Next month’s conference will bring together the most influential, dynamic and innovative figures in financial reporting for an in-depth exploration of the challenges and opportunities posed by a rapidly changing accounting landscape.
FEI Daily spoke with Scott Taub, Managing Director, Financial Reporting Advisors, ahead of FEI’s 2018 Accounting Change for Finance Leaders. Taub will be providing a technical accounting “pulse check,” explaining what’s new at the SEC, FASB, and PCAOB, and what all the change means for preparers.
FEI Daily: What are the biggest challenges facing the preparer community?
Scott Taub: There are several big, new accounting standards that have to be applied. One is revenue recognition. Public companies are applying for the first time now, private companies, that's coming up. Then, right after revenue recognition we get leasing. And right after leasing we have the new standard on loan losses and credit impairments. So these are three very significant new standards that are all coming one after another. We probably will not see any new standards that are that broadly applicable and create that much change coming in such a short time again for at least a decade or more.
That is a very big challenge for companies. But there are plenty of others as well. The need to keep up with changes in systems and technology is something that is constant and, unlike accounting standard changes where you have a big effort to make the change and then things largely stay steady for a while, it seems in the area of technology, it just keeps changing. Finish one project, and then it's time to start on the next major project. So protecting information, cyber crime, identity theft. Companies continue to have to work so hard on that. I think that that is a huge challenge. Obviously, most of that has nothing to do with accounting and reporting, but it bleeds into reporting when it comes to how you communicate about any problems and your efforts to resolve them.
Then, adding to the reporting and the technology aspects is internal controls to make sure that you're properly gathering the information needed and ensuring that that information has good integrity.
FEI Daily: When it comes to revenue recognition, what lessons can be learned from year-end public companies?
Taub: There are a lot of lessons that can be learned. The first thing I can say is that over the course of the last three years, as companies were getting ready for this standard, there was a lot of worry. There was a lot of concern. There were certainly points I thought to myself, ‘I'm not sure that companies are actually going to be ready for this.’ But when it actually came time to book the entries, make the disclosures, it seems to have gone relatively smoothly.
We are not seeing a whole host of companies that are unable to file their first quarter 10-Q, which is the first time, for most companies, that they are required to apply ASC 606. There was a lot of work and a lot of concern, but it seems to have gotten done and it seems to have gone, in my view, much smoother than I thought it would when we actually got down to booking the entries and preparing the financial statements. Preparation pays off, is a lesson.
I would also say that as I look at the disclosures that are coming out, it’s easy to spot companies that have been thoughtful in making their disclosures, that have really taken the requirements to heart and tried to make disclosures that are illuminating and helpful, and then, at the other end, it's very easy to find examples of companies who, I think when it came time to disclosures, either tried to disclose as little as possible, or alternatively didn't pay attention to it and wound up making disclosures that are not particularly helpful. I suspect the companies in that latter group are apt to get some SEC comments in that area in the very near future.
FEI Daily: How significant is the impact of adoption?
Taub: Well, the impact of all the analysis and work that led up to adoption is huge. I talk to companies all the time and when I talk to their accounting people, they say that even if it didn't have a huge impact and we didn't have to change out numbers a lot, boy did we learn a lot about what we sell and how we sell it, and that thought process has helped companies transfer a lot more knowledge from the operations group to their accounting group. I think that has been a very significant impact regardless of how much the financial statements are changing.
When we get to your actual impact on the financial statements, I said when this standard first came out that I thought that the accounting for 95 percent of transactions would stay the same but I figured about half of companies had transactions in that 5 percent that would change. As I look at the impact that companies are reporting, I think that I was in the ballpark. You get a lot of companies that are saying that there were no material effects and a lot of companies that are reporting significant cumulative effect adjustments, but then on an ongoing basis they think that things will be about the same, and then a smaller group of companies that are saying, ‘We have some substantial changes to the way things will be booked going forward.’ So I think it's come out as we've expected.
Some have complained that they went through all this effort and there was very little change to the numbers. But it doesn't surprise me that a lot of companies are in that boat because it's not like the accounting standards we were applying in the past were intended to do something very different than the new ones. We were always trying to transparently report the results of operations, so the fact that many companies are not having huge changes, is not a surprise. If we were in a position where two thirds of companies had huge changes coming out of this, I'd be shocked. That would mean that our accounting in the past was really terrible, and it wasn't, so it doesn't surprise me that the number of companies that are saying our revenue numbers will be materially different in the future is maybe on the order of 10 percent. That doesn't surprise me.
FEI Daily: Do you think the new standard is actually better than what we had in place?
Taub: For a number of reasons, I think it is. Now, whether it really turns out to be better, it'll be the users or analysts that make that call as to whether they think that they understand companies better now than they did in the past, but in terms of the work I do there are a couple of things that make it appear to me that 606 is improvement.
For one, under the old standards, very often when somebody would ask me a question of how to account for something they were dealing with, I would have to start my answer by saying, ‘Well, there's nothing in GAAP that covers this, however, this is what practice does.’ So, it was all kind of based on practice and folklore and you had to be there to know how it was done.
Under the new standard, I very rarely need to say anything like that. Almost invariably when somebody asks a question and we're thinking about it under 606 I can say, ‘Here are the principles in the standard that apply.’ So we have a much better basis and a much better framework to deal with and I think that has been an improvement.
In addition, because there is one framework that applies in all industries and all kinds of transactions, I don't have situations where I have to say to a company, ‘Because you are in your industry, you do it this way, but if you were in a different industry, you would do it another way.’ That was always very confusing to me and uncomfortable. We don't have that anymore, so I think those areas have been improvements and I think the disclosure requirements are clearly an improvement.
FEI Daily: Moving to the leases standard, where should calendar year-end pubic companies be in the process of their adoption?
Taub: Leases has been interesting to me. I think that the FASB made the least changes that they could make to leasing while getting leases on the balance sheet. I had thought that it wouldn't be all that significant an effort. It turns out I was wrong and I was wrong for a couple of reasons.
Number one, it appears that there is a significant effort that needs to take place to find all the leases. This has been a surprise to me because companies already had to disclose information about leases and while the definition of a lease changes a little bit, it didn't change significantly. However, it seems that perhaps because the information was only in a footnote before, the processes in place to identify and collate information from all the leases, may not have been what we wish they were. I'm still talking to public companies that are worried about identifying -- finding -- all the leases.
FEI Daily:What about private companies?
Taub: Private companies better not wait until the end and better not assume that they already know where all their leases are because the experience of other companies suggests that that's just not the case.
The second area that's turned out to be much harder than I expected is systems. When you have something that goes from footnotes to actually being in the balance sheet, I think everybody agrees that the system that you apply needs to be more robust and have more controls. Those systems essentially had never been developed for leasing before, so companies are behind in developing their systems and that is causing some significant problems.
Six months before having to adopt the standard, they would like to be loading all this information into their systems, checking the integrity of the numbers and all of that. In many cases, the systems just aren't ready yet, so that's kind of coming down to the wire as far as getting the systems ready to go, and that also surprised me because, again, the calculations do not seem all that complicated. They're not all that different from what we had to do before for capital leases, the information needed is information we already used to gather for footnote disclosures so it hadn't occurred to me that this would turn out to be as big an effort as it is.
FEI Daily: How impactful was this change on ICFR (internal control over financial reporting)?
Taub: The data needed to do the lease accounting is not significantly different than the data you needed to do the footnotes in the past. You have to manipulate it differently, certainly, but it's not all that different. What has come to light, however, is that the controls applied to gathering that data in the footnotes in the past were not the kinds of controls that people feel are necessary when the numbers are going in the balance sheet and income statements, so there is a significant impact on controls.
In the past, if your decentralized offices, factories, and sales locations entered into little leases, it didn't really matter all that much. Now, it does. Now you need to collate all of that information which means you now need controls so that everybody around the world who actually might enter into a lease, A, understands when something is a lease, and B, understands what information needs to make its way to the accounting department so it can be correctly reported.
FEI Daily: What about tax reform? How have companies handled the guidance put out by both the SEC and the FASB?
Taub: I think that guidance has been received well and from what I can tell is being applied in a reasonable way. I would say that the SEC’s SAB 118 was really meant to tell companies ‘Do what you can as soon as you can and tell everybody what you did and what's still to be done.’ That’s a summary of the guidance.
There were certain things that, even though it was a rush, you could get done before you filed your year-end 10k. You could revalue your deferreds. That's not hard. You could come up with an estimate, in most cases, of what your one-time foreign earnings repatriation tax would be, and most companies did that, so I think companies made the estimates that they could.
In the first and second quarters, I would anticipate that companies ought to be finishing everything up. Even though SAB 118 says, ‘We understand that it may take up to a year,’ it certainly wasn't meant to be ‘you can ignore it for a year.’ It seems like the disclosures are coming along so I think this has gone as well as could reasonably be expected
FEI Daily: What advice do you have as they continue to assess the impact throughout the year?
Taub: The key thing is going to be keeping users and readers and financial statements up to date on what's done and what's still to be done. This isn't a situation where a company ought to be trying to disclose as little as possible about where the uncertainties are; rather, companies should be explaining what it is that they're still worried about.
Some companies have expressed concern that there are areas where we still need some interpretation from the Department of Treasury or the IRS. That happens all the time in taxes and we know how to deal with that. There's nothing particularly unusual about it. I think that going forward, this ought to go like many other changes go. We deal with them as they come, as our understanding gets better. We update our estimates. We change our disclosures. I don't see that that should be all that difficult an issue.
I do think companies need to be very careful with what kind of adjustments they're making related to taxes when it comes to reporting non-GAAP measures. Some companies are thinking that they would like to do something with respect to the rates and present some sort of non-GAAP measure that either presents old earnings on new rates or new earnings on old rates, or some form of blended rate across the years. I think that could get awfully complicated and a little bit dangerous because we all know that, had different rates been in place at different times, companies would have made different business decisions. It's very hard to provide a non-GAAP measure on taxes like that and I think the SEC is going to be looking in a very detailed way at any kinds of non-GAAP adjustments in those areas.
FEI Daily: What do you tell companies you work with about the PCAOB's auditor's reporting standard?
Taub: I do think that's a big deal for companies to focus on. Auditors will be, starting next year, required to report critical audit matters --this is new paragraphs in your audit opinion about the things that the auditors found most difficult in terms of getting the audit done.
Companies should now be talking with their auditors about ‘If you had to report those things now, what would they be?’ And then companies can figure out whether they wish to do something about that in the meantime. These may represent areas where internal controls are weak. These may represent areas where the company may not have sufficient expertise to deal with things in the best way possible. And it may well represent areas that are just big risk areas for the business.
These may be things that companies want to focus on ahead of time. For one, so they won't be critical audit matters by the time the reporting requirement comes around, because the company will have gained better control of the area, but also in terms of messaging and talking about things. It shouldn't come to the point where an auditor mentioning something as a critical audit matter is the first anybody has ever heard of it, right? These things are important to the audit because they are important to the company and if the auditor has trouble dealing with an issue, chances are it's something the company has had to devote some resources too as well, and if companies find that they have not been talking about those areas in the past, they may want to start doing so now, instead of just letting the auditors do it when the time comes.
My big thing that I talk to companies about with the auditors reporting model is talk to your auditors about it now. Don't wait to get the draft report to be the first time that you talk about potential critical audit matters.