Audit Implications of the New Revenue Reporting Standard A Panel Discussion By CPAJ Staff Featured, February 2019 Issue | March 2019 Get Copyright Permission About the Panelists The panel featured Meredith Canaday, CPA, partner in the department of professional practice at KPMG; Sheri Fabian, technical partner in the national professional standards group at Grant Thornton LLP; and Scott Taub, CPA, managing director at Financial Reporting Advisors LLC. Robert Colson, PhD, CPA, distinguished lecturer in the accounting department at Baruch College, New York, N.Y., moderated the panel. The following is an edited and condensed summary of the panel discussion. The views expressed are the panelists' own personal views and not necessarily those of their employers or those employers' boards, management, or staff. * * * Colson solicited questions from the audience to ask the panelists. The first question, directed at Taub, asked for the most challenging consultations he had faced in implementing the new revenue recognition standard. He said the most common issues are defining contracts, manufacturing custom goods, and evaluation of customer rights. "Almost every contract between two businesses has some termination clauses in it, and those can affect your definition of the contract," he said. Regarding manufacturing custom goods, Taub said that "companies need to think about whether they ought to be recognizing revenue over time, rather than upon shipment. FASB and IASB thought about this and under certain circumstances, they concluded revenue should be recognized during production." This also ties into termination of contracts, he says, as the right to payment comes into play, even if such termination is not contractually allowed. With regard to customer options, business must evaluate whether they represent material rights that need to be accounted for. "This is something that people have not necessarily been thinking through in the past, in the same way as under ASC 606." Colson then asked Canaday about her experience with early adopters of the standard. "I think it's natural for companies, as well as for auditors, to feel like the most conservative answer is the right answer, and that's not necessarily the case," she said. The new framework, Canaday explained, introduces its own biases contrary to the traditional bias of companies accelerating revenue that auditors tend to audit against. Taub added that companies he has talked to have been surprised that an accounting approach that delays revenue recognition might not be the correct one any more. He also noted that, while some companies are happy with the standard and some are not, "all of them have learned a lot more about the contracts that their operations people are entering into than they used to." Beyond the Accounting Department When reviewing contracts, Canady said the first step is separating contracts into "standard" and "nonstandard"; nonstandard contracts may require expert review, while standard ones will need appropriate controls to ensure they are indeed standard. Fabian agreed, saying, "We stress that this has got to go beyond the accounting department." She added that the sweeping changes in the standard will require a strong look at controls, "all the way from recording the transaction to gathering the information that they need for their disclosures, because the disclosures are different." Changes to Disclosures Colson then asked Taub to cover how companies might handle disclosures around disaggregation of revenue. Taub was quick to point out that there is a strong differentiation between public and private companies. "Public companies need to disaggregate revenue with as many different cuts and in as much detail as is needed to give an idea of how different buckets of revenue respond differently to economic or market factors," he said. "For private companies, it's different; you're only required to break it down between revenue recognized at a point in time and revenue recognized over time. You are encouraged to do more than that, but don't have to." Canaday agreed, saying that the new rules will lead to "tough conversations with the client." She also said that testing controls will be important. "You may design your audit test to audit revenue in a way that is not on the same basis as what's dis-aggregated in the disclosure. Do I need to design new and different audit procedures specifically for those disclosures?" Pictured: Robert Colson, Sheri Fabian, Meredith Canaday, Scott Taub Fabian added that the goal of the new disclosure objective is to ensure consistency in the information companies give to different stakeholders (i.e., shareholders, analysts, the public). "I would expect most of these [revenue disclosures] are going to look very different than what we've seen in the past," she said. Colson then asked how companies are handling no longer being able to make boilerplate disclosures for many forms of revenue. Fabian replied that companies are "struggling to figure out what the right balance is," noting that the SEC has advised some registrants that they are not being specific enough. Taub added that the addition of quantitative disclosures makes it harder for companies to be boilerplate: "For some companies, a rollforward of contract assets and liabilities is easy to do; for others, it's really hard and may not be meaningful. So there is some thought that needs to go into getting those disclosures correct." "For some entities, disclosures is the biggest impact," Canaday added. "The quantitative disclosures create new system and process challenges. ... As auditors, you just don't need to wait until the end and expect to get a checklist from the client and fill it out." Other Questions Colson asked about unforeseen implications of the standard for internal controls over financial reporting. Canaday answered that the removal of bright lines and the shift to greater use of judgment has made inspection of controls more important. "Do you have the right people at the right competence level executing the process? Has your client responded to the accounting risks by designing appropriate controls?" Fabian added, "Does the client have the right skill set to evaluate and understand their contracts, and flow them through the model?" Colson then asked what key estimates clients have struggled with. Taub cited contingent revenue, which must now be estimated, while Canaday said that the removal of the option to assume the maximum for returns reserve estimates has stymied some clients. Fabian added that some significant reversals that look like errors might be valid changes to estimates. Colson's next question was about clients who try to avoid disaggregating and disclosing a significant revenue stream that analysts would want to know about. Canaday said that justifying not making the disclosure will be difficult if the revenue stream would have a significantly different reaction to an economic downturn. Taub agreed, saying that this would be an attention point between companies and their auditors and between companies and the SEC, as it has been in the past. Finally, Colson asked about the PCAOB and what issues it might pay attention to in its inspections under the new standard. Fabian said that the PCAOB has put out a practice alert on auditing revenue that makes a good starting point, while Canaday said that things that are important in other areas of the audit will be just as important in revenue recognition. Answer the following questions What are the five steps to ASC 606? (CLO 1) Why are revenues from Microsoft Office 365 accounted for differently than Microsoft Office 2019? (CLO 1) What is Le Compte Rendu au Roi? How is Accounting Standards Codification 606 intended to increase financial statement transparency? (CLO 1)