Tag Archive: revenue recognition

Boardroom Implications for the New Revenue Recognition Standard

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It’s all a matter of time—at least when it comes to recognizing revenue at public companies. The Financial Accounting Standards Boards (FASB) and the International Accounting Standards Board (IASB) in 2014 developed an accounting rule that is set to change how companies approach revenue recognition. The rules, available here, go into effect for public companies with fiscal years beginning after December 15, 2017, and will have major consequences for financial reporting in many industries.

To address the executive-compensation implications of the revenue recognition standard, NACD, executive compensation advisory firm Farient Advisors, and law firm Katten Muchin Rosenman cohosted a meeting of the Compensation Committee Chair Advisory Council on April 4, 2017. During that meeting and its related teleconference, Fortune 500 companies’ compensation committee chairs came together to discuss leading practices and key considerations related to the impact of the new revenue recognition standard. Jose R. Rodriguez, partner in charge and executive director of KPMG’s Audit Committee Institute, joined council delegates for the discussion. The meeting was held using a modified version of the Chatham House Rule, under which participants’ quotes (italicized below) are not attributed to those individuals or their organizations, with the exception of cohosts. A list of attendees’ names are available here.

About the New Standard

A 2014 press release from FASB explained the rationale behind the new standard, noting that revenue is an important metric that investors use when trying to understand how a company has performed and its potential for future performance. Previous accounting standards from the International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP), however, were somewhat at odds, according to the press release. Those inconsistencies between IFRS and GAAP meant that different industries that had very similar types of transactions were accounting for revenue in sometimes very different ways. The revenue recognition standard aims to bring more consistency to accounting done for similar types of transactions.

A key part of the new standard is that revenue can only be recognized—among other requirements—once customers actually benefit from the services or goods that the company has already provided them, as noted in the Journal of Accountancy. The Journal continues that if a company provides a customer with goods or services over time, such as a yearlong service contract, the company can recognize revenue as the customer receives benefits in the contract period. For more information on the standard, see this four-page overview and in-depth guide from KPMG.

Key Questions Directors Should Ask
While the level of disruption that the revenue recognition standard will cause varies by industry and company, four questions important for all boards emerged from the Advisory Council meeting:

  1. How will the new revenue recognition standard affect our company specifically?
  2. Does the board understand the key milestones for the revenue recognition standard and how the company is progressing in light of those milestones?
  3. How will compensation plans be affected?
  4. How will our disclosures need to change?

How will the new revenue recognition standard affect our company specifically?

Impact of the new standard will vary widely for a few reasons.  First, sales and service contracts can differ significantly depending on industry—consumer products, health care, manufacturing, IT, and so on. Additionally, the types of sales contracts—and, therefore, the way revenue is recognized—can differ even within a single company, depending on the types of products and services sold. The company’s suppliers and vendors are a third factor influencing change: “Even if the standard doesn’t affect our core business, we could be working with partners and vendors that are affected,” said one director. “One of my companies has hundreds of millions of dollars in service contracts,” another delegate commented. “Our whole income statement is going to change.”

“Every company’s finance department has been looking at this,” Rodriguez said. “Ask your CFO to brief the board about the major income-statement changes that will occur for the company. What will be affected across all revenue lines? How are key reporting processes changing to accommodate the new standard?”

Does the board understand the key milestones for the revenue recognition standard and how the company is progressing in light of those milestones?

Rodriguez said that a pitfall for many companies is not investing enough time upfront in ensuring compliance with the new standard. “Some companies are finding that this is a bigger lift than they thought [to adopt the standard], so they are having to scramble to coordinate.”

Rodriguez shared several steps that companies can take to prepare:

  • Forming cross-functional task forces that integrate finance, accounting, IT, legal, and HR to ensure activities are coordinated.
  • Designating a revenue group to analyze contracts in different regions and locations to ensure all jurisdictions are covered.
  • Devoting sufficient time and resources to make required changes and upgrades to IT and reporting systems, especially in companies that have multiple legacy systems in place.
  • Developing a communication plan to explain to affected employees (especially on sales teams) how the changes will impact their work. “This is actually a huge change-management process,” one council delegate said. “You have to re-train sales people about how they design contracts and agreements.”

How will compensation plans be affected?

Council delegates agreed that compensation committees need to have a clear understanding of how the new standard will affect the key metrics that drive compensation for all levels of employees, from rank-and-file to the C-suite (For more information on incentives and risk taking, please see NACD’s brief, Incentives and Risk Taking). Changes to the way revenue is reported could have a major impact on the numbers used in annual bonus plans, as well as on long-term incentive plans that are already in place.  “With multi-year incentive plans that are in mid-cycle, the effects could be quite complex,” said Dayna L. Harris, partner at Farient Advisors. “For compensation committees, it will be important to ensure incentives are paid out in a way that’s appropriate to what was originally intended to keep consistent with the compensation philosophy the board has devised.”

Compensation committees can ask the following questions:

  • Is the company adopting the new standard prospectively or retrospectively, and how will that change our revenue numbers?
  • Which compensation plans will be affected beyond the CEO and named executive officers (e.g., sales staff at multiple levels)?
  • What do we anticipate will be the impact on the peer groups we use to benchmark executive compensation?

Rodriguez suggested that compensation committees schedule a briefing session with the external auditor, audit committee chair, CFO, and compensation consultant to discuss these and other questions. Members of the audit committee can also be invited to the briefing.

How will our disclosures need to change?

As noted in the Report of the NACD Blue Ribbon Commission on Board-Shareholder Communications (p. 17), “Directors have a general responsibility to oversee the company’s disclosure programs. They also need to take special care in reviewing certain specific disclosures—notably the company’s regular financial disclosures, such as the proxy statement, 10-Ks, 10-Qs, and 8-Ks, as well as any securities registration statements filed with the [U.S. Securities and Exchange Commission (SEC)].” A director observed, “In addition to the changes to reports, we need a strategy to communicate with our major investors. They will be asking questions about why compensation payouts appear to have ‘changed.’”

The SEC will task review teams with scrutinizing public companies’ financial disclosures, 10-Ks especially, to determine if the statements include information on the revenue recognition standard, Bloomberg BNA reports. Mark Kronforst, chief accountant of the SEC’s Division of Corporation Finance, told Bloomberg BNA, “I don’t think that we will be shy about issuing comments if we don’t see the disclosures.”

“Accounting changes should not interfere with a good business decision, performance outcomes on incentives, and appropriate incentive payouts,” said Harris. “With an accounting change in the middle of a performance period, compensation committees will need to provide full transparency into incentive payout decisions, especially if they appear larger than expected under the new accounting. There’s a whole list of ramifications if that transparency is lacking, from proxy advisors’ criticisms to activist investors’ reproach.”

And there’s no time like the present to understand those ramifications and ensure that management stays on top of key milestones.

Key Insights From the Audit Committee Chair Advisory Council

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On June 19, NACD and partners KPMG’s Audit Committee Institute (ACI) and Sidley Austin LLP co-hosted the most recent meeting of the Audit Committee Chair Advisory Council, bringing together audit committee chairs from major U.S. corporations, key regulators and standard setters from the Securities and Exchange Commission (SEC), Public Company Accounting Oversight Board (PCAOB), and Financial Accounting Standards Board (FASB), and other audit experts for an open dialogue on the key issues and challenges impacting the audit committee agenda.

As detailed in the summary of proceedings, the forum provided timely insights into a number of issues that are top of mind for audit committees. Key insights from the dialogue include:

  • As the PCAOB continues to focus on enhancing auditor independence, skepticism, and objectivity, audit committees are wrestling with how to make the best use of PCAOB inspection reports, with some questioning the timeliness and relevance of the reports and the use of the term “audit failure.”
  • Audit committees continue to discuss the potential value of more robust reporting from the audit committee and external auditors to provide greater insight into their work. Most delegates agreed that the auditor’s statement is the right area of focus.
  • Companies should be preparing for the impact of FASB’s “big four” convergence projects—revenue recognition, leases, financial instruments, and insurance contracts—with a particular focus on the lead time IT departments will need to implement systems changes.
  • Under new leadership, the SEC is refocusing on corporate accounting fraud and the quality of financial disclosures, while moving ahead with its already heavy rule-making agenda resulting from Dodd-Frank mandates and the JOBS Act.
  • The allocation of risk oversight duties among the audit committee, full board, and other board committees is receiving increased attention, as the risk environment becomes more complex and audit committees reassess their risk oversight responsibilities.
  • In their oversight role, directors serve in a part-time capacity, while management is full time, resulting in executives having a much deeper knowledge of the operational aspects and risks of the company. To overcome this inherent imbalance, directors should apply a “healthy” level of skepticism to the information and assumptions management provides.
  • The audit committee’s effectiveness hinges not only on having the right mix of skills and backgrounds, but also having a robust onboarding process and commitment to continuing director education.

For the full day’s discussion and proposed council action items, click here to read the summary of proceedings.

Update on FASB Projects

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In just twenty minutes, Financial Accounting Standards Board (FASB) Chairman Leslie F. Seidman provided conference attendees with an overview of today’s key accounting issues. Although she tried to frame it as a briefing one would give in an elevator, she observed it would need to be “a very large elevator, in a very tall building.” Seidman chose two topics to highlight, providing sufficient information so attendees would be able to inquire their management teams further.

Seidman first addressed FASB’s project on convergence and the adoption of IFRS standards. Although FASB has been committed to adopting global accounting standards since the 1990s, the project has somewhat stalled in the last several years as a result of the financial crisis. Not only have key components seen significant delays, in July the Securities and Exchange Commission (SEC) issued a report on the project which did not include a decision or recommendations for future work.

Although Seidman believes the financial crisis has highlighted the need for consistent reporting globally, the fallout has shifted attention away from the convergence project. Additionally, the economic recession has made the cost-benefit analysis of switching standards an even larger issue. Because the vast majority of companies in the U.S. are domestically focused in both their operations and where they raise capital, the benefits of consistent standards must outweigh the potentially significant costs. Furthermore, if globally accepted standards are implemented, they will not necessarily be applied consistently, which can result in reporting that is still not comparable.

Despite the project’s roadblocks, the FASB will continue to work with the IASB. Directors can expect either reports or exposure drafts to be issued in the first quarter of 2013 on revenue recognition, leasing and certain areas of financial measurement. An exposure draft on the impairment element of financial instruments is expected to be released in the fourth quarter of 2012.

Seidman also discussed the issue of disclosure reports. Specifically, a call for companies to use disclosures to highlight only material information. Reports should also be structured to highlight the most important information in footnotes. She noted two companies, Sprint and Hartford, who voluntarily cut the length of disclosures without FASB assistance. At these companies, senior management committed to an examination of footnotes to remove immaterial, irrelevant information.