In order to fully appreciate the implications of the new revenue standards it is helpful to understand the process which led to the changes.
Over the past decade, the Financial Accounting Standards Board (FASB), which establishes generally accepted accounting principles in the United States of America (US GAAP), and the International Accounting Standards Board (IASB), which establishes generally accepted accounting principles for over 100 adopting countries (International Financial Reporting Standards or IFRS), embarked on a joint project to develop criteria for revenue recognition and reporting that would accomplish key goals, including, but not limited to:
While the final standards issued by the FASB and the IASB were not fully converged, many of the major principles in the standards are now more closely aligned than they were under legacy US GAAP and IFRS. Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, and related subsequent amendments (collectively, the new revenue standards) provide guidance on both how revenue should be recognized by organizations and disclosed to stakeholders in financial statement footnotes.
How will revenue recognition diverge from current guidance under the new standards?
Under the new five-step approach required by ASU 2014-09, focus is placed on gaining a holistic understanding of contract elements and terms and disclosing this information to financial statement users.
When contracts include variable consideration or provide the customer with both a good and a service, an entity’s evaluation of how and when consideration is earned will require careful assessment. Currently, contracts are often tracked at the contract level, once the new standards are in place, tracking may be necessary at either a disaggregated level that corresponds to identified performance obligations and associated transaction prices in the contract, or at an aggregate level with other contracts. Furthermore, contracts that include warranty provisions or options to purchase additional physical goods or services will need to be analyzed to identify potentially distinct performance obligations.
While contracts receive considerable focus under the new standards, substance will continue to take priority over form, as the FASB did not want entities to manipulate contracts in order to achieve preferred accounting conclusions. With that said, contract pricing may begin to shift as the new standards are implemented, in order to facilitate alignment of the point at which customers are billed and the point at which revenue is recognized.
How will industry-specific situations be treated under the new standards, now that prior guidance is being replaced by principles-driven fundamentals? Where can my entity find additional information?
The shift away from detailed, proscriptive industry guidance has left many in positions of financial reporting responsibility wondering how they can best comply with the new standards, while also remaining aligned with industry practice.
While the FASB and the IASB worked to provide guidance with applicability across industries, as soon as the finalized core standard was issued, 16 revenue recognition task forces were established by the AICPA to address potential industry-specific issues that were either not addressed or ambiguous in the capstone guidance. The industries involved in the project include aerospace and defense, construction contractors, hospitality, not-for-profits, software, and telecommunications, among others.
Industry-specific questions have been identified by the task forces which are then reviewed by the AICPA’s Revenue Recognition Working Group (RRWG) and Financial Reporting Executive Committee (FinREC), as well as the FASB’s Transition Resource Group (TRG), where applicable. More information regarding the revenue recognition implementation issues that these groups have identified and discussed is posted regularly on the AICPA Revenue Recognition Resource Center and the FASB Revenue from Contracts with Customers Project Update.
Coming up next
The next post in this ongoing series will highlight allowable transition methods, elements of the standards that should be considered in current contract negotiations, and critical actions that should be taken immediately. In the following months, we will explore the five key elements of the new revenue recognition criteria in more detail.
For further information on the revenue recognition standards or questions on how your organization can transition to the new standards, contact Rachel Plumley at 301.231.6200 or firstname.lastname@example.org, or Philip Steigner at 301.231.6200 or email@example.com. Stay tuned for future posts.
No matter if you are a small, medium or a large business, by now you’ve heard the most important reportable item on your financial statement is about to change. What you should be asking yourself however is: are you ready for it?
In September 2016, the Financial Accounting Standards Board (FASB) warned companies that many will need to accelerate their preparation in order to be ready by the revenue standard’s effective date. The new standard replaces approximately 120 elements of industry-specific guidance in current U.S. GAAP with a more principles-driven approach to revenue recognition, and thus implementation may become an extensive project.
Published in May 2014 as FASB Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, with related additional ASUs subsequently providing guidance on narrower elements, the standards collectively are the result of more than a decade of debate about how businesses and groups should report revenue. The standards offer core principles to determine how and when to record revenue, unlike the rules-based guidance U.S.-based entities are accustomed to applying.
Why is revenue the most important measure?
All users of financial statements (including management, shareholders, lenders, analysts, investors, and regulators) look to revenue as a performance and health measure of a company. Because revenue is reported as a cumulative amount of a certain period of time, trends and comparisons are analyzed as well as revenue being an important input in key financial ratios. Revenue can be the attraction or diversion to a company’s ability to attract investors, borrow money, calculate compensation and benefits, and even in tax planning.
Check back with us as we provide a series of updates and guidance to help you prepare now and in the future.
This is the first in a series of publications designed to provide assistance with implementing and understanding FASB’s new standard on revenue recognition. We are excited to give you a more in-depth view into how the changes will impact the measurement and disclosure of what is considered the most important measure of a company’s performance. Over the following months, we hope you will follow along and join us in looking at this new standard. We will provide you with what you need to know to determine the best strategies for successful adoption of the standard, as well as a practical approach to updating your policies and procedures to achieve convergence.
Financial statement fraud schemes commonly take the form of overstated revenue. That was indeed the case in a recent SEC investigation into the falsification of time records by certain professional services employees of Saba Software, a provider of cloud-based intelligent talent management solutions that had its IPO in 2000. According to the SEC, “[t]he improper time-reporting practices enabled Saba Software to achieve its quarterly revenue and margin targets by improperly accelerating and misstating virtually all of its professional services revenue during a four-year period as well as a substantial portion of its license revenue.”
For the applicable time periods, Saba reported annual revenue in the $100M to $120M range. As a result of the time record falsification scheme, revenue was overstated by at least 5% annually, resulting in a cumulative $70M overstatement of pre-tax earnings. From a GAAP perspective, Saba’s improper time-keeping practices precluded it from demonstrating VSOE and therefore required recognition of professional services revenues on a completed contract basis. In short, Saba recognized revenue earlier than it should have, which caused operating results to be materially misstated.
Although there was no indication that the company’s CFO was involved in the scheme, the SEC applied the “clawback” provision of Section 304 of the Sarbanes-Oxley Act of 2002, ordering that nearly $500,000 be reimbursed to Saba for stock-sale profits and bonuses. Separately, a former CEO also agreed to a similar “clawback” of $2.5 million last September, and Saba itself received a $1.75 million financial penalty in connection with the fraudulent accounting scheme.
As this SEC investigation illustrates, emerging and later-stage companies in the technology sector should be on the lookout for improper billing and revenue recognition practices, including premature and/or accelerated revenue recognition. As part of our Forensic & Valuation Services practice, Aronson LLC helps clients investigate financial statement misstatements and asset misappropriation schemes. To learn more about how our team of Certified Fraud Examiners can assist your organization, contact Bill Foote at 301.231.6299.
 A publicly traded firm until recently, Saba was taken private last month and is now owned by a San Francisco based private equity group.
 See SEC Order dated 2/10/2015 at http://www.sec.gov/litigation/admin/2015/34-74240.pdf. During the applicable time periods Saba actually employed two different CFOs; the $500,000 is a combined figure.