Levin Lobs Challenge to FASB, SEC on Rev Rec

by Edith Orenstein

All eyes are on the Financial Accounting Standards Board (FASB) and the U.S. Securities and Exchange Commission following a letter sent by Sen. Carl Levin (D-Mich.) to the Chairman of the FASB.

In the letter, Levin warned of the potential for abuses in financial reporting from the more 'principles-based' Revenue Recognition standard issued by the U.S. accounting board in May of this year versus the SEC's more prescriptive, 'rules-based' revenue recognition requirements set forth in Staff Accounting Bulletin No. 101 (SAB 101).

Levin's letter (PDF), carrying the Subject Line: ReConvergence that Isn't Working, first received wide public attention in an October 31 article written by Steve Burkholder, published in Bloomberg BNA's Accounting Policy and Practice Report,  Levin Slams FASB-IASB Convergence Work; Urges U.S. Panel to Fortify Revenue Rules .

Levin posits in his letter that FASB's new Rev Rec rule, issued concurrently with the International Accounting Standards Board's (IASB) new Rev Rec rule in May, 2014, amounts to a "relaxation of  revenue recognition standards," particularly when compared side-by-side with the more prescriptive SAB 101, which was created during then-SEC Chairman Arthur Levitt's pursuit of fraudulent financial reporting.

The Senator calls upon FASB to "strengthen the new standards for revenue recognition," and, "At a minimum... issue anti-abuse rules to combat the potential misuse of the principles-based convergence standards and make enforcement of accurate accounting standards both possible and effective."

Rev Rec 101: How Does FASB's Standard Differ from SAB 101?

To examine the questions raised in Levin's letter, particularly as relate to the new Revenue Recognition standard, let's compare the five principles of FASB's new Rev Rec standard versus the four principles stated in SEC's SAB 101:

SEC Staff Accounting Bulletin 101 (SAB 101), published Dec. 3, 1999, states: "The staff believes that revenue generally is realized or realizable and earned when all of the following criteria are met:

  1. Persuasive evidence of an arrangement exists,
  2. Delivery has occurred or services have been rendered,
  3. The seller's price to the buyer is fixed or determinable, and
  4. Collectibility is reasonably assured.
FASB Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), requires five principles to be satisfied, to recognize revenue:
  1. Identify the Contract with a Customer
  2. Identify the Performance Obligations (Promises) in the Contract
  3. Determine the Transaction Price 
  4. Allocate the Transaction Price to the Performance Obligations in the Contract
  5. Recognize the Revenue When (or as) the Reporting Organization Satisfies a Performance Obligation 
In asserting that there may be a threat of more abuse of FASB's 'principles-based' rev rec standard, when compared to SAB 101, Levin focuses on the fact that, "SAB 101 requires that collectibility from the customer must be 'reasonably assured."   This is in contrast to a view some may have that FASB's standard has lowered the threshold for revenue recognition, pointing to the "probable" threshold identified in a footnote in FASB ASC No. 2014-09,  further defining what "Contract" means:

"A contract is an agreement be­tween two or more parties that creates enforceable rights and obligations. The new revenue recognition guidance applies to each contract reporting or­ganization has agreed upon with a customer and meets the follow­ing criteria:

  • Approval and commitment of the parties
  • Identification of the rights of the parties
  • Identification of the payment terms
  • The contract has commercial substance, and
  • It is probable that the reporting organization will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer."
The Senator also posits that FASB's new rev rec standard will permit recognition of revenue when a company transfers inventory to its warehouse - even potentially with a right of return - the subject of past revenue recognition abuses, vs. requiring transfer of inventory to a customer.

However, a footnote in FASB's ASC 2014-09, further defining Principle 5 above, as to when revenue may be recognized, states:

A reporting organization recogniz­es revenue when (or as) it satisfies a performance obligation by trans­ferring a promised good or service to a customer, which is when the customer obtains control of that good or service.
This point will likely be addressed in FASB's detailed response.

FASB's Initial Response

Robert W. Stewart, Senior Vice President, Public Affairs at the Financial Accounting Foundation - parent of the FASB, provided the following statement as an initial response to the issues raised in Sen. Levin's letter:

"The FASB’s first priority always has been to develop accounting standards that serve the best interests of investors and others who participate in U.S. capital markets – and other markets around the world that use or reference Generally Accepted Accounting Principles (GAAP).

We very much appreciate Sen. Levin’s interest in the continued success of the U.S. capital markets and our efforts to work with the International Accounting Standards Board and other standard setters to make global accounting standards more comparable.

The specific issues he has raised regarding the new revenue recognition standard – and the broader issues regarding the appropriate relationship between the FASB and the IASB – are very important. We will address both in a detailed response that we are preparing to the senator’s letter.”

What Will SEC Say?

Attention will also turn to the SEC, and its newly installed Chief Accountant, Jim Schnurr, for their thoughts on Levin's claims, the status of SAB 101, and whether further rev rec guidance is likely from the SEC.

In remarks at a Financial Accounting Standards Advisory Council meeting in September, the SEC's Senior Associate Chief Accountant indicated the SEC will determine what action, if any, it will take, based on monitoring implementation of FASB's new standard, including issues brought to the FASB-IASB Joint Transition Group on revenue recognition.

As reported by Compliance Week's Tammy Whitehouse in Septemeber, in SEC Offers Early Relief on Revenue Recognition, Whitehouse cities the SEC official's comments at the FASAC meeting:

The staff also is considering whether the SEC should make any changes to its own regulations on revenue recognition or whether it might be necessary to rescind or revise any staff guidance on revenue recognition. “We expect our efforts in monitoring implementation as issues come to light will inform us on that,” she said.
My Two Cents

It will be interesting to see how the SEC, in particular will respond - whether formally or informally, to the assertion made by Sen. Levin, that FASB's rev rec standard represents a 'relaxation' of previous rules on revenue recognition, including, significantly, SEC's SAB 101. Although the Senator's letter was addressed to the Chairman of the FASB, (to which FASB is preparing its formal response, as noted above) and not addressed to - or even cc'ing - the Chairman or Chief Accountant of the SEC, I believe the question of the status of SEC's SAB 101 and any potential future rev rec guidance by the SEC  is a question that FASB and SEC-watchers will be looking for some kind of indication from the SEC itself.

Further, I would expect some commentary on this issue to come from the SEC sooner than later - perhaps the timetable may have been sped up by Sen. Levin's letter - and not necessarily solely as the result of monitoring implementation issues, including those discussed by the FASB-IASB Transition Resource Group - a group of top experts that meets periodically, most recently on Friday, October 31.

In fact, at last week's Rev Rec Transition Resource Group (TRG) meeting, FASB Vice Chairman (and former SEC Chief Accountant) Jim Kroeker stated that FASB is undertaking an active outreach exercise in response to calls from some corners to delay the effective date of the new FASB rev rec standard. Kroeker added, as reported by Denise Lugo of Bloomberg BNA in, FASB Evaluation on Deferral for Revenue Rules Likely Ready Early 2015 (subscription required) that FASB expects to complete its consideration of this issue by Second Quarter, 2015.

Significantly, Kroeker urged constituents calling for a delay of the rev rec standard, to move ahead with implementation efforts, on which to base a call for deferral of the standard, rather than to simply put off implementing the standard.  According to Bloomberg BNA's Lugo, Kroeker told the TRG:

I would say ‘those who haven't begun a process of adoption—get started, so we can actually have data to understand what the application challenges are in transition,” he said.
In my view, perhaps with the light of day shown below the lens of Sen. Levin's letter, widely publicized by BBNA's Burkholder concurrent with the move of clocks back to Standard Time, the question of the status of SEC's SAB 101 vis-a-vis - not 'versus' - FASB's new rev rec standard, may be something that calls for clarification sooner than later, as companies move to implement the new standard and gauge its impact.

Cullen Walsh, Assistant Director at the FASB, will comment on a number of issues related to the new  Revenue Recognition standard as part of the FASB Update Session at FEI’s Current Financial Reporting Issues (CFRI) Conference, at the Marriott Marquis Times Square Hotel in New York City on Nov. 17-18, 2014.