Defining Issues February 2014, No. 14-9 Implementing the Forthcoming Revenue Recognition Standard Advanced planning will provide companies with the flexibility to spread the work of implementing the new revenue recognition standard over a longer period and include process and system changes as part of the solution. 1 It also will allow time for dualreporting capability prior to the effective date and handling unanticipated complexity. Contents Changes Will Affect the Entire Company... 2 Identify Gaps with New Requirements... 2 How Will the Selection of a Transition Approach Impact Planning?... 4 Preparing for Implementation... 5 Start Assessing the Standard s Impact... 8 Appendix Implementation Resources... 10 Key Facts The revenue recognition standard, which is scheduled to be issued within the next few months, is expected to be effective for public entities for fiscal years, including interim periods within those years, beginning after December 15, 2016. For nonpublic entities, the standard is expected to be effective for fiscal years beginning after December 15, 2017, and interim periods thereafter (although they may adopt at the same time as public entities). Companies that may experience the most challenges with implementing the standard include those that: Currently recognize revenue using industry-specific guidance; Have customer contracts with diverse terms and conditions; Have arrangements with goods or services delivered over long periods; or Have systems or processes that do not easily provide new data requirements. Among the industries that are likely to experience significant changes are telecommunications, aerospace, construction, asset management, real estate, and software. In the months after issuance of the new guidance, the FASB plans to issue documents that will address common questions posed by these industries. 2 Changes won t be limited to these industries, so all companies should consider the need to develop implementation plans. Key Impacts Companies will need to develop strategies to capture the additional information needed for the new requirements and disclosures. Implementation efforts may need to include resources from areas throughout the company and not just accounting and finance. 1 FASB Proposed Accounting Standards Update, Revenue from Contracts with Customers, November 14, 2011, available at www.fasb.org, and IASB ED/2011/6, Revenue from Contracts with Customers, November 2011, available at www.ifrs.org. 2 FASB Outlook: What You Need to Know About Revenue Recognition, available at www.fasb.org.
Changes Will Affect the Entire Company Companies that expect significant changes in their revenue recognition policies or find that new information must be captured to comply with the new recognition, measurement, and disclosure requirements of the revenue standard will need to examine its impact throughout the company. Implementation efforts may need to include resources from areas such as tax, information technology, internal control, financial planning and analysis, sales and marketing, contracting and pricing, human resources, and compensation and benefits. Program management that ensures the right individuals within the company are involved in the implementation process and appropriate change management activities are undertaken will be important to achieving an effective and efficient implementation. These individuals also must have a working knowledge of the standard. 2 Identify Gaps with New Requirements After developing an understanding of the standard, the next step companies should take is analyzing their current revenue policies and disclosures so that those can be mapped against the new requirements. Once that is done, companies can identify the gaps. This analysis will identify the accounting policies that may need to change and the additional disclosures that will be required. Factors to consider during the gap analysis include: Arrangements with customers that are subject to transaction- or industryspecific revenue guidance that is being superseded; Revenue that is spread across multiple business lines or multiple geographies that could involve different implicit promises through differences in customary business practices; Customer contracts with unique revenue recognition considerations or terms and conditions;
AICPA Revenue Recognition Task Forces Airlines Aerospace and Defense Broker Dealers Construction Contractors Depository Institutions Gaming Health Care Hospitality Insurance Investment Companies Not-for-Profit Oil and Gas Power and Utility Software Telecommunications Timeshare The degree of variation in the nature and type of goods or services being offered; The degree to which contracts include multiple performance obligations, variable consideration, or licenses of intellectual property; The pattern in which revenue is recognized; The current accounting treatment of costs incurred to acquire or fulfill a contract with a customer; Whether centralized access to the population of customer contracts exists; Documentation about how existing policies apply to individual arrangements or revenue streams; Sales of nonfinancial assets (including in-substance nonfinancial assets) not part of an entity s ordinary activities such as sales of intangible assets and property, plant, and equipment; and Additional disclosure requirements. Disclosure Requirements. Companies will need to disclose significantly more information about their contracts with customers than under current U.S. GAAP. Nonpublic entities likely will have some relief from the disclosure requirements. Quantitative disclosure requirements expected to be in the standard include the disclosure of disaggregated information about revenue, changes in contract assets and contract liabilities, and the unfulfilled performance obligations that remain at the end of the reporting period. In addition, there are qualitative disclosure requirements such as significant factors related to determining the transaction price, allocation of the transaction price to performance obligations, and the timing of satisfaction of performance obligations. As new or revised disclosure requirements are identified in the gap analysis, companies should consider how to best accumulate the incremental information. New Judgments Required. The revenue standard will require new judgments, estimates, and calculations that are not required by current U.S. GAAP. For example, companies may need to make judgments about whether a contract exists, the number of performance obligations in a contract, the transaction price when consideration is variable, the standalone selling price of performance obligations needed to allocate the transaction price to performance obligations, and the measure of progress on performance obligations satisfied over time. As changes in accounting policies are identified in the gap analysis, the areas that will require new judgments, estimates, and calculations will need to be identified. In addition, as the effective date of the standard approaches, additional guidance could result from issues discussed by the FASB/IASB Joint Transition Resource Group and various industry groups, including the Revenue Recognition Task Forces formed by the AICPA. 3 Companies will need to actively monitor these activities and be prepared to adjust their implementation plan as new guidance is developed. The Appendix provides a list of other resources that may be helpful in considering the potential impact of the standard. 3 3 The AICPA recently established Revenue Recognition Task Forces (see list in the left margin). For additional information, visit the AICPA s Web site at www.aicpa.org.
How Will the Selection of a Transition Approach Impact Planning? The standard will require companies to transition using either a cumulative-effect method or a retrospective method (with or without the use of one or more optional practical expedients). Cumulative-Effect Transition Approach. The standard will apply to all uncompleted contracts under current U.S. GAAP as of the adoption date. The cumulative effect is the difference between the cumulative revenue recognized under current U.S. GAAP on uncompleted contracts as of the adoption date compared to cumulative revenue that would have been recognized had the requirements of the standard been applied to those contracts. This amount is reflected as an adjustment to retained earnings or net assets at the adoption date (January 1, 2017, for a calendar-year public entity). A ship-and-bill business that satisfies its performance obligations quickly and has no ongoing maintenance or service obligations may find few arrangements that are not completed as of the adoption date. Therefore, little analysis of historical customer contracts would need to be done. If there are customer contracts with ongoing unfulfilled performance obligations such as services or undelivered goods, the arrangements will need to be evaluated under the standard to identify the differences that exist as of the adoption date. Longer-term arrangements will complicate this analysis because a longer historical period must be examined. The cumulative-effect transition approach requires disclosure of the amount that each financial statement line item changed in the year of adoption along with an explanation of the significant changes. During the year of adoption, companies electing the cumulative-effect transition approach will have to be able to determine what revenue and other impacted accounts (e.g., contract assets, contract liabilities, and contract costs) would have been under current U.S. GAAP. For companies with significant differences in the amount and timing of revenue or cost capitalization under the new standard, maintaining the ability to determine revenue under current U.S. GAAP could effectively require business processes and information technology systems capable of determining the amounts under both current U.S. GAAP and the new standard for the first year of application. Retrospective Transition Approach. Companies using this approach will need to recast revenue and expenses for all prior periods presented in the financial statements in the year of adoption. Certain optional practical expedients will be available to simplify this approach. For example, companies may elect not to restate contracts that began and ended within the same annual reporting period. Companies will need to both (a) apply the provisions of the new standard to the historical periods presented, and (b) determine the cumulative effect of applying the new standard as of the beginning of the first historical period presented. SEC registrants that elect the retrospective approach will need to consider the requirement to present five years of annual selected financial data under Regulation S-K. 4 Unless the SEC provides relief from that requirement, registrants will need to extend their retrospective application of the standard to include each of the five years covered in that disclosure. 5 4 4 SEC Regulation S-K, Item 301, Selected Financial Data, available at www.sec.gov. 5 SEC Financial Reporting Manual Topic 1610, Accounting Basis, available at www.sec.gov.
Both transition approaches present challenges for implementation. However, the choice of transition approach could greatly impact the implementation plan and therefore should be considered early during the planning phase. Because of the impact the standard may have and the transition options available, companies will need to plan for adoption well in advance of the effective date. 5 Preparing for Implementation The new requirements will make it necessary for some companies to gather information that was historically not required for financial reporting purposes (e.g., costs incurred in obtaining a customer contract). Preparing an inventory of the incremental information needed and mapping those needs to existing sources will be critical steps during the assessment phase. Companies will need to consider the internal controls that will be necessary to ensure that the information is complete and accurate. Evaluating the most effective and efficient way to source incremental information in the assessment phase will facilitate making systems changes in a cost-effective manner. Matters to consider when evaluating how to best gather and capture this new information include whether: Legacy Systems Need to Be Modified to Provide New Functionality or Information Outputs. The need to modify legacy systems can create challenges, particularly if the application is highly customized, or the enterprise resource planning software application is no longer being significantly enhanced by its vendor. A scarcity of programmers or numerous distinct legacy systems can increase the compliance cost, and can be a critical consideration in determining the most desirable implementation approach. Information System Vendors May Provide Products to Collect New Information. Many major enterprise software companies have been monitoring the standard-setting process and are in the process of developing upgrades to their revenue functionality to address the requirements of the standard. While some of these features may be available well in advance of the effective date, others may not be available until closer to, or even after, the effective date. Software Automation Solutions May Be Available. Other revenue automation solutions that can be used in conjunction with existing software systems may be available to address some of the information system needs. Manual Solutions May Provide a Viable Alternative. In some instances, the use of spreadsheets or databases may provide a sufficient solution, particularly when sourcing information for historical periods. Internal Controls Should Be a Key Consideration Companies may need to design and implement new internal controls or modify existing controls to address risk points resulting from new processes, judgments, and estimates. New risk points may arise from changes to information technology systems and reports that provide data inputs used to support the new estimates and judgments. To the extent data is needed to comply with the requirements of the standard, companies will need to consider the internal controls that will be necessary to ensure the completeness and accuracy of this information especially if it was not previously collected. Because the standard may require new judgments and perhaps different analyses, companies should consider the skill level, resource capacity, and training needs
of employees who will be responsible for performing the new or modified controls. Tax Implications The change in revenue recognition caused by the new standard could also impact the income tax reporting and related financial reporting for income taxes. 6 It will be important for tax professionals to be involved in assessing the standard s impact. Tax professionals will need to understand any changes in the amount or timing of revenue recognition that may result for financial reporting purposes to evaluate the impact on taxes. Examples of tax implications include changes to the: Accounting for financial reporting purposes that may not be acceptable for income tax purposes, resulting in temporary differences between financial results for accounting and tax purposes; and Attribution of revenue to goods and services included in multiple element arrangements, which would result in changes in how sales and use taxes are calculated. Potential Impact to Financial and Business Practices Companies will need to understand the impact that the standard may have on financial results so they can manage changes to business practices. Some examples include: Significant changes in the amount or timing of revenue and earnings could result in changes in key performance indicators or other metrics used to communicate financial results. Companies should develop internal and external communication plans so interested parties can understand the implications of the new measures on historical and current key performance indicators. Changes in revenue and earnings may impact sales commissions, bonuses, and other employee incentive plans. The earnings or revenue goals included in these plans may need to be reconsidered. Companies with new long-term compensation plans that extend beyond the effective date should consider provisions allowing companies to reset the target once the standard is effective to avoid potential conflicts in future periods. Companies considering the use of these provisions in share-based payment arrangements need to consider the impact that these terms will have on establishing a grant date for awards. 7 Companies amending share-based payment arrangements also should consider the accounting and tax implications that result from a modification of the award. Changes in earnings may affect compliance with debt covenants or financial assurance tests. Negotiations of new borrowings may need to include provisions that allow covenant ratios to be reset to reflect the impact of the new standard. Failure to include these provisions could cause companies to seek amendments to the contractual terms, and this may be a costly process. To the extent that currently outstanding debt arrangements with financial 6 6 For additional information see KPMG s Defining Issues No. 13-14, The Revenue Recognition Project: Tax Considerations, available at www.kpmginstitutes.com/financial-reporting-network. 7 FASB ASC Topic 718, Compensation Stock Compensation, available at www.fasb.org.
covenants will be in place subsequent to the effective date, companies should proactively consider whether those arrangements need to be amended to avoid a potential covenant violation. Similarly, companies subject to financial assurance tests will need to consider the impact on their forecasted compliance with the requirements. Ongoing or contemplated finance transformation projects, including systems implementations, may need to consider how implementation of the standard will impact the project requirements to avoid costly rework. Companies should consider business practices and strategies (e.g., pricing, marketing, and contracting) that are impacted by implementation of the standard. Planning for changes in pricing strategies may be critical and require coordination with legal and business operations personnel. Companies also may consider changes to their existing business models because the standard can affect how they recognize revenue. Companies exploring new strategies should not only consider the accounting implications of those strategies, but also the effect on internal control over financial reporting. Communication Plan and Auditor Coordination Companies should develop a plan for communicating with internal and external parties. Companies should consider the following: Parties charged with oversight and governance will need to be kept abreast of key decisions made in developing the implementation plan and the progress made in analyzing and implementing the standard. These parties could include executive management, internal audit, the audit committee, the board of directors, and others charged with governance. Internal stakeholders who are involved in the implementation or who will be affected by it such as individuals within investor relations, business operations, sales and marketing, information technology, and legal must be informed. External stakeholders, such as financial analysts, investors, and lenders will be interested in the standard s impact on financial trends. Companies also should involve their external auditor in the implementation planning that includes developing milestones and touch points to ensure that accounting decisions, judgments, estimates, and internal control considerations are vetted to minimize surprises later in the process. 7
SEC Registrants Defining Issues February 2014, No. 14-9 Prior to the adoption of the standard, SEC registrants will be required to disclose its expected impact. 8 The expectation is that companies disclosures will become more robust as the effective date of the standard nears. Matters required to be disclosed include the transition method that is expected to be used for adoption and the impact that the adoption is expected to have on the financial statements. In addition, disclosure of the potential impact of other significant related matters that registrants believe might result from the adoption is encouraged. These could include changes in business practices put in place as a result of the standard. For example, the software industry and perhaps others may consider the elimination of the industry-specific revenue guidance in current U.S. GAAP an opportunity to make changes in pricing policies, contracting practices, or other elements of their business. While the standard will supersede most of the FASB s revenue guidance, SEC registrants will need to monitor the SEC staff s actions with respect to its existing guidance. 9 8 Start Assessing the Standard s Impact Because the effective date will not occur for several years, it might seem early to start assessing the impact of the standard. However, with no option for prospective adoption, some companies will want to implement process and systems changes early to enable a dual-reporting capability prior to the effective date. A timely start to the implementation process will allow companies to assess the impact and design an appropriate implementation plan that allows time for unanticipated complexity. Advanced planning also will provide companies with additional flexibility to maximize the use of internal resources by spreading the work over a longer period and including system design changes as part of the solution. By starting early, companies also will be able to thoroughly execute the implementation process, which includes four primary phases. 8 Staff Accounting Bulletin Codification Section 11.M, Disclosure Of The Impact That Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrant When Adopted In A Future Period, available at www.sec.gov. 9 Staff Accounting Bulletin No. 104, Revenue Recognition, available at www.sec.gov.
Next Steps. Companies should take steps to understand the standard and to evaluate the impact it will have on their financial reporting and their operations. In some cases, companies may quickly decide that the impacts are minimal, in which case it may be appropriate to wait longer to develop an implementation strategy. However, other companies will be faced with substantial impacts that will require a major implementation effort and therefore should begin planning as soon as possible. Companies should consider the following actions during 2014: 1. Establish a cross-functional project team and other necessary governance structures (i.e., steering committee) that will be responsible for educating employees about the standard and developing an implementation plan. 2. Analyze current revenue policies against the standard to identify expected accounting changes. In some cases, detailed reviews of individual customer contracts may be required. 3. Evaluate the expected accounting changes to identify new information needed to support calculations, estimates, and disclosures that are being introduced. 4. Map the new information requirements to existing systems and processes to determine where gaps exist. Identify how to best fill those gaps (manual process changes, system changes, etc.). 5. Build a project timeline considering the degree of accounting change expected, the amount of new information needed, the process and system changes that likely will be required, and the requirements for calculating the transition adjustments. 6. Determine the resources needed for implementation and their availability. 7. Begin communicating with those charged with governance and internal stakeholders who will be involved or affected by the implementation effort. 8. Consider the impact to internal controls that may result from the introduction of new estimates and judgments and process changes. 9. Review the expected accounting changes with tax personnel and evaluate the extent to which tax resources will need to be involved in the implementation. 10. Identify other parties beyond accounting and tax that will need to be involved (e.g., individuals within investor relations, business operations, sales and marketing, information technology, and legal). 11. Develop initial thoughts about the transition approach. 12. Involve the external auditor in implementation planning. 9
Appendix Implementation Resources The following information on our Financial Reporting Network may assist companies as they plan for implementation of the forthcoming standard. Our Executive Accounting Update provides a high-level overview of the forthcoming standard and includes industry-specific supplements that identify specific industry issues to be evaluated and a transition supplement that provides considerations for evaluating the transition options. CFO Financial Forum Webcasts present our analysis of the forthcoming standard based on the FASB s November 2011 revised exposure draft and significant decisions reached during redeliberations. We will host a CFO Financial Forum Webcast on Implementation Considerations. After the FASB issues the final revenue recognition standard, we will host a series of new CFO Financial Forum Webcasts to discuss the new standard. 10 Defining Issues analyze the revised exposure draft and significant decisions reached during redeliberations. We will publish a Defining Issues that provides an overview of the final standard shortly after it is issued. Issues In-Depth No. 12-1, Boards Revise Joint Revenue Recognition Exposure Draft, provides a detailed analysis and discusses significant implications and potential application issues of the revised exposure draft. We will publish another edition of Issues In-Depth after the final standard is issued. Podcasts provide a five- to ten-minute summary of significant decisions and implications of the forthcoming standard. Revenue recognition podcasts are available on all of the Boards redeliberations on the revised exposure draft. Additionally, podcasts are available discussing some potential impacts of the forthcoming standard on specific industries. Our International Standards Group (ISG) also publishes several resources for financial reporting professionals. While the focus of ISG publications is on IFRS rather than U.S. GAAP, companies that report under IFRS may find these publications useful. These resources are accessible on our Financial Reporting Network Web site at www.kpmginstitutes.com/financial-reporting-network Contact us: This is a publication of KPMG s Department of Professional Practice 212-909-5600 Contributing authors: Brian K. Allen, Michael P. Breen, Paul H. Munter, Benjamin B. Reinhardt, Stephen G. Thompson, and Jonathan M. Hunt Earlier editions are available at: http://www.kpmginstitutes.com/financial-reporting-network Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the forthcoming standard or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP.