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Rev Rec Implementation Far From Over: A Q&A With Deloitte’s Eric Knachel


As companies adopt the revenue recognition standards and benchmark their disclosures, they will find themselves in one of three categories.

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As public companies continue to better understand the nuances of the new revenue recognition standard, the issue of disclosures remains a critical pain point for CFOs.

Benchmarking can be extremely helpful. But what steps can companies take if they find their revenue recognition practices are out of line with what others are doing? FEI Daily spoke with Deloitte Partner, Professional Practice Group Eric Knachel about what companies must turn their attention to in disclosures now that the first few filings have been completed.

FEI Daily: Public companies with fiscal years ending December 31st have now adopted the new revenue recognition standard (ASC 606) and applied it for the first time to their quarterly reports. What work is left to do?

Eric Knachel: I think one of the important things for companies and others to understand is that even though the adoption date was January 1 for calendar year-end companies, it doesn't mean that the revenue recognition implementation process is over. Far from it.

Certainly a lot of the heavy lifting is done. Now, they're going through a benchmarking exercise where they are comparing both their disclosures as well their accounting. They're comparing that to what other companies, competitors, peers have done. They're comparing their disclosures, and they're preparing their accounting. I think when they do that companies find themselves in one of three categories.

You either find yourself thinking that, ‘My disclosures, my accounting, is in line with what others are doing,’ so I might refer to that first category as alignment. You think to yourself, ‘Okay. I'm in the same place as others.’

Now, the other two categories are when you're different, so you're misaligned. I would say if we were to talk about disclosures for a moment, you can be misaligned and be on the short end, or misaligned and feel like you're doing too much. Let's say that you look at your disclosures, and you realize that you're providing a lot less in the way of disclosures than your competitors and your peers. You're misaligned and at risk. You're probably asking yourself, ‘Are we providing less in the way of disclosures? Why is that? Is that because we have different types of transactions? Is that because we simply didn't provide enough information? Are we complying with the standard?’ If you're on the short end, it probably raises a bit of a red flag. You're a little bit concerned. ‘Are we at risk here?’

The other category would be if you're misaligned, but you're providing a lot more disclosure. There, again, you'd ask yourself the same type of questions, but, also, ‘Do we just have different transactions?’ Or is there an opportunity to continue to comply with the standard, but actually reduce the amount of information that's being disclosed? Therefore, also reduce the amount of work and effort involved. You really find yourself in one of those three buckets. You're trying to figure out which bucket you're in and why.

One of the things that complicates this whole exercise is that, in this benchmarking exercise, it's a moving target. What I mean by that is that it's not as though every company files, and then their disclosures and their accounting just stays the same. Disclosures and accounting continue to evolve for a few reasons. One reason is because other companies are doing the same thing. They're benchmarking, so they might be changing their disclosures and so forth. You have this whole SEC comment letter process. The SEC could be issuing comments to a particular company, and as a result of those comments, a company may be revising their disclosures and/or accounting.

Therefore, the comparison or benchmarking that one particular company might be trying to do, what they're comparing themselves to can be evolving at the same time. It's a bit of a moving target, and they're not necessarily sure why. In other words, they're comparing themselves to Company X, Y, and Z and those companies are revising their disclosures and maybe their accounting. They're not sure if that's because of an internal reassessment. Is it because the SEC gave them comments and are requiring them to make a change? Do those companies have different transactions than you? It's not always obvious. That makes the benchmarking a difficult exercise. It also makes it an ongoing exercise because it's not a static population.

FEI Daily: Looking at 100 comment letters, the SEC seemed to want to see more explanation and context around the accounting process behind filings– what do companies need to do to provide more clarity?

Knachel: In SEC Comments Reflect Registrants’ Efforts to Implement ASC 606we identified certain areas that the SEC seemed to focus on. Three in particular kept coming up: significant judgments, performance obligations, and contract costs.

In the significant judgment, they're often asking ‘How did you determine to do this… such as combine performance obligations. Why did you think this measure of progress over time made sense? Why did you conclude to limit the amount of variable consideration?’ They ask those kinds of questions.

If I were to take a step back and look at the SEC comments more holistically, you have these themes in terms of topics that keep coming up, but big picture, the words that keep coming out over and over regardless of the topic, it's expand and clarify. Whether we're talking about judgments, performance obligations, significant financing components, whatever it might be, expand and clarify. When I look at the SEC comment letters, that's the biggest takeaway, that the SEC feels like companies are not providing enough information in their disclosures. That information is important for two reasons. One, it provides the necessary information to understand the transactions, but it also explains the accounting. Sometimes the SEC's focus might be the disclosure itself. At other times, it goes deeper than that in terms of ‘Explain the accounting and how you're accounting for this.’

That becomes very important because the new revenue standard is going from a rules-based to a principles-based model. In this principles-based model, what investors and analysts want to be able to do is analyze and evaluate companies.

Now that you have this principles-based approach, in order to understand the trend and do this apples-to-apples comparison, you have to understand the judgments that are being made because, on the surface, if you just look at the numbers but you don't understand the judgments and the different assessments that a company made in determining those numbers, you don't necessarily have the full picture. You may not really be in an appropriate position to understand, ‘This company’s revenues went up 10 percent in quarter, but why did they go up 10 percent? Did they really have more sales or is it because of something that happened from an accounting position that inflates that or goes the other direction?’ Likewise, when you're comparing one company to another, am I really making an apples-to-apples comparison, or are there different judgments, different accounting policies that are being used that, if I were to equal those out, would there be a difference between the companies or not?

FEI Daily: You noted in the upcoming ‘Unfinished Business’ report that the SEC isn’t likely to review all filings in the near term for companies having adopted the new revenue recognition standard, so lack of contact from the SEC does not necessarily mean there are no issues to address. How can companies ensure that they’re compliant?

Knachel: You're absolutely correct. The SEC receives literally thousands of files. I don't know exactly what process they use to decide which companies to review and when, but there's no way, physically, based on the resources that they have, that they could review every company every quarter. There's no way for them to systematically do those reviews. It's important for companies to understand that silence does not necessarily mean that the SEC thought you had great disclosures, and great accounting, and that there are no questions. Just because a company hasn't heard from the SEC, it doesn't mean that they're not going to hear from the SEC at a later date.

As a result, companies shouldn't think, ‘We've done our accounting, we issued our disclosures, and so we'll just put our heads in the sand and assume that all's good until we hear otherwise.’ They do need to go through this benchmarking exercise and compare themselves to other companies, talk with their advisors, look at SEC comment letters. They need to do all that because, if you're in an industry where there are 10 other companies that you think are very similar to you, they're all accounting for something a certain way, and you're doing it differently. I can't tell you for sure that that means that that company is wrong because there could be nuance differences and so forth. If I was a company, and I was in that situation, I'd be a little nervous. I would want to take a fairly detailed assessment of understanding why there is a difference? Is there a difference in the type of transactions, or something about how contracts are worded? I would want to try to understand that. I would want to talk to my advisors. I would look to see if there are SEC comment letters on this topic.

Other companies might change. In my example, maybe that one company, maybe they do have it right. Maybe the other 10 have it wrong, but the SEC hasn't commented on any of the companies. You're not really sure. Then you might see that one of the other company has changed. Is that because they changed on their own or is that because they got an SEC comment letter? It's not always clear. You have these kind of moving parts which all lead to some uncertainty and confusion. That's make it a difficult time for companies to navigate through the process. Investors and analysts the same thing.

It highlights the importance of recognizing that, just because the adoption date was January 1st, the exercise is far from over and companies need to be mindful of that, particularly as we come up on year end here. I would expect that this process of benchmarking, and SEC comments, and so forth, that's going to be ongoing for at least the next 6-12 months, a heavy volume. I would add that we've seen comment letters come in the last week, and I'm sure we'll see comment letters come in in the weeks and months to come. It's not like the SEC has a deadline per se where they say ‘All comments have to be issued on such and such date.’ They're going to continue to pull in. A company that thinks, ‘I haven't heard anything,’ well that silence doesn't necessarily mean that your disclosures and your accounting have been blessed by the SEC. Far from it.