This article, "Implementing New Standards for Revenue Recognition, Leases, and Financial Statements," originally appeared on CPAJournal.com.
The panel began with a discussion of the new standard for revenue recognition and the process for implementing it. Siegel highlighted some of the more prominent changes, such as moving the recognition of collectability to the beginning of the contract process and re-terming deliverables as performance obligations. Kalavacherla gave an auditor’s perspective on how boards of directors are reacting to the new requirements, saying that the five-step framework provided by FASB has provided a good benchmark. “If you follow through, the revenue recognition will meet the principles of the standard,” he said.
Thuener reported that Google’s parent company, Alphabet Inc., had already adopted the standard, as most public companies are in the process of doing. She also stressed the importance of new required disclosures and the processes needed to develop them. She advised private companies, which have a later implementation date, to avoid complacency and begin their transition efforts early, saying, “It is not a quick, easy process.”
Regarding how the standard has affected the financial statements of early adopters, LaMonte said that “one of the things we’re hearing is, it isn’t going to change the numbers that much.” He also reiterated Thuener’s point about disclosures, saying that Moody’s would be watching companies’ assessments.
Kalavacherla discussed companies’ forthcoming strategies for the transition, noting that 52% of executives at a recent KPMG forum have not decided on a method of adoption. He urged companies not to take the transition lightly, saying that “this is a generational change, and people need to embrace that in that spirit.” Continuing, he outlined the three options for implementation: full retrospective, retrospective with a menu of options, or modified retrospective (“cumulative catch-up,” as Kalavacherla described it). He said that each company’s choice will depend on its situation, although he expects that most companies will settle on the modified retrospective method. He also reminded the audience that the standard also impacts the reporting of costs.
Strauss asked the other panelists for their takes on which method companies should use. LaMonte opined that companies will ultimately have no choice but to do a full or nearly full retrospective analysis, regardless of which method they choose, because of the need for comparison. “You cannot get to your first quarter of 2018 and say, ‘My revenue is up 3% versus the first quarter of 2017, and I have no idea why, because I’m on a new set of accounting standards,’” he said. Taub added that companies he has talked to realize this and will be using some form of the modified retrospective method.
Thuener described Google’s transition process, saying that using the modified retrospective method required a second set of books for the first year, to handle the comparison between the old and new standards. Thuener again advised companies to plan ahead, especially with their auditors, so that the process doesn’t hit a logjam when auditing financial statements for multiple years under multiple standards.
Strauss then asked Siegel and Taub about the technical issues they have seen so far. Siegel shared that FASB’s Transition Resource Group (TRG) received 108 submissions, which led to some additional guidance. Licenses in particular were a thorny issue: “People just told us that the standard as we wrote it was not operational,” he said. This led to both FASB and the IASB writing an Accounting Standards Update [ASU 2016-10] on the subject to “clarify and make it as operational as we could.”
Taub added that coordination between FASB and the IASB during the process was strong, with both contingents having the same view of the standard: “We didn’t have problems where we were reading it one way and they were reading it another way.” In terms of licenses, he said that refocusing the model on the type of intellectual property rather than the activity of the license made that part of the standard much more operational.
Thuener recommended that companies’ first step during the transition process be understanding where data about the company’s revenue streams sits within the company’s information systems, especially for companies with multiple, intersecting systems. “Don’t underestimate how long it takes your IT department to make some of these changes,” she warned, saying that it took Google “one to two years to get them to make some of the changes.” She also stressed the importance that systems, both before and after implementing the standard, are compliant with the Sarbanes-Oxley Act of 2002.
Strauss asked Kavalacherla whether companies are modifying contracts in anticipation of adoption. Kavalacherla confirmed that he has been involved with several such modifications, with the goal of making the contracts easier to account for, under the new standard. He advised modifying contracts rather than simply informing counterparties of changes in intent to enforce certain provisions. “I need to see a contract modification, legally signed by both parties,” he said. “The sooner you do it, the better off you are.”
Strauss then turned to LaMonte for a user’s perspective, stressing the volume of new disclosures. LaMonte highlighted the disclosures around dis-aggregation of revenues, saying that they would be “incredibly valuable to us in terms of understanding a company’s performance.” He also said that, during the run-up to adoption, SAB 74 disclosures should become more robust. “Let us know if the numbers are going to change. Don’t wait until the very end and surprise us,” he said. Taub agreed, stressing that it is important for companies to be as clear as possible about how far along in the process they are.
New Leasing Standard
Moving on to the new leasing standard, Strauss asked Siegel whether the new standard is considered principles-based. Siegel replied that “in some ways, it’s a little more principles-based, but in other ways it’s got some rules.” Regarding the classification of leases, FASB has allowed companies to follow the old, “bright-line” guidance “as a way to make it easier to figure out the classification,” Siegel said.
Strauss then asked LaMonte for a user perspective, to which LaMonte replied that he is happy with the standard’s solution of putting leases on the balance sheet. “It will bring reported financial results closer to the way [Moody’s has] historically looked at things,” he said.
Thuener discussed implementation efforts, saying that the 2019 effective date gives companies time to deal with both the leasing and revenue recognition standards. “Adopting lease accounting can be as pervasive as adopting revenue recognition,” she said, involving similar information gathering and processing. “Don’t underestimate how long this could take.” Given this, Thuener said, she was not sure whether any companies would adopt the standard early.
Taub then discussed the transition process. The basics, he said, were pretty simple: “Capital leases, leave them as they are. Operating leases, put it on the books based on the remaining payments as of the adoption date, which is the beginning of your earliest period presented.” The guidance, he admitted, is very long—three times as long as that for revenue recognition—but most of it is for “unusual questions.” He added that rethinking asset impairment is not required.
“For most people, early adoption may not be a viable candidate,” Kavalacherla agreed. He pointed out that the modified retrospective method for the lease standard is different than for revenue recognition, saying that it specifically requires restatements for the past three years, rather than a cumulative catch-up approach. He added that operating leases should be discounted at the borrowing rate. “A lot of people will think the minimum lease payments will come automatically, but there are nuances,” he said.
Strauss asked the panel whether companies are familiar with the mechanics of balancing the books for operating leases. Siegel replied that “what we tried to do for operating leases is make the P&L the same as it is today.” Thuener added that journal entries will change, and that making the distinction between operating leases and service contracts will be important. She also said that differences between GAAP and IFRS will “cause significant issues” for companies reporting under both.
Finally, Strauss asked LaMonte how the new standard might affect credit ratings. LaMonte was “unconcerned” about the effect of putting leases on the balance sheet, saying that “most sophisticated users” were doing so already. Regarding lease covenants, however, he said that companies will need to be careful not to stumble over this issue. He also said that most lenders, in his opinion, would understand that lessors tend to modify covenants to accommodate the new standard.
Measurement of Financial Instruments
The final standards discussed by the panel involved how companies report the value of financial instruments. “I think really the big change is fair valuing equities,” said Thuener. “You no longer have a cost method … You now have to mark those to market through the income statement.” She added that “for companies, that’s going to lead to a lot more volatility through other income and expense.” She also said that judgments on what constitutes “observable” and “orderly” will be important, and that companies should set clear policies.
“Adopting lease accounting can be as pervasive as adopting revenue recognition,” Thuener said.
Taub discussed the effective date of the standards, saying that the sections on accounting for equities have become shorter thanks to a reduction in the number of allowed methods. As an example, he gave the temporary impairment test, which he called “absolutely a fool’s errand; who can actually say, “I’m confident that my investment in equity securities is going to rebound?’” Overall, he characterized the standard as moving in a simpler, more positive direction.
Moving to credit losses, Kavalacherla said that the standard, while a “radical” change, mainly affects financial institutions and insurance companies, and that, like the leasing standard, this standard will create complexity for multinationals. Siegel added that putting this standard’s date at January 1, 2020, was part of FASB’s effort to stagger implementation in response to feedback. He also said that the standard will require big changes in methodology and thinking from companies, and that the effect of the standard at implementation is difficult to judge at this point, largely because of uncertainty about the economy two years from now.
Finally, Strauss asked Taub for suggestions for companies preparing for the transition. Taub said that the credit loss standard will be more difficult for companies, particularly banks. Kavalacherla added that while developing the necessary systems and processes will be a challenge, the process will initiate some good dialogue between companies, auditors, and regulators. Both he and Taub also encouraged small companies to reach out to the SEC for guidance if needed.
Audience Q&A
Strauss asked Thuener about the size of Google’s implementation team on revenue recognition. She replied that “a lot” of people got involved, because the process engaged the entire business: “[the] revenue accounting team, technical accounting team, legal, investor relations, the IT team on the systems; it’s pretty pervasive.” She said that she also expects the leasing process to involve the same amount of people or more.
Strauss also asked Siegel about any upcoming guidance from FASB on the various standards. Siegel said that there was no new guidance planned on revenue recognition, and that questions on leasing had not so far required any strong guidance. He did, however, leave the door open for future technical corrections or more substantive guidance, if necessary. Strauss followed up by asking about the SEC’s involvement, to which Siegel answered that the SEC monitors FASB’s efforts and communicates with its teams “throughout the standards-setting process,” and that more senior members of FASB and the SEC’s Office of the Chief Accountant meet quarterly.
Norman Strauss, distinguished lecturer of accountancy at Baruch College, moderated the panel.
Marc Siegel, board member at FASB;
Mark LaMonte, managing director of Moody’s Investment Service;
Scott Taub, managing director of Financial Reporting Advisors LLC;
Prabhakar Kalavacherla, a partner in the audit quality and professional practice group at KPMG; and
Amie Thuener chief accountant at Google, were the panelists
