May 25, 2017

Revenue Recognition: Watch Out for Material Weaknesses!

Last month, John blogged about disclosing material changes to ICFR that result from the new revenue recognition standard – which takes effect at the start of next year. It’s also worth noting that revenue recognition is one of the most common accounting issues that trigger a material weakness. And having a material weakness is more than just embarrassing – SEC Chief Accountant Wes Bricker cited these nasty consequences in his recent speech:

– Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies

– After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points

According to this Deloitte memo, companies can avoid a material weakness by identifying controls necessary to make judgments under the new standard. Here’s a teaser:

The new revenue standard requires companies to apply a five-step model for recognizing revenue. As a result of the five steps, it is possible that new financial reporting risks will emerge, including new or modified fraud risks, and that new processes and internal controls will be required. Companies will therefore need to consider these new risks and how to change or modify internal controls to address the new risks.

For example, in applying the five-step model, management will need to make significant judgments and estimates (e.g., the determination of variable consideration and whether to constrain variable consideration). It is critical for management to (1) evaluate the risks of material misstatement associated with these judgments and estimates, (2) design and implement controls to address those risks, and (3) maintain documentation that supports the assumptions and judgments that underpin its estimates.

You’ll need to consider one-time controls that relate to implementing the new standard as well as ongoing controls to track information and support sound revenue recognition judgments going forward. And remember – strong controls are also a “must” for your pre-adoption transition disclosures…

Revenue Recognition: Enhance All Of Your Revenue Disclosures…

This blog from Cydney Posner digs in to the myriad of revenue recognition disclosure issues that are coming our way. I blogged last month about transition disclosures – but those are just the tip of the iceberg. In recent remarks, Sylvia Alicea of the SEC’s Office of Chief Accountant explained:

The disclosures required by the new standard are designed to allow an investor to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

The pertinent facts and related reasonable judgments related to a registrant’s contracts with customers, including the significant judgments made in applying the principles of the new revenue standard, should be disclosed to better inform investors’ decisions.

This disclosure will be different & more detailed than what currently exists – and it’s best to think through it before you face a looming reporting deadline.

Revenue Recognition: Impact on Contracts

Here’s a friendly reminder that you should already be incorporating the new revenue recognition concepts in your contracts. This blog by Steve Quinlivan elaborates on drafting tips that align with the 5 steps outlined in the new standard. Here are a few things to watch for:

– In some situations, you might have to combine contracts entered into around the same time with the same customer & account for them as a single contract

– If the contract involves both goods & services – and you want to separately recognize revenue for these deliverables – make sure to draft them as distinct obligations and allocate the contract price

– Variable consideration can make it tricky to estimate & recognize revenue

– Make sure your team understands that performance under the contract – not necessarily timing of payments – triggers revenue recognition

For even more detail on these points, take a look at this speech from Sylvia Alicea of the SEC’s Office of Chief Accountant.

Liz Dunshee