Given the sweeping changes companies will likely have to make under the new Financial Accounting Standards Board’s revenue recognition standard, they should focus on reaching out to investors to help them understand the effect of the new standard on their financial reporting, according to Wesley R. Bricker, deputy chief accountant of the Securities and Exchange Commission.
Revenue is the origin of such key performance measures as operating income, net income, and earnings per share, Bricker noted late last week at the 2016 Baruch College Financial Reporting Conference. Sales is also the starting point for important analytical ratios like margins, return on equity, and return on assets, as well as for such valuation metrics as revenue multiples and price-to-earnings, he said.
“As a result, the new revenue standard has the potential to change not only the top line, but also the bottom line and analysis that depends on the financial statements,” Bricker added.
“While all industries and business models will likely be impacted to some degree by the new guidance, investors should pay particular attention to those companies with complex business models (such as those with long-term contracts or multiple performance obligations within a contract), since the new guidance could significantly impact the timing and amount of reported revenue, ” he said.
Under the new standard, he noted, “revenue is recognized when control of the good or service transfers from the seller to a customer. This model represents a shift from the current revenue recognition guidance which emphasizes the transfer of ‘risks and rewards,’ rather than control, as a criterion for recognition,” he said.
To provide perspective on how many transactions could be affected by the new revenue standard, as well as FASB’s new leasing standard, the SEC accounting official noted that in 2014, the S&P 1500 companies, which comprise about 90% of U.S. market capitalization, recognized revenue in their financials that adds up to more than $12.8 trillion. And that, of course, doesn’t include the potential recognition of currently deferred revenue when the new guidance becomes effective.
FASB requires public companies to apply the new revenue standard to interim reporting periods beginning after December 15, 2017. Nonpublic organizations should apply it to interim reporting periods within annual reporting periods beginning after December 15, 2019.
When interpretive questions come up about the new revenue recognition standard concerning their specific revenue arrangements, corporate finance managers and independent auditors should refer them to FASB’s Revenue Transition Resource Group, said Bricker.
While the SEC staff “will continue to respect well-reasoned, practical judgments … grounded in the principles of the standard,” he said, “aggressive interpretations that appear to be taken to achieve a specific outcome, such as preserving existing reporting, will not be well received, particularly when that outcome is inconsistent with the principles of the new standard,” the commission official declared.
Bricker encouraged corporate accounting managers to consult with the SEC’s Office of the Chief Accountant when their companies have “unusual, complex, or innovative transactions for which no clear guidance exists” or are “applying the guidance in a manner differently from the manner in which [Transition Resource Group] members believed the guidance should be applied.”
For example, corporate accountants might want to check with the SEC if they have questions about how the word “contract” may be defined under the new standard. “While a future contract might appear to be likely or even compelled economically or by regulation, in the staff’s view it would be inappropriate to recognize revenue for a contract before the contract exists with enforceable rights and obligations,” he said.
Bricker also noted that guidance in the new standard “explicitly limits what contracts may be combined” for purposes of revenue recognition. The SEC’s accounting staff, for instance, has “objected to a registrant’s proposal to extend the contract combination guidance beyond contracts with the same customer or related parties of the same customer,” he noted.