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.

Juliette's Lemonade Stands

The Background: In the upcoming summer, thirteen-year-old Juliette wanted to make some cash the old-fashioned way: by getting someone else to earn it for her. Who better than her two younger brothers Victor and Sam? After all, they were eager and would work for chocolate. Who knows, maybe her parents would even pay to get rid of them engage the boys in some intellectual activity... Planning for Lemonade Season: Juliette decided to withdraw $300 from her savings account to start two lemonade stands, one each for Victor and Sam. She spent $60 each on two used tables, which had about six seasons remaining. She bought packages of cups and lemonade mix. Juliette also spared no expense to secure two high-quality glass pitchers at a cost of $42 total. The pitchers should last three seasons, or at least that's what the ad said. She skipped buying chairs figuring the boys could stand for a good two hours without complaint or permanent back problems. She also figured she would have to pay them $2 each day they decided to work (yes, violating every child labor law in existence, but she was only 13 and unlikely to see hard jail time). Since each stand would be within walking distance of their home, they could get ice from the freezer as needed, and retrieve water from the garden hose out front. Victor's Set-Up: She set Victor's lemonade stand up first and provided him with 100 plastic cups (cost of $5 total) and four pounds of lemonade mix (cost of $20 total), and she gave him a table and a pitcher. He also got $10 in cash to use for change. Walking away, she was confident that her $116 investment would pay off. As soon as Juliette rounded the corner, Victor called for their mommy and asked to borrow $7 to buy a big umbrella to shelter his delicate skin from the harmful UV rays. Victor is now officially ready for Lemonade Season. Sam's Set-Up: Juliette next turned her sights to Sam's lemonade stand, which would be around the corner. Since he was younger, she only provided him with 50 plastic cups (costing $3 total), and two pounds of lemonade (cost of $10 total). She provided him with his table and glass pitcher. She then gave him only $2 to use for change because she didn't trust him with the cash. She was glad she'd only got $96 invested into Sam's lemonade stand as she didn't think he was going to work very hard. On the other hand, she figured people might buy more junk from younger kids, so who knows? Sam proceeded to watch his big sister head into the house, stirred up the first pitcher of lemonade, made a big "CONTRIBUTIONS WELCOME" sign, then headed over to his buddy's house to play. Of course he poured a couple of cups for the road - after all, they might get thirsty. Juliette hid the remaining money under her mattress just in case it was needed for a good reason in the first couple weeks of the season, then put on her bathing suit. As she headed to the beach with her friends, Juliette couldn't help but wonder if she should have left her hard-earned money in the bank, earning 5% interest guaranteed. This case was prepared by Mark Potter, Professor of Finance at Babson College. It was developed as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The funding for the case was provided by the Teaching Innovation Fund at Babson College. It is not intended to serve as an endorsement, source of primary data or illustration of effective or ineffective management.

Victor's Season: Victor worked a total of 25 days but hadn't been paid yet as he didn't want to take the money until Juliette gave him the ok. He sold 90 cups of lemonade at a price of $2 each and provided her with detailed charts and graphs showing daily and hourly sales. He received cash from 80 customers, and another ten customers said they would pay by the end of the following week. He had a list of everyone who owed money and how much they owed, where they lived, and a signed IOU from each person. He used up three of the four pounds of the lemonade mix. Victor paid mommy back $4 out of what was owed to her for the umbrella. Juliette took a total of $6 from Victor's cash on hand to buy some sunscreen for herself during the summer. The umbrella appeared to be in great shape; it seemed like it could be used for many more years. She gave Victor a pat on the back and told him he may be up for a raise for next year - something like a cost of living adjustment plus 1%.

Sam's Seaons: The first week of the summer, Juliette got worried that she had too much money tied up into her younger brother's stand. So she borrowed $50 from their dad and said she'd pay him back at the end of the summer, plus an additional $5 of interest. Sam said that he had worked a total of 15 days and already taken the $30 that he said he had earned. He claimed to have sold 45 "or so" cups of lemonade, and there was a total of $117 cash on hand at season's end, crumpled up in a can Sam handed to her. Sam swore that he had sold $153 worth of lemonade, and he also remembered selling lemonade to a group of five kids who said they'd drop by at some point to pay up. He had no idea who they were but thought two of them looked familiar. There were no cups left, no lemonade mix was in sight, and the pitcher was broken. Juliette took $8 from Sam's stand during the season to buy some pizza for herself and her friends. There was a note from a neighbor indicating that Sam took some lemonade mix when he supposedly ran out and still owed $4. The table looked pretty rough and Juliette figured that it only had two years of life left on it. Juliette talked to Sam about pink slips, reductions in staff, and layoffs, and she blamed it all on some sort of banking crisis permeating the Eurozone.

Write an essay In 2000 words, explain what can be learned from the two articles mentioned above.