Selecting a Transition Method

Editor’s note: We are happy to introduce our new guest columnist, Shauna Watson, Global Managing Director of Finance & Accounting for RGP. Shauna, a subject matter expert in U.S. GAAP, IFRS, SEC and PCAOB regulations, will share her valued opinion on a number of topics in this space. Today, she focuses on one of the key aspects of the subject on everyone’s mind, namely the newly converged revenue recognition guidance.

Companies are breathing a sigh of relief with the FASB’s recent proposal to defer the effective date of the new Rev Rec standard as they’re finding that more work than anticipated will be required to comply with the standard – even if the expected financial statement impact is minimal.  There was (and I dare say still is) a serious concern for those wanting to adopt using a full retrospective approach that there simply was not enough time to assess the impact and make the necessary changes to systems and policies.  The FASB’s deferral proposal will likely be approved and thus companies will have an additional year to comply, which will give more companies the option of showing the comparative information required by a full retrospective transition.

As a refresher, the proposed effective date for the standard for U.S. public companies is annual periods beginning after December 15, 2017, and interim periods within that year, so for calendar year public companies, 2018. Private companies are allowed an additional year for annual reporting (i.e. 2019), and don’t need to comply for quarterly reporting until after their first annual report (2020).  The FASB did not permit early adoption, though calendar year-end companies may now adopt as early as 2017 if desired.

Initially, IFRS was effectively the same timeframe except that early adoption is permitted. Although the IASB has yet to decide whether it will allow a deferral, it appears a similar one-year deferral will be proposed shortly.  Despite other areas of the standard becoming less aligned as the Boards discuss technical interpretations and modifications, this is an important area for alignment because if the IASB doesn’t defer,  multinational companies would have the additional challenge of implementing the standard for entities needing to comply with IFRS ahead of the US GAAP implementation.

Transition Options

The first of the two transition options available is a full retrospective method with some practical expedients. If you do a full retrospective, that would mean presenting the 2018 financials with comparative 2017 and 2016 statements for public companies, which would equate to an opening balance sheet (and cumulative effect adjustment) at January 1, 2016 – less than a year away!  Companies with processes and controls and especially systems in place at this point will find the dual reporting requirement for current and future GAAP much easier.  The first date that quarterly information will be required on a comparative basis is the first quarter of 2017, which will make it even more imperative that companies have auditable cut-off procedures in place as of that date.

Companies wanting to show full retrospective presentation, which many will find preferable from a comparability and trending standpoint, are already feeling the pressure.  This, as well as the additional guidance the FASB expects to issue to help clarify technical interpretations, is the reason the standard was deferred in the first place.

As an alternative to the full retrospective method, the Boards also decided late in the deliberations to allow a modified retrospective presentation, which would show a cumulative effect at the date of adoption, but no prior year comparative data. So if the date of adoption is the beginning of 2018, that’s the date it would affect your retained earnings, and all contracts open at that date would be restated, while anything closed out prior would not. For the adoption year – 2018 for calendar-year companies – additional disclosures (essentially the quantitative impact on every financial statement line item) would be required for comparability purposes so that the user of the financial statements could tell what it would have looked like under the old GAAP.

Factors to consider

While the modified retrospective approach is arguable less work, there are several considerations to be examined when determining whether to use the modified retrospective or the full retrospective.

One of the biggest considerations is what your peers are going to present. Investors will likely look for consistent information between peer companies and like to be able to see trending information. Working closely with the industry groups that have been established or are being established would be advisable.  Don’t wait until the last minute to have that discussion with your investors/analysts either – unless you’re prepared to adopt under either method, that would not be a good surprise, and we have seen fire drills driven by investors in the past, particularly with the Registration process.  One last note on this…once you discuss this with your investors and analysts, and have a decision as to the transition method you plan to use, be sure to consider the required SAB 74 disclosures.

Other Considerations:

System Limitations:  Many do not currently have the dual reporting capability which would be ideal for full retrospective adoption, although even the modified retrospective requires dual reporting for the year of adoption (editor’s note: learn more about RevPro 3.0, which will include this capability). You need to look at the limitations and whether you have time to implement a new system or whether you would try to do that some time along the way.

Contract Characteristics: To the extent your contracts are longer in duration or have non-standard terms, whether there are a lot of them, where they’re located and in what language could certainly impact the amount of effort required to do a full retrospective approach.

Availability of Historical Data: Historical data often needs serious cleanup before it can be used to implement the new requirements.  Often, on implementing new standards, errors are discovered in data or accounting which will need to be assessed for materiality and possible restatement.

Impact on Other Contracts: Revenue is obviously an important metric and it drives many other metrics (net income, EBITDA, EPS).  Be sure you’ve identified other contracts (executive and stock compensation, earnouts, debt covenants, etc.) which could be impacted.

Disappearing Revenue:  Since the cumulative effect will be recorded directly to Retained Earnings, there may be some previously planned Revenue which never shows up in the revenue line item in your financials.  As an example, companies who have Deferred Revenue at December 31, 2016 may find that Revenue would have been recognized earlier under the new Standard (for example, in 2015, a year which will not be presented), and thus that Deferred Revenue amount would be reclassified to Retained Earnings.  A similar thing can happen with costs that are required to be capitalized under the new Standard – they may be recognized twice – once as an expense, say in 2015, then capitalized through the transition adjustment, and amortized in future periods!

As you can see, many factors must go into this decision-making process. Many companies remain in the early stages of trying to assess the impact and select a transition method. Indications are that many would like to do a full retrospective, but they’re not sure whether it’s either necessary or if they’re able to do so.

If you haven’t started a high-level action plan, I would say, get started now.  Most companies will be impacted to some extent, and they’re finding out there’s more work to be done than they thought.  Also, companies are resource-constrained and many have sought outside help for additional capacity and expertise.  Starting now will not only allow companies to implement effectively, but to carefully assess the right mix of internal and external resources, and likely utilize in-house resources more fully.  And since the planned transition approach is a key driver of the amount of work to do, there’s no time to wait to perform that gap analysis and select the best transition method for your business, your investors and your budget.

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