaluation to determine the appropriate timing and amount of revenue recognition. The core principle of the new revenue recognition standard is that companies will recognize revenue to depict the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods.

Mr. Schnurr also discussed the increased requirement of judgements and their importance.  These judgements will be applied by companies and evaluated by auditors, investors, and regulators and must be thoughtfully researched and justifiable.  The assessment process must use relevant facts and circumstances surrounding the transaction and will often need to include and understanding of the contract including contract terms (both written and oral), the economic substance of the arrangement, and attention to any contingencies such as those that can impact amounts recognized.  He also made a point to call out the importance of the documentation of judgements and how they should be reflective of the complexity and materiality of the arrangement.

Status of the Revenue Transition Resource Group (TRG)

Mr. Schnurr commented on the TRGs and how both the FASB and IASB formed TRGs to solicit, analyze, and discuss issues arising from the implementation of the new revenue guidance. The discussions were intended to provide a forum for stakeholders to learn about the new standard and from their peers.  He noted that over 50 issues had been addressed by the TRGs and a few had been referred to the Boards for consideration resulting in standard changes and the delay of the effective date by a year.

Though the TRGs have been working well, Mr. Schnurr voiced concern over the IASB’s announcement in January 2016 that it will discontinue TRG meetings until it determines there are additional implementation questions that warrant a meeting of their TRG.  The FASB will continue to have TRG meetings and will continue to address implementation issues that may arise.  The IASB will monitor the FASB TRG meetings to determine if any issues should also be addressed by their TRG.  In a response to the IASB’s decision not to hold TRG meetings, Mr. Schnurr stated:

Without joint participation of the IASB’s TRG in the coming scheduled FASB TRG meetings, there is a concern that IFRS 15 may be interpreted through a U.S. GAAP lens without the perspective of IFRS preparers. I encourage IFRS preparers to provide input to the FASB staff and the FASB TRG participants to the extent they believe they have important factors that should be considered for discussion by the FASB TRG.

Mr. Schnurr reassured everyone that he and his team will continue to participate in the TRG meetings as observers.  The SEC staff will use the TRG discussions to help in their evaluation of the reasonableness of a company’s revenue recognition policies.  He also expects companies to monitor the TRG discussions and meeting minutes to inform their selection and implementation of reasonable policies and to consult with the SEC if any of their policies are inconsistent with the TRG discussions.

Status of Registrant Implementation

Having discussed the standard setters’ framework for addressing implementation issues, Mr. Schnurr felt it was important to discuss the progress to date on companies implementing the new standards.  To this, Mr. Schnurr said the following:

In a survey conducted by PricewaterhouseCoopers LLP (PwC) and the Financial Executives Research Foundation in the fall of 2015, 75% of responding companies indicated that they had not completed their initial impact assessment and, of those, 27% had not begun their assessment at all. Other firms have conducted similar surveys with consistent results, all of which lead to the observation that implementation efforts appear to be lagging at many companies.

Based on the impact most companies see from the regulation change, the lack of adoption or progress on implementation is very concerning.  Mr. Schnurr was also quick to point out:

Implementation of the new standard requires significant effort by companies, including analyzing contracts and designing new systems, processes and controls. Given the importance of high quality application of the standard, I believe executive management, the audit committee, and the company’s external auditor should discuss implementation status and plans, as well as the allocation of sufficient resources with appropriate skill sets to execute the plan.

The duration of projects and the timing of the standards adoption have Mr. Schnurr concerned.  He also feels the auditors need to ensure appropriate attention has been given to the standard adoption as he notes:

Auditors have an obligation under PCAOB standards to communicate with the audit committee about any concerns regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting.

The main point of the registrant implementation section was to stress that the process is long and everyone is already behind.

Industry Groups

Mr. Schnurr then turned his attention to the industry groups discussing their important role in the implementation activities, including education around the application of the principles in the new standard.  The SEC continues to monitor and support the AICPA industry task force as well as other formal and informal groups in identifying and addressing implementation issues. He went on to note that the success of the implementation groups will be measured by not only the ability to educate around the guidance in a timely manner but also by the ability to identify the right interpretive questions.  To this point, Mr. Schnurr noted that in September 2015, concerns where expressed around the timely submission of implementation questions to the TRGs.  Since then, the industry groups have continued to improve in this area and he thanked them for their efforts though there is still more work to be done.  He then discussed material conclusions with the following:

I encourage industry task forces to identify issues and seek consistency in material conclusions. Where consistency is not achieved by task forces, I encourage members to escalate issues to the TRG for further discussion. To the extent that a registrant has an interpretative question that may not be appropriate for the TRG, either because it is not likely to be pervasive or is specific to a particular set of facts, OCA is available for consultation.

Mr. Schnurr went on to talk about how investors don’t have to wait until adoption as they have an opportunity to participate during the transition phase.  He mentioned that companies will have to disclose the anticipated effect of new accounting pronouncements that have been issued, but not yet adopted and encouraged investors to monitor and use the disclosures to understand the impact on a company as a result of the new standard.  The SEC is looking forward to reviewing the disclosures to understand how companies believe they will be impacted.  If the impact is as yet unknown, the company should make a statement to that effect and should include when the assessment is expected to be completed.  The purpose of the disclosure is to provide useful information to the consumers of the financial information as they need time to analyze the impact on companies.

Status of Office of the Chief Accountant (OCA) Activities

The SEC continues to monitor the activities of the TRGs, AICPA Task Force, and other organizations to understand and ensure the implementation of the new revenue recognition standard and encourage consistent adoption in the US and abroad.  Because the FASB’s and the IASB’s new revenue standards are largely converged, the SEC expects consistent reporting outcomes for identical transactions. In cases where there are different views on the application of the new standard, the SEC will consider the intent of the Boards when determining the application of the standard.  The SEC is also consulting with companies on their individual revenue recognition policies.  Mr. Schnurr went on to note that:

…the consultation process includes collaborating with the FASB, IASB and other securities regulators. In forming our views, the staff considers the basis for the standard setters’ conclusions, as well as the implementation discussions at the TRG. The staff also considers how the new revenue standard was intended to change existing practices, as well as the consistency of proposed revenue recognition for similar transactions within and across industries.

The SEC is also evaluating existing Commission and SEC guidance to understand the impact of the new standard and then to inform companies of situations where such guidance is no longer relevant.  One example was staff comments included in the FASB’s codification around freight services in process, shipping and handling fees and costs, gas-balancing arrangements, and the presentation of expenses related to “free” goods and services which would no longer apply once a company adopted the new revenue recognition standard.

Internal Control over Financial reporting (ICFR)

When discussing the implementation of the new revenue standard, Mr. Schnurr noted that the process may involve the development of new or redesigned business processes, systems and controls. He also feels the effective design and operation of internal control over financial reporting (ICFR) is critical to the success of a company’s adoption of the new standard.  He noted that the discussion of controls over the past year has been necessary given the importance of the controls around judgements. Mr. Schnurr also believes:

…the implementation of the new revenue standard provides an opportunity to be proactive and improve the design and operation of management review controls that may exist within a company’s revenue recognition process, including with reference to the various estimates and judgments that the new revenue standard may require. Therefore, as you evaluate your contracts with customers, it would be appropriate to take a fresh look not only at your historical accounting policies and how they may need to change but also at the design of the related controls (both existing and new) to ensure they are designed to operate in a manner that is sufficiently sensitive or precise to prevent or detect a material misstatement in the financial statements.

Mr. Schnurr continued to discuss the importance of ICFR and the opportunity the new standard provides to revisit a company’s existing controls.  It is also an opportunity to look at business process-level controls, the control environment, and risk assessments.  ICFR continues to be a point of focus for the SEC as they have devoted a significant amount of time and effort to understanding and providing initial responses to concerns of various companies regarding the ICFR assessments.  Mr. Schnurr also points out:

…the PCAOB continues to identify deficiencies in the audits of ICFR. Our involvement in a number of registrant matters related to ICFR would also suggest that some of these audit deficiencies may be, at least in part, indicative of deficiencies in management’s design or operation of controls, including management review controls.

The SEC continues to work with the PCAOB to understand the concerns of the preparers, auditors and companies.  The SEC encourages regular discussions between management, auditors, and audit committees on existing and emerging issues in assessments of ICFR and will continue to monitor this throughout 2016.

Non-GAAP Measures

Mr. Schnurr then turned his attention to Non-GAAP measures being used in financial reporting.  While this was not directly related to the revenue recognition standard and its implementation, the topic was relevant to SEC filings and financial statements.  The SEC is concerned with the amount non-GAAP measures being used and the manner in which they are presented.  Sometimes, the analysts and news media provide the non-GAAP measures without referencing the GAAP results thus misleading the investors.  This is evident in his statement:

Non-GAAP measures are intended to supplement the information in the financial statements and not supplant the information in the financial statements. However, when the financial news networks report quarterly earnings, they very frequently report the non-GAAP measure of earnings with no reference to the actual GAAP earnings, often not even identifying it as having been adjusted.

The SEC staff will continue to monitor the use of non-GAAP measures as part of its selective review process as well as provide guidance and comment letters.  The use of non-GAAP measures should also be looked at by management as well as the auditing committee to understand why the measures ae being used and if they are appropriate.  The goal is for non-GAAP measures to supplement the financials not supplant them.

Conclusion

In summary, Mr. Schnurr acknowledged that the issuance of the new revenue recognition standard was an important milestone on the road to a converged set of high-quality accounting standards. He noted that the implementation of the standard was a major challenge but an achievable one.  He also made sure to call out that, while progress has been made on the implementation and adoption of the standard, there is clearly more work to do.  He closed with the following remarks:

Given that relevant and reliable financial reporting is of utmost importance to investors, it is critically important that ICFR be robust and that the audit of their effectiveness be of high quality. Finally, considering the importance of financial reporting, it is incumbent that alternative non-GAAP measures merely supplement GAAP measures and are not a substitute for them.

Call to Action

If you would like to learn more about Revenue Recognition, Proof of Concepts, Revenue Projects, or any other topic, please do not hesitate to reach out to me.  I would also like to invite you to join me for Bramasol’s next webinar to be held later this month.  As the leader in SAP Revenue Recognition, Bramasol can act as your guide to understanding SAP RAR and how to get started.  Learn more about revenue recognition projects by visiting Bramasol’s website where you can find information on eBooks, blogs, videos, and much more.

If you have any questions about the changes, Revenue Recognition, what to do, or would like to speak with me about something else, please feel free to reach out to me directly.  You can find me at larrym@bramasol.com or follow me on twitter @LarryTheSAPGuy.