With autumn upon us in the Pacific Northwest, the accounting community is busy closing the third quarter’s books, updating forecasts and fine-tuning fiscal 2018 budgets. While on the home front, kids are settling into their school routines, homeowners are completing those forgotten outdoor projects and everyone will soon be searching for the perfect pumpkin to carve. With demands of your time and energy coming from all angles, do you know if your accounting team has appropriately allocated resources to tackle the new revenue recognition standard, one of the most comprehensive standard overhauls in recent years? Hopefully yes, but for those nonpublic entities hesitant to take the first steps, the time is NOW.
Topic 606 – Understanding the Standard
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606). This standard, which was the by-product of the FASB and International Accounting Standards Board’s (IASB) joint effort to converge US and International accounting standards, replaced nearly all pre-existing revenue recognition guidance currently employed under US generally accepted accounting principles (US GAAP). The result was a framework on how an entity should account for its revenue producing transactions.
Public entities are required to implement this standard during the first interim period within annual reporting periods beginning after December 15, 2017; which would be the first quarter of fiscal 2018 for a calendar year-end public entity. Nonpublic entities are allowed an additional year as implementation is to take place during annual reporting periods beginning after December 15, 2018, or fiscal 2019 for a calendar year entity.
In conjunction with this implementation, entities will adopt one of two methods for applying the standard within its financial statements. The first approach, known as the retrospective method, will require application of the standard to each period reported in the financial statements. This will require a full restatement of any comparative figures from prior years presented in the financial statements and disclosures. The second approach, known as the modified retrospective method, will allow for a cumulative effect adjustment to be recorded at the adoption date (i.e. January 1, 2019 for a calendar year-end nonpublic entity). While this may seem like a more simplistic adoption method, please note that entities utilizing the modified retrospective method will still be required to disclose the effect of applying the new standard to allow readers the ability to evaluate comparable results.
With the issuance of Topic 606, the FASB introduced the ‘Five Step’ model for entities to follow in order to recognize revenue from contracts with customers. Those five steps are outlined as follows:
- Step 1 – Identify the Contract
- Step 2 – Identify the Performance Obligation(s)
- Step 3 – Determine the Transaction Price
- Step 4 – Allocate the Transaction Price to Each Performance Obligation
- Step 5 – Recognize Revenue as Each Performance Obligation is Satisfied
As evaluating the intricacies of this standard goes beyond the scope of this article, the “ASC Topic 606 – Revenue from Contracts with Customers” Practice Aid prepared by BDO’s National Assurance Practice provides a useful summary of the five step model for public and nonpublic entities and introduces key terms and concepts adopted within this standard.
Assessment and Implementation of the Standard
Before discussing the steps entities should take today to begin the assessment process, it should be noted that nonpublic entities have the welcoming advantage of learning from the work done by those public entities nearing their formal effective date. In June 2017, KPMG completed a survey[1] of 245 entities, 76% public and 24% nonpublic, which identified certain findings that nonpublic entities should be mindful of:
- “…nearly a quarter of private company respondents have not begun their assessment (compared to 8 percent of public companies who had not begun as of Summer 2016).”
- “The process has a tendency to be more complex, time-consuming and costly than anticipated…”
- “Only 6 percent of respondents believed they were faced with minimum impact requiring “little to no action” on their part.”
- “Internal communications need to be improved; 33 percent said C-level executives had little or no involvement in the process.”
- “Nearly 71 percent of public companies have either elected the cumulative effect transition method or are leaning towards it.”
With these findings in mind, it is in a nonpublic entities best interest to begin the assessment process today. As outlined in the “Example ASC 606 Adoption Timetable” prepared by BDO, this assessment can be broken down into five stages. While each stage should be tailored to the complexity of an entity’s revenue transactions, this tool provides a comprehensive list of steps to be considered as part of the adoption of this standard.
Stage 1: Understanding, Scoping, and Planning
It should be noted that Stage 1 is the most important step in the implementation process as it provides the guidelines for all future work performed in stages 2 through 5. An entity’s accounting team should take time to read and comprehend the standard. It should then identify who internally or externally can provide the knowledge and expertise needed to interpret and apply the standard to the entities revenue streams.
Stage 2: Technical Analysis and Assessment
Once the revenue streams and transaction types have been identified, the entity will need to allocate resources to evaluate the impact of the standard. This will include evaluating industry specific guidance, determining a transition method to be applied at adoption, identifying systems and internal control considerations, and, hopefully sooner than later, involving external auditors to review the scoping and implementation action plan.
Stage 3: Testing and Implementation
With an implementation action plan approved both internally by the entity’s management team and externally by auditors and/or other services providers (i.e. banks, lending institutions, leasing companies, insurance companies, etc.) involved in the process, an entity will move into the testing and implementation stage. As outlined in the timetable, this stage includes a number of heavy-lifting steps whereby resources will need to ensure tracking of revenue transactions is being captured in a useful manner that can produce financial information under both current GAAP and Topic 606. For nonpublic entities, it will be important to consider the adoption method to be utilized as it will impact the financial information that will need to be produced. It will also be crucial to have external auditors begin their testing of the completeness and accuracy of this financial information to ensure all parties agree with the data being produced.
Stage 4: Financial Reporting and Disclosure
With useful financial information available, an entity is now in the home stretch. In stage 4 the entity will begin to identify the impact the adoption has on its financial statement disclosures. This is an important point to note, as many nonpublic entities may rely on their external auditors to prepare the financial statements and disclosures. Without the assistance of the entity, it would be very difficult for an external auditor to produce the footnote disclosures required under the new standard. These expanded disclosures include, but are not limited to, the evaluation of the adoption impact on financial statement figures, disaggregation of revenue, disclosure of performance obligations, and other qualitative factors. Proactive evaluation of the disclosures with external auditors will make the process more efficient and cost effective.
Stage 5: Post Adoption
Regardless of the impact of the adoption of the standard, an entity should ensure it establishes appropriate controls to maintain accounting policies, evaluate new revenue contracts and ensure personnel stay on top of this standard. After making an investment of time, energy and money, it is in an entity’s best interest to maintain a high standard of financial reporting.
And You’re Off…
While it is always easy to find a more pressing project, nonpublic entities should start to develop their implementation plan today for this important standard. With the resources made available in this article, those in financial reporting positions should feel empowered to begin the process of identifying resources, both internal and external, that are available to assist. Taking time today to comprehend the standard, evaluate its impact, and proactively communicate with external auditors will vastly improve the efficiency and cost-effectiveness of implementing this standard.
If you have any questions surrounding the adoption of this standard, please contact your (Perkins & Co) advisor.
Through its alliance with BDO, Perkins & Co has access to the Practice Aids seen in this article. Further resources are publicly available by BDO through their Revenue Recognition Resource Center.
[1] KPMG’s 2017 Accounting Change Survey, The Deadline is Approaching for Accounting Change