Revenue Recognition implementation takes a lot longer than many people think. By focusing on accounting only, companies won’t get an accurate picture of their overall readiness. Oftentimes, it's the operational aspects that prove to be even more challenging and more time-consuming. FEI Daily spoke with Eric Knachel, senior consultation partner, revenue recognition at Deloitte & Touche LLP, about readiness and Deloitte’s Revenue Recognition Roadmap.
FEI Daily: What will readers find in the new roadmap?
Eric Knachel: We tried to develop a roadmap with different readers in mind. There's information around the initial adoption of the standard and a large amount of technical interpretations. We've also tried to summarize positions from the transition resource group and the FASB. We've also included a section that deals with implementation. Implementation dealing with not only the accounting aspect of implementation, but also the broader aspect of what is involved in implementation. It goes beyond accounting. It's going to involve information technology, legal, human resources, etcetera.
I think we've tried to address a number of different aspects of the new standard beyond just some technical issues, recognizing that a lot of people are in different stages of their implementation process.
FEI Daily: Where are we in the revenue recognition timeline?
Knachel: It depends by company and their year-end. I would say that most companies are generally in what I would refer to as an “assessment phase”. They have made some progress over the summer. When we say on average companies are in the assessment phase, I think that can be a little bit misleading. I would tend to divide companies into two large buckets. One is large companies in those sectors where they believe they have potentially significant changes, such as aerospace and defense, media and technology. Large companies in that space have made progress. For smaller companies, it's a lot more diverse in terms of their progress and readiness. Generally speaking, I'd say a lot of those companies are behind and still in the earlier stages of their assessment.
FEI Daily: Can you explain the difference between a full retrospective application and a modified retrospective application?
Knachel: Full retrospective involves going back and evaluating and recasting the earlier years that get presented for all contracts in the scope of the new standard. Whereas with modified retrospective a company only needs to evaluate those contracts that are still in process (i.e., that have not been completed) at the date of initial adoption.
Under the modified retrospective approach, a company would determine the impact of applying the new standard to the contracts that are still in process at the date of initial adoption and record the difference between applying the old vs. the new standard as a cumulative effect in the financial statements. The revenue standard is then applied prospectively to these contracts as well all contracts entered into after initial adoption. So whereas under the full retrospective method all contracts that existed in the prior years must be considered, under the modified retrospective method a company does not have to evaluate all contracts that existed in prior years – only those that remain in process at the date of initial adoption.
FEI Daily: What are the advantages and disadvantages of each and how should you decide which route is best for your company?
Knachel: One of the big drivers is the amount of work and the resources that go with that.
On the surface, the full retrospective method (recasting the prior years), sounds like a lot more work. However, in the modified retrospective you still need to go back and look at contracts that were entered into prior years that are still ongoing today. In the year of adoption, you have to record your financial statements under both standards. So you have duel reporting requirements.
I think the most significant thing that companies should be considering is (1) what their peers are doing, and (2) what their analysts want. Analysts typically want to be able to understand trends and they want to be able to compare a company from last year to this year and they also want to be able to compare one company to another company.
If you think about it, if your financial statements have not been recast under the new standard in prior years, that comparison from last year to this year becomes very difficult.
What we've heard from an increasing number of companies is that analysts’ expectations, and evaluating what their peers are doing, are very significant factors. In a number of cases, that seems to result in companies taking a very hard look at the full retrospective method and perhaps pursuing that method of adoption.
FEI Daily: Are we starting to see companies talking about their implementation plans in their disclosures?
Knachel: At this point, I would say not extensively. That's been a subject that has been addressed by the SEC in various speeches and comments that they've made. The SEC is emphasizing that as we get closer to the presumed adoption date, there's an expectation that we should start to see more disclosure, more detail, more granularity in terms of what companies are thinking.
FEI Daily: Are technology tools evolving to help companies with implementation?
Knachel: They are evolving, but it does remain a challenge. I think companies are seizing this opportunity to say, "As long as we're doing that, let's really take a hard look at how we might streamline some of our business operations. What can we change about how we do business?”
FEI Daily: What is your recommendation to companies that have fallen behind when it comes to implementation?
Knachel: Simply stated, the clock is ticking. Time is running out. They need to work on readiness. Looking at the calendar, assuming they're a year-end company, the next three months before they hit their year-end close, those months are critical for them to move forward and make progress. I think that it involves all aspect of their business and, obviously, accounting. The recommendation would be not to limit your efforts and your readiness activities solely to accounting. I think that companies tend to focus on accounting only and that doesn't really encompass all that's involved when you talk about readiness.
There are three areas that come up frequently. The first is IT. When companies get into the accounting, they realize that the company's current systems are not capable of gathering and reporting the data that's required under the new standard, both for financial and reporting and also disclosures. Then, I think they realize that from a legal standpoint the term “contractual arrangements” needs to change due to the new accounting rules. Specifically, legal terms around termination, provisions, and pricing need to be evaluated. The third one is HR. You need to have resources and training to have sufficient people to implement the new standard.
Another thing that's recently come up is compensation arrangements. Many times companies have different types of compensation arrangements or bonus plans that are tied to revenue. The new revenue standard changes how a company can measure revenue.
FEI Daily: What are some of the challenges companies are running into?
Knachel: I would divide the challenges broadly into two categories: operational and technical.
From a technical standpoint, as companies move forward with their assessment phases, they come across new fact patterns or variations of fact patterns that require interpretation. The guidance and the new standard and those interpretations can be complex and can sometimes require involvement from the FASB, the AICPA. That can add complexity and delay the process.
From an operational standpoint, some of the software and solutions are still in the process of being developed. I think that's an issue. Oftentimes the software solutions that they need to include as part of their framework need to be customized based on the companies’ specific business model. It's typically not cookie-cutter.