I continue to explore the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), for public business entities, certain not-for-profit entities, and certain employee benefit plans, which was issued in May 2014. The amendments become effective for public entities for annual reporting periods beginning after December 15, 2017. In other words, we are now less than six months away from a new Revenue Recognition (“new rev rec”) standard which may significantly impact the compliance profession, compliance programs and compliance practitioners going forward. I recently sat down with Joe Howell, Executive Vice President (EVP) at Workiva Inc. and asked him if he could walk me through some of the key changes and how it might impact compliance going forward. Today we conclude our consideration of the five elements of the new rev rec standard by looking at elements four and five.
The key to understanding the new rev rec standard is that it is judgment based, not rule based. This will allow more room for interpretation but also allows for more room for manipulation. This is where the new rev rec standard intersects with compliance and where the compliance practitioner needs to not only understand the new rev rec standard but also understand the role that internal controls will play in complying with this new standard going forward.
There are five elements that you must consider to make a determination of whether revenue can be recognized. FASB identifies these five elements as the following:
FASB states Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract with the following:
If a contract has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.
To allocate an appropriate amount of consideration to each performance obligation, an entity must determine the standalone selling price at contract inception of the distinct goods or services underlying each performance obligation and would typically allocate the transaction price on a relative standalone selling price basis. If a standalone selling price is not observable, an entity must estimate it. Sometimes, the transaction price includes a discount or variable consideration that relates entirely to one of the performance obligations in a contract. The requirements specify when an entity should allocate the discount or variable consideration to one (or some) performance obligation(s) rather than to all performance obligations in the contract.
An entity should allocate to the performance obligations in the contract any subsequent changes in the transaction price on the same basis as at contract inception. Amounts allocated to a satisfied performance obligation should be recognized as revenue, or as a reduction of revenue, in the period in which the transaction price changes.
FASB states Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation with the following:
An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service.
For each performance obligation, an entity should determine whether the entity satisfies the performance obligation over time by transferring control of a good or service over time. If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.
Step four requires a company to allocate the transaction price to the performance obligations and five then follows to recognize the revenue after a business has satisfied it the performance obligation. According to Howell, this “means you have to figure out what is the ability to judge if what’s going to be returned. If you’re just starting out and they have a right to return, and then you have no transaction history, then it’s really hard to build the case that it’s not impossible but it’s harder to build a case that you can recognize some part of that revenue.”
As you might guess at this point the key is to document evidence of the performance obligations to support your conclusions. So Document, Document, and Document are still the three most important things. But here Howell noted that this requirement does not fall solely on the shoulders of the accounting function of an organization. He stated that a company must “build processes with their sales organization, their sales op organization, their marketing organization, their legal department to figure out what is the evidence. Now, this requires that the accountants have conversations with your sales team early on to figure this out but also as we talked about the capturing the judgments related to the cost to acquire the contracts, that they work closely with the sales organization on these commissions.” This is another way of saying “operationalize the process.”
These final two elements demonstrate the convergence between the new rev rec standard and overlap of the compliance profession, compliance programs and compliance practitioners going forward. Compliance internal controls are in place to both detect and prevent. Now they can also be used to gather the information which will be presented to auditors under the new rev rec standard. Many professional are focused on the new rev rec from the auditing and implementation perspective. Tomorrow I will conclude on what it all means for the Chief Compliance Officer (CCO) and compliance function going forward.
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