Prepare Your Clients for the New Revenue Recognition Standard
The aim of FASB’s new standard is to improve the accuracy and relevance of financial results by shifting from a rules-based model to a principals-based model, says Eric Knachel, Senior Consultation Partner in the Professional Practice Group at Deloitte & Touche LLP. One of the greatest challenges that public companies have faced in their recent implementation of this standard, however, has been the issue of “judgment vs. consistency.”
Knachel says transitioning from a rules-based model to a principles-based model requires companies to apply more judgment than ever to account for various kinds of transactions, and leaves the door open for uncertainty.
This matters, Knachel says, because judgments can vary from one company to another, and different companies can report different accounting results when presented with a similar set of facts.
The bottom line
While the new standard is intended to improve the accuracy of financial results, and better reflect the economic substance of transactions, questions remain on how to navigate certain situations.
This same challenge will face smaller or private companies when they adopt the standard meaning CPAs should begin helping their clients in the private sector, including their small business clients, assess the potential impact the new standard will have on their accounting and daily operations.
With the January 2019 effective date for private companies quickly approaching, AccountingWEB and Knachel recently discussed how CPAs can help their small business clients prepare to tackle some of the uncertainties that may come along with the new revenue recognition standard.
Full transcript of the AccountingWEB and Eric Knachel interview
AccountingWEB: Deloitte has said this shift to a new principals-based model of revenue recognition will have “broad implications and may affect many parts of an organization: financial statements, business processes, taxes, and internal controls over financial reporting.” Can you please give us a specific breakdown of some of the ways this new standard will impact the accounting of small businesses?
Knachel: Small businesses may enter into transactions that include a variable/contingent portion of the transaction price. Under historic accounting principles, contingent consideration was not recognized as revenue until the applicable contingencies were resolved. Pursuant to the new accounting rules small companies will need to estimate the amount of contingent consideration that will be received and potentially record revenue related to those contingencies prior to the resolution of such matters.
Small businesses may also enter into transactions that include both products and services with varying payment terms. The nature of the products and services (e.g., whether such services are considered distinct and therefore separable) may impact the timing of revenue recognition. Similarly, whether products/services have an alternative future use along with contractual terms (e.g., termination penalties and payment terms) may also impact the timing of revenue recognition for various types of transactions and businesses.
AW: Are there any types of small businesses in particular that will be most impacted by the new standard?
Knachel: The standard will particularly impact small businesses that do not use standardized contracts and/or those that have nonsystematic transactions. Many small businesses vary or modify their contractual arrangements routinely and use their flexibility to make such changes as a competitive advantage and to respond to customer needs. However, because accounting under the new standard can be very fact and circumstance based, specifically as it relates to contractual terms, differences in contractual terms and one-off type transactions need to be examined carefully in order to determine the appropriate accounting treatment.
Additionally, small businesses that operate in the hi-tech industries (such as software and software-related services industries) will be particularly impacted.
AW: What general steps can CPAs suggest their small business clients adopt to prepare for the January 2019 deadline?
Knachel: CPAs should have their small business clients: 1) identify their various revenue streams, 2) obtain a sample of representative contracts, and 3) review those representative contracts. The ultimate objective of said review is to determine the appropriate accounting for the contracts, and will entail understanding the revenue standard’s provisions and identifying the key contractual terms that will drive the accounting treatment for particular revenue streams/arrangements.
Additionally, as part of the implementation process, CPAs should make sure the appropriate personnel at their small businesses are involved in the implementation process. Specifically, individuals outside of the accounting function, as applicable, should play an active role in the implementation process in order to appropriately consider the related impacts to areas beyond financial reporting, such as contractual terms and business processes for example.
AW: Again, you say one of the most challenging aspects of dealing with the new standard is the issue of “judgment vs. consistency.” Can you please explain how the issue of “judgment vs. consistency” poses challenges for companies in general?
Knachel: The FASB’s new revenue recognition standard aims to improve the accuracy and relevance of financial reporting by shifting from a rules-based mode to a principles-based model. Under a principles-based model, companies may use more judgment when deciding how to account for various types of transactions, instead of being forced to apply hard-and-fast rules that might not fit the actual economics of the situation.
However, applying judgments in a principles-based environment can be very difficult and such judgments can vary widely. Differing judgments under the new revenue standard may be considered acceptable. However, companies need to tread carefully and be comfortable their judgments can be justified. Plain and simple, they need to evaluate, when is it okay to have differing judgments and when is it problematic?
AW: How will the issue of “judgment vs. consistency” impact small businesses in particular? What risks or challenges does it pose?
Knachel: Small businesses will not only have the general challenge of “judgment vs. consistency” as previously described, but may also face additional obstacles as they work through this challenge. Specifically, smaller companies may have limited access to established industry peer groups that are often a very valuable sounding board to discuss and vet issues. Additionally, small businesses may have a more difficult time engaging standard setting organizations, regulators, and AICPA industry groups to discuss and debate issues and differing views.
The bottom line? Small businesses may not have the ability to readily access third parties that have proven to be instrumental in addressing this challenge.
AW: Can you please briefly outline an action plan CPAs can use to help their small business clients proactively manage the challenges of “judgment vs. consistency” in particular?
Knachel: CPAs and small business should follow the implementation approach previously described (i.e. identify various revenue streams, etc.). As it relates specifically to the challenge of applying judgment in this principles-based framework, CPAs and small businesses should look to maximize and leverage applicable interpretive guidance such as AICPA industry papers and Transition Resource Group (TRG) papers.
Taking this approach allows CPAs and small businesses to narrow the questions and uncertainties that remain when evaluating accounting alternatives. With a more narrow set of questions, CPAs and small businesses may want to solicit third-party resources for focused queries.
AW: What lessons can small businesses take away from public companies that have already been through this transition?
Knachel: Get busy now and don’t procrastinate. Public companies that approached the standard with a high-level assessment and then delayed the actual implementation activities often found themselves in a fire drill exercise. Also, consider the implications beyond accounting. For example, are there bonuses or executive compensation payments linked to revenue metrics, and how will a company address this situation?
Additionally, small businesses may find the accounting treatment and financial statement disclosures provided by public companies to be an informative resource. However, small businesses need to be careful not to “blindly follow” the accounting treatment or disclosures of public companies. The appropriate accounting treatments and related disclosures are often very fact and circumstance based. Such facts and circumstances may not be provided in sufficient detail in a company’s reported financial statements for another company to make an appropriate comparison, and other considerations, such as materiality may also influence a company’s public disclosures.
You might also be interested in
Deanna Arteaga is a professional freelance writer and public relations specialist who for the past six years has covered CPA industry trends for AccountingWEB. She also writes about CPA firm marketing, higher education and professional development for CPAs, and workplace trends in the accounting profession. She has more than 20 years...