- SEC Chief Accountant Wesley R. Bricker recently spoke on advancing effective internal controls and credible financial reporting as it relates to the new revenue recognition standard. Mr. Bricker provided his thoughts on implementation of the new revenue recognition standard, including thoughts on transition disclosures and potential changes in internal controls.
Highlights of Mr. Bricker's remarks regarding implementation of the new revenue standard included:
- Timely implementation of the new revenue standard is important. The standard, including the disclosures in accordance with the standard, is an important step forward in financial reporting, both domestic and foreign, and when implemented, it is designed to enhance the comparability of companies' reported revenues.
- In the encouraging column, some public companies have indicated that they plan to apply the new revenue standard in preparing their first quarter 2017 financial statements, as permitted by the transition guidance in the new standard. In the worrisome column, however, some companies need to make significant progress this year in their implementations. In a survey of public companies released in October 2016, eight percent of respondents at that time had not started an initial assessment of the new revenue recognition standard, while an overwhelming majority of the others were still assessing the impact.
- Particularly for companies where revenue recognition implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why and provide informative disclosures to investors about the status so that investors can assess the implications of the information. Successful implementation requires the engagement of senior management throughout an organization.
- A company must support its presentation, whether gross or net, according to the core principles in the standard, so that investors can understand the nature of the revenue transaction. The new revenue standard does not eliminate all of the judgment required in this area of financial reporting.
- Today's revenue recognition guidance is primarily a risk and rewards based model, while the new standard is focused on control. While registrants may determine that, as a result of applying the new guidance, the presentation of revenue is the same as under today's revenue guidance, the evaluation will need to be based on the new standard, which has new concepts.
- Additional judgments may be needed in applying the new standard, and in some cases those judgments may necessitate changes to internal control over financial reporting.
- Regarding transition disclosures, if a company does not know, or cannot reasonably estimate the expected financial statement impact, that fact should be disclosed. But, in these situations, the SEC staff expects a qualitative description of the effect of the new accounting policies, and a comparison to the company's current accounting to aid investors' understanding of the anticipated impact. It should also disclose the status of its implementation process and significant implementation matters yet to be addressed.
- From a preliminary look at recent Forms 10-K and 10-Q filings, a number of companies have enhanced their transition disclosures, although for others there is still more work to do. For example, some companies indicate that the impact of the new revenue standard is not expected to be material. The changes in the new standard will impact all companies. Even if the extent of change for a particular company is slight, the related disclosures to describe revenue streams may not be. The basis of any statement that the impact of the new standard is immaterial should reflect consideration of the full scope of the new standard, which covers recognition, measurement, presentation, and disclosure for revenue transactions.
Mr. Bricker also discussed potential impacts to internal controls as a result of the new revenue recognition standard and noted:
- The new revenue standard may require changes to relevant business processes and the control activities within them. However, it might also require a refresh of the other components of internal control over financial reporting, including professional competence. Expectations related to the control environment and the other components of ICFR are reflected in the principles of the COSO (2013) framework.
- An aspect of the COSO framework emphasizes the importance of being able to attract, develop and retain competent individuals in alignment with the financial reporting objectives. All companies must have appropriate resources to evaluate revenue arrangements and properly apply the principles of the new standard. While those resource needs might be satisfied, for example, through a designated accounting policy function or through a relationship with a qualified service provider, having resources with sufficient training and competence is fundamental to the effectiveness of a company's overall control environment. With a general movement towards more principles-based accounting frameworks, companies need to assess and continually reassess the impact to their existing accounting and financial reporting competencies and make adjustments as appropriate to their training, retention, and recruitment programs.
- The new revenue standard will require judgments. This highlights the importance of another element of a company's control environment, setting the right "tone at the top" and expectations for responsible conduct throughout the organization. Appropriate tone at the top is the foundation for the consistent application of the sound judgments required by the new standard. Management should consider whether the existing controls support the formation and enforcement of sound judgments or whether changes are necessary.
- Companies may also need to consider any changes they may make to their established business practices as they transition to the new standard. For example, companies may amend or tailor their contracts with customers. Application of the new standard, including preparation of the required disclosures, may also require gathering and analyzing new information and sharing such information with relevant parties. Management should consider whether its reporting systems are designed to accurately capture the effects of changes to customer contracts and other information required for compliance with the new standard and ensure the integrity of such information throughout the financial reporting process. Therefore, it will be important to take a fresh look at the information and communication component of ICFR and the related controls over a company's information technology.
- It is important to keep in mind that the effectiveness of any changes to internal controls are predicated on a comprehensive and timely assessment of risks that may arise as a result of applying the standard. Such risks may exist at various levels and in different areas of a company and their appropriate identification and assessment may require involvement of management and employees from both the accounting and financial reporting function and other functional areas of a company.
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