The future of revenue recognition is here

By Genevieve Hancock, CPA

If your company is anything like mine, everyone is tired of hearing about ASC 606 implementation, and absolutely no one wants to hear you walk them through the five-step model one more time. Many industries landed back in a similar place to where they started, but there were some that were entirely uprooted. Some went from modified cash basis to full accrual under an entirely new standard (welcome to my world), others dealt with amendments and ASUs that came later in the game and changed the preparation for the standard yet again, while some private companies have yet to adopt.

We may never see another change in our lifetimes that is as impactful and requires as much assessment and change management as the implementation of ASC 606 — Revenue from Contracts with Customers. One thing ASC 606 accomplished was pointing out a major blind spot in many companies’ finance organization cultures — a lack of a lovely blend of a specialized but flexible expertise in technical accounting, contract application of this accounting, project management and change management skills to address the change to everyone involved. 

Amendments

Accounting standard updates and letters from FASB’s Emerging Issues Task Force (EITF) have been abundant over the last few years. Nearly every area of the codification was affected by the change to ASC 606 or the later-issued accounting standard updates. Even to this day, seldom thought-of effects caused by 606 permeate real estate sales guidance via anti-speculative clause paragraph amendments, or even expenses with ASC 705 amendments related to variable rebates for vendor contracts. Some of the more beneficial updates came from Transitional Resource Group meetings and the EITF, such as clarification around how to calculate and account for basic allowances for doubtful accounts and the fact that this calculation presentation and accounting was not changing as substantially as originally thought. Others that affected fewer areas were based on ASC 606, such as determining who is the customer in a service concession arrangement with ASC 853. Most of the amendments did not have a wide scope of companies unless they were clarifying the original accounting standard update related to ASC 606 — Revenue from Contracts with Customers.

Improvements to disclosures and SEC reporting

One of the largest changes to revenue recognition is related to the required disclosures to the financial statements. Many new and comparative disclosures — generally on a prospective basis if the modified retrospective transition method was elected — were added to the checklist for the notes to the financial statements. The key to having full disclosures is to explain the delta between the new and old numbers for the disclosure amounts. Disclosing the new calculation was not enough in many circumstances, but rather the marginal difference between the old calculation and the new calculation needed explanation where applicable.

For example, for transition disclosures under ASC 605, the company was calculating a certain portfolio of contracts with net treatment. Under ASC 606, its is no longer allowed to account for these transactions on a net basis, and the difference is material enough to disclose, so the reason and amount of the difference should be thoroughly explained and disclosed in the notes to the financials related to the financial statements. The U.S. Securities & Exchange Commission (SEC) has directed many companies on the disclosure requirements related to the transition, with the intention of the disclosures being the quantitative impact, significance and clear timeline for implementation around the transition.

One of the more complex required disclosures is the disaggregated revenue disclosure as it relates to the revenue streams of the company. The revenue streams should be disaggregated into categories based on the nature, amount and timing of recognition related to the cash flows and as to how they are affected by economic factors. This disclosure is one that many companies are still being asked to refine and is one where comparative financial information is preferred but not required when the modified retrospective method of transition was elected. It is important to note that there is a lot of management judgment required around this disclosure, as well as that there is (generally interpreted, but not specifically laid out) a minimum number of revenue streams required to be disclosed. Investors and analysts have put a lot of emphasis on the amounts disclosed to be used on a go-forward basis as one of many indicators of the financial health of a company.

Another area of concern around disclosures is related to performance obligation disclosures. This disclosure can be incredibly difficult for companies to adequately complete as of the beginning of the adoption period due to the specific requirements for the disclosure. The more intricate of the requirements is ensuring that the disclosure around the rationale as to why the measure of progress selected for each disclosure is an accurate representation of the pattern of transfer.

Amounts related to assets to fulfill or obtain a new contract should be disclosed and should not to be confused with contracts liabilities, otherwise known as deferred revenue, which is generally the amount of cash received in advance of satisfying a performance obligation. Contract assets related to costs to obtain and costs to fulfill can be very specific on a company level, but must be able to be tied on the specific contract level. The full calculation for these can be very different from company to company and the aggregate amount of the costs should be disclosed in any required financials, noting the difference between the last set of financials to the current and the drivers for the change (i.e. the net increase or decrease to the asset account).

Other considerations

Don’t forget internal controls or financial systems. Not all financial systems are able to immediately adapt from the change from ASC 605 to ASC 606, so part of the planning process must include any additional time spent adapting the financial reporting and production or billing systems to be able to reflect the changes as needed. The internal control framework is another item that should be closely monitored, with an additional level of one-time controls around the adequacy of the transition for any private companies with audits of internal controls around financial reporting. The quantitative aspect of the change is what the investors are relying on, but do not overlook the auditing controls to show that the numbers are being properly processed and reliably presented. Most interpretations of the standard in relation to new internal controls describe that companies should implement new controls to ensure any changes are captured, even if the total change is insignificant or immaterial to the financial statements.

Looking forward: Private company implementation

After nearly five years working on the implementation, change and maintenance of ASC 606, I can state with full confidence that if you are part of a private company and you are only partially complete on assessment or, worse, you haven’t even started on the implementation — you should focus on that and gear up for the change now. Trying to document revenue streams, assess on portfolio and at least a sample contract interpretation approach, change the accounting (on either adequate topside or underlying financial systems changes) and calculate the comparable financial information on either a modified or full retrospective approach is quite the undertaking in both time and expertise. Maybe it will be perfect, but more than likely, no matter how you prepare, you will end up with some sort of unforeseen fallout. Be it an obstacle around financial systems capabilities, or a change in how you are allocating the amounts, you should be finalizing your assessments and ensuring that the process is tested and measured and that your disclosures are in order.

Public companies benefited greatly from early adopters of ASC 606 through the notes and comments related to the disclosures around ASC 606. Since these companies adopted early, the entire accounting ecosystem was able to feel out and have a basis to look at for learnings on where to improve or focus on calculations.

Talk to the internal and external auditors in your company about control considerations and disclosure requirements to begin to set up an adequate framework for financial statement disclosures. Review the notes to the financial statements of public companies in the industry as a basis for what has been done and improve upon your own from there. Take the learnings from publicly issues comment letters or EITF meetings to discuss the learnings from early adopters and now public companies, one year into application of ASC 606. And ensure you have someone who is fully versed on ASC 606, even if that means dedicating a person for this transition. Proactive anticipation can help ease the stress of implementation at the last minute, rather than being reactive in the final months of potential implementation.

And if the company is really trying to implement best practices, then mock up the notes to the financial statements and the transition disclosures in advance to be reviewed and adjusted as needed.

Conclusion

When it comes to project management, starting early on large implementations such as this one can make or break how much additional work a company puts in. Hundreds of hours of time and effort are less likely to be overwhelming when you spread them over a year to two years. Having the right people on the team to assess, or further developing the skill sets of existing employees through more technical requests or contract interpretation, can also make or break a project timeline. While we may never see another change as large as the one around ASC 606 and revenue recognition, the only constant is change, and the FASB will continue to issue relevant updates that will need to be applied across a wide range of companies and industries.

Genevieve Hancock, CPA, is a technical accountant leading the corporate revenue recognition initiatives for Brown and Brown Insurance in Daytona, Florida. She is a member of the Editorial Task Force for Disclosures magazine, and the Young Professionals Advisory Council for the VSCPA.