Tag Archives: auditor independence

Revenue Recognition – The Clock is ticking!

Are you ready to implement the FASB/IASB New Revenue Recognition Standard? With just a handful of months to go – The countdown is on! SECI is conducting training workshops throughout the U.S. to prepare filers for the changes and arm them with the tools for implementation. Workshop leaders use interactive lecture, examples and case studies to impart solid knowledge of the provisions of the FASB’s and IASB’s new revenue recognition standard and build an understanding of how the new standard changes revenue recognition accounting and also how it affects the related estimates and judgements. Upcoming workshops include August 24-25 in Grapevine, September 11-12 in Las Vegas and December 13-14 in New York City.

http://www.pli.edu/Content/Implementing_the_FASBIASB_New_Revenue_Recognition/_/N-1z10od3Z4k?ID=290619

Going Concern Reporting – The Gap in GAAP Versus GAAS- Part Three

By: George M. Wilson & Carol A. Stacey

 

Our first two posts in this series have presented an example of a company (Sears Holdings) and auditor reporting requirements for going concern issues as well as reviewed reporting requirements for companies. In this last post we review reporting requirements for auditors and explore the gaps in more detail.

 

Auditor Requirements

 

For auditors of public companies the PCAOB did not change existing GAAS when the FASB Issued ASU 2014-15. Auditors follow this guidance in section AS 2415 of the PCAOB’s auditing standards:

 

02        The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited (hereinafter referred to as a reasonable period of time). The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in AS 1105, Audit Evidence.

 

02        The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited (hereinafter referred to as a reasonable period of time). The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in AS 1105, Audit Evidence.

 

The Gaps

 

There are gaps between what companies disclose and how auditors report. Two of the gaps are:

 

  1. The time period for going concern considerations, and

 

  1. The probability level for the company compared to the auditor for these disclosures

 

Time Period Gap

 

The auditor’s GAAS reporting requirement clearly states that the period over which going concern issues are evaluated is a “reasonable period of time, not to exceed one year beyond the date of the financial statements being audited”. The requirement under GAAP for companies is “within one year after the date that the financial statements are issued”. In practice, many auditors have actually used the period of one year after the financial statements are issued as their going concern disclosure threshold, but they are not strictly required to do this.

 

Probability GAP

 

The disclosure requirement for management in GAAP is that if it “is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued” then they must make disclosures. This threshold of “probable” has its roots in one of the earliest FASB standards (SFAS 5, now ASC 450) dealing with contingencies. This standard set out the definition of “probable” as:

 

“The future event or events are likely to occur”.

 

The auditor’s GAAS standard uses the probability threshold “substantial doubt”:

 

The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time

 

So, what is the difference between “probable that an entity will not be able to meet its obligations as they become due” and “substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time”? This is of course a matter of judgment. Many practitioners would believe that probable is a higher threshold than substantial doubt. What is clear is that this is a subjective evaluation.

 

The PCAOB addressed this difference in their guidance about the new disclosure requirements. This language is from Staff Audit Practice Alert No. 13:

In evaluating whether the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework, including whether they contain the required disclosures, auditors should assess management’s going concern evaluation. In making this assessment the auditor should look to the requirements of the applicable financial reporting framework

In addition, auditors should continue to look to the existing requirements in AU sec. 341 when evaluating whether substantial doubt regarding the company’s ability to continue as a going concern exists for purposes of determining whether the auditor’s report should be modified to include an explanatory paragraph regarding going concern. The AU sec. 341 requirements for the auditor’s evaluation, and the auditor’s reporting when substantial doubt exists, have not changed and continue to be in effect. Under AU sec. 341, the auditor’s evaluation of whether substantial doubt exists is qualitative based 341.Accordingly, a determination that no disclosure is required under the ASC amendments or IAS 1, as applicable, is not conclusive as to whether an explanatory paragraph is required under AU sec. 341. Auditors should make a separate evaluation of the need for disclosure in the auditor’s report in accordance with the requirements of AU sec. 341.

 

This is of course another gap between GAAP and GAAS. Time will tell how the market reacts to this kind of presentation. And this explains why Sears Holdings disclosed their going concern uncertainty and their auditors did not modify their report.

 

There is one more interesting aspect to all this disclosure and auditor reporting discussion. What happens in a Form 10-Q where generally there is no auditor’s report?

 

The requirements in ASC 205-40-50 for interim periods are:

 

If conditions or events continue to raise substantial doubt about an entity’s ability to continue as a going concern in subsequent annual or interim reporting periods, the entity shall continue to provide the required disclosures in paragraphs 205-40-50-12 through 50-13 in those subsequent periods. Disclosures should become more extensive as additional information becomes available about the relevant conditions or events and about management’s plans. An entity shall provide appropriate context and continuity in explaining how conditions or events have changed between reporting periods. For the period in which substantial doubt no longer exists (before or after consideration of management’s plans), an entity shall disclose how the relevant conditions or events that raised substantial doubt were resolved.

 

Sears Holdings’ Form 10-Q for the first quarter of F/y 18 includes this disclosure:

 

We acknowledge that we continue to face a challenging competitive environment and while we continue to focus on our overall profitability, including managing expenses, we reported a loss in the first quarter of 2017, when excluding significant items noted in our Adjusted Earnings Per Share tables, and were required to fund cash used in operating activities with cash from investing and financing activities. We expect that the actions outlined above will further enhance our liquidity and financial flexibility. In addition, as previously discussed, we expect to generate additional liquidity through the monetization of our real estate, additional debt financing actions, and potential asset securitizations. We expect that these actions will be executed in alignment with the anticipated timing of our liquidity needs.

 

We also continue to explore ways to unlock value across a range of assets, including exploring ways to maximize the value of our Home Services and Sears Auto Centers businesses, as well as our Kenmore and DieHard brands through partnerships or other

means of externalization that could expand distribution of our brands and service offerings to realize significant growth. We expect to continue to right-size, redeploy and highlight the value of our assets, including monetizing our real estate portfolio and exploring potential asset securitizations, in our transition from an asset intensive, historically “store-only” based retailer to a more asset light, integrated membership-focused company.

 

We believe that the actions discussed above are probable of occurring and mitigate the liquidity risk raised by our historical operating results and satisfy our estimated liquidity needs during the next 12 months from the issuance of the financial statements. The PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.

 

If we continue to experience operating losses, and we are not able to generate additional liquidity through the actions described above or through some combination of other actions, while not expected, then our liquidity needs may exceed availability under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to our outstanding second lien debt) falls below the principal amount of such second lien debt plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for such debt on the last day of any two consecutive quarters, it could trigger an obligation to repurchase or repay second lien debt in an amount equal to such deficiency.

 

No more use of the term “substantial doubt”. It might be helpful if the change from year-end to quarter-end was explained in more detail.

 

As always, your thoughts and comments are welcome!

Going Concern Reporting – The Gap in GAAP Versus GAAS – Part One

By: George M. Wilson & Carol A. Stacey

 

This is the first of three posts about an interesting conundrum in reporting that arose last year. The FASB, with ASU 2014-15, now requires disclosures by companies about going concern issues. However, there can be gaps between what companies are required to disclose and impact of going concern issues on the auditor’s report.

ASU 2014-15 added subtopic 205-40 “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” to the Accounting Standards Codification. This update became effective for periods ending after December 15, 2016. Previously there was no specific requirement for management to make these disclosures. (This is of course Generally Accepted Accounting Principles, or GAAP).

Auditors have had guidance in this area for many years courtesy of the PCAOB’s standard in AU section 341, which is now section AS 2415 in the PCAOB’s reorganized auditing standards. (This is Generally Accepted Auditing Standards, or GAAS).

 

To explore the gap between GAAP for companies and GAAS for auditors when reporting going concern issues we are going to present a series of three posts:

 

This first post will present an example of a going concern disclosure by a company and whether or not the auditor’s report was modified. (Spoiler – there was no mention in the auditor’s report!)

 

The second post will explore company disclosure requirements.

 

The third and last post will review auditor’s reporting requirements and detail the gaps between company and auditor reporting.

 

Sears Holdings, the retailer that owns Kmart and Sears, provided an example of this gap in their Form 10-K for the year ended January 28, 2017. In their financial statements Sears Holdings included this language:

We acknowledge that we continue to face a challenging competitive environment and while we continue to focus on our overall profitability, including managing expenses, we reported a loss in 2016 and were required to fund cash used in operating activities with cash from investing and financing activities. We expect that the actions taken in 2016 and early 2017 will enhance our liquidity and financial flexibility. In addition, as previously discussed, we expect to generate additional liquidity through the monetization of our real estate and additional debt financing actions. We expect that these actions will be executed in alignment with the anticipated timing of our liquidity needs. We also continue to explore ways to unlock value across a range of assets, including exploring ways to maximize the value of our Home Services and Sears Auto Centers businesses, as well as our Kenmore and DieHard brands through partnerships or other means of externalization that could expand distribution of our brands and service offerings to realize significant growth. We expect to continue to right-size, redeploy and highlight the value of our assets, including our real estate portfolio, in our transition from an asset intensive, historically “store-only” based retailer to a more asset light, integrated membership-focused company.

 

Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.

 

If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.

 

Sears Holdings used the term “substantial doubt”, but indicated that they believed their plans mitigated this “substantial doubt”.

 

This was the report of Sear’s Auditors:

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

No mention of a going concern issue at all in the auditor’s report! What is an investor to think? Historically, when the only concrete guidance was in GAAS, it was very rare to see this issue not discussed in both the financial statements and the auditor’s report.

 

This is, of course, part of the gap between GAAP and GAAS. In our next post we will begin to explore the space in this gap!

 

 

As always, your thoughts and comments are welcome!

Demystifying Alternative Financing Solutions for Emerging and Growing Companies

Auditors and Financial Officers of companies who raise capital with complex financial instruments often find themselves drowning in convoluted accounting issues and restatements. Avoid the confusion by attending the live workshop, Debt vs. Equity Accounting for Complex Financial Instruments being held June 23rd in San Francisco. Through a detailed review of the accounting literature and numerous examples and case studies this Workshop will help you build the knowledge and experience to appropriately recognize, initially record and subsequently account for these complex financing tools

http://www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z10odmZ4k?ID=290521&t=WLH7_PDAD

Breaking News: Late last week, the PCAOB voted to make a significant change in auditing standards:

 

“The standard will create the first significant change to the standard form auditor’s report in 70 years, according to PCAOB Chairman James Doty.”

http://www.journalofaccountancy.com/news/2017/jun/pcaob-expands-auditor-reporting-duties-201716790.html

 

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PLI will highlight this significant event at our upcoming live program next Monday (June 12th)   in New York City  “Audit Committees and Financial Reporting 2017”

Representatives from the PCAOB and SEC will be on hand to discuss the new standard.

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Audit Committees and Financial Reporting 2017: Recent Developments and Current Issues

Co-Chairs: Catherine L. Bromilow – Partner, Governance Insights Center, PwC Linda L. Griggs – Consultant John F. Olson – Gibson, Dunn & Crutcher LLP

Join PLI on June 12 for a look at the rapidly changing responsibilities of the audit committee. Our expert faculty of government regulators, public company directors, audit committee members, lawyers and CPAs will give you the information and tools you need to successfully perform and meet the many challenges facing audit committees and boards today. You will benefit from their practical advice and real-world experience.

 

New York City and Live Webcast – June 12, 2017

Groupcast Locations: Atlanta, Boston, Cleveland, Philadelphia, Pittsburgh and Mechanicsburg – June 12, 2017

Key Topics Will Include:

  • The most important developments in the past year for audit committees, including SEC and PCAOB developments
  • Implications of the Trump administration on regulations implementing Dodd-Frank
  • Key accounting developments: important changes and GAAP/IFRS convergence update
  • How to build and maintain strong compliance programs
  • Ethical issues arising when advising audit committees

Special Feature:

  • Up to one hour of Ethics CLE credit

Credit Information: CLE, CPE, CPD and CFE Credit

Register Now!

 

Rev Rec Trail Blazers? We Can Learn Together!

By: George M. Wilson & Carol A. Stacey

What do United Health Group, Alphabet, and Ford have in common? What if we also included Raytheon? That’s right, all these companies have early adopted the FASB’s new revenue recognition standard! Microsoft and Workday have also indicated that they plan to early adopt. Microsoft has indicated they will adopt as of July 1, 2017 and file their first 10-Q under the new method for the quarter-ended September 30, 2017. Workday has said that they will early adopt as of February 1, 2017 and hence their first 10-Q under the new method will be for the quarter-ended April 30, 2017, which should be filed soon. Here is a summary of some of the early adopters:

 

Early adopters who have filed with ASU 2014-09:

Alphabet                                        January 1, 2017           Modified Retrospective

Ford                                                 January 1, 2017           Modified Retrospective

United Health Group               January 1, 2017            Modified Retrospective

First Solar                                     January 1, 2017            Full Retrospective

General Dynamics                     January 1, 2017            Full Retrospective

Raytheon                                     January 1, 2017            Full Retrospective

 

Planned adoptions – no filing yet:

Workday                                  February 1, 2017         Full Retrospective

Microsoft                                July 1, 2017                 Full Retrospective

 

(If you know of any other companies that have early adopted it would be great if you could mention them in a comment on this post or email Carol or George – Thanks!)

 

As is always the case with a major new standard, it is helpful to learn from the experience of folks who have gone past the frontier to the leading, and hopefully not the bleeding, edge! Here are a few highlights and links to Form 10-Q’s with the new standard adopted.

 

From Alphabet’s Form 10-Q for the first quarter of 2017:

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (Topic 606) “Revenue from Contracts with Customers.” Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605), and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. We adopted Topic 606 as of January 1, 2017 using the modified retrospective transition method. See Note 2 for further details.

 

Alphabet’s disclosures, including how they decided to disaggregate revenues, make for interesting reading!

 

From Fords Form 10-Q for the quarter ended March 31, 2017:

 

On January 1, 2017, we adopted the new accounting standard ASC 606, Revenue from Contracts with Customers and all the related amendments (“new revenue standard”) to all contracts using the modified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. We expect the impact of the adoption of the new standard to be immaterial to our net income on an ongoing basis.

 

You can read about the impact of the change on revenues and review Fords Note 3 – Revenue to see how they decided to present the new disclosure for disaggregated revenues.

 

Raytheon, who had previously announced they would early adopt, did so in their Form 10-Q for the First Quarter of 2017, which you can find here.

 

Note 2: Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. In July 2015, the FASB approved the deferral of the new standard’s effective date by one year. The new standard is effective for annual reporting periods beginning after December 15, 2017. The FASB permits companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016. Effective January 1, 2017, we elected to early adopt the requirements of Topic 606 using the full retrospective method.

 

Raytheon’s disclosures for the full retrospective adoption, and the volume of their disclosures overall because of their government contracting business, are great reading for anyone facing similar issues.

 

From United Health Groups Form 10-Q for the quarter ended March 31, 2017:

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” as modified by subsequently issued ASUs 2015-14, 2016-08, 2016-10, 2016-12 and 2016-20 (collectively
ASU 2014-09). ASU 2014-09 superseded existing revenue recognition standards with a single model unless those contracts are within the scope of other standards (e.g., an insurance entity’s insurance contracts). The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

 

The Company early adopted the new standard effective January 1, 2017, as allowed, using the modified retrospective approach. A significant majority of the Company’s revenues are not subject to the new guidance. The adoption of ASU 2014-09 did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows as of the adoption date or for the three months ended March 31, 2017. The Company has included the disclosures required by ASU 2014-09 above.

 

General Dynamics early adopted with the full retrospective method. From their Form 10-Q for quarter one 2017:

 

The majority of our revenue is derived from long-term contracts and programs that can span several years. We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which we adopted on January 1, 2017, using the retrospective method. See Note Q for further discussion of the adoption, including the impact on our 2016 financial statements.

 

 

First Solar also early adopted and used the full retrospective transition method. Here is an excerpt from their Form 10-Q for quarter one of 2017:

 

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized at an amount that reflects the consideration expected to be received in exchange for such goods or services. In addition, ASU 2014-09 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

We adopted ASU 2014-09 in the first quarter of 2017 using the full retrospective method. This adoption primarily affected our systems business sales arrangements previously accounted for under ASC 360-20, which had required us to evaluate whether such arrangements had any forms of continuing involvement that may have affected the revenue or profit recognition of the transactions, including arrangements with prohibited forms of continuing involvement. When such forms of continuing involvement were present, we reduced the potential profit on the applicable project sale by our maximum exposure to loss.

 

Microsoft and Workday will also be filing with the new standard this year, so watch for their first 10-Q’s this year. Here is Microsoft’s SAB 74 disclosure (not included here is the section in which they say it is their intent to also early adopt the new lease standard as of July 1, 2017), followed by Workday’s SAB 74 disclosure for revenue recognition.

 

Microsoft:

Revenue from Contracts with Customers

In May 2014, the FASB issued a new standard related to revenue recognition. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). We plan to adopt the standard using the full retrospective method to restate each prior reporting period presented.

 

The standard will be effective for us beginning July 1, 2018, with early adoption permitted as of the original effective date of July 1, 2017. We plan to adopt the standard effective July 1, 2017. While our ability to early adopt using the full retrospective method depends on system readiness, including software procured from third-party providers, and completing our analysis of information necessary to restate prior period consolidated financial statements, we remain on schedule and have implemented key system functionality to enable the preparation of restated financial information.

 

We have reached conclusions on key accounting assessments related to the standard. However, we are finalizing our assessment and quantifying the impacts related to accounting for costs incurred to obtain a contract based on guidance issued by the FASB Transition Resource Group as part of their November 2016 meeting. We will continue to monitor and assess the impact of any changes to the standard and interpretations as they become available.

 

The most significant impact of the standard relates to our accounting for software license revenue. Specifically, under the standard we expect to recognize Windows 10 revenue predominantly at the time of billing rather than ratably over the life of the related device. We expect to recognize license revenue at the time of contract execution rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will depend on contract-specific terms and in some instances may vary from recognition at the time of billing.

 

We expect revenue recognition related to our hardware, cloud offerings including Office 365, LinkedIn, and professional services to remain substantially unchanged.

We are nearing completion of retrospectively adjusting financial information for fiscal year 2016 and are progressing as planned for fiscal year 2017. We estimate our revenue would have been approximately $6 billion higher in fiscal year 2016 under the standard primarily due to the net change in Windows 10 revenue recognition.

 

 

Workday:

 

We have closely assessed the new standard and monitored FASB activity, including the interpretations by the FASB Transition Resource Group for Revenue Recognition, throughout fiscal 2017. In the fourth quarter of fiscal 2017, we finalized our assessment of the new standard, including completing our contract reviews and our evaluation of the incremental costs of obtaining a contract. Based on our assessment, we decided to early adopt the requirements of the new standard in the first quarter of fiscal 2018, utilizing the full retrospective method of transition.

 

The impact of adopting the new standard on our fiscal 2017 and fiscal 2016 revenues is not material. The primary impact of adopting the new standard relates to the deferral of incremental commission costs of obtaining subscription contracts. Under Topic 605, we deferred only direct and incremental commission costs to obtain a contract and amortized those costs over the term of the related subscription contract, which was generally three years. Under the new standard, we defer all incremental commission costs to obtain the contract. We amortize these costs over a period of benefit that we have determined to be five years.

 

As always, your thoughts and comments are welcome! And if you hear of or know of any other early adopters please put that in a comment to this post, or email George or Carol

Demystifying Alternative Financing Solutions for Emerging and Growing Companies

Auditors and Financial Officers of companies who raise capital with complex financial instruments often find themselves drowning in convoluted accounting issues and restatements. Avoid the confusion by attending the live workshop, Debt vs. Equity Accounting for Complex Financial Instruments being held May 25th in New York City and June 23rd in San Francisco. Through a detailed review of the accounting literature and numerous examples and case studies this Workshop will help you build the knowledge and experience to appropriately recognize, initially record and subsequently account for these complex financing tools

http://www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z10odmZ4k?ID=290521&t=WLH7_PDAD

Challenging Accounting Judgments, Principles Based Standards and ICFR

By: George M. Wilson & Carol A. Stacey

As you have undoubtedly heard from a variety of sources (including this post we made last December), the new revenue recognition, financial instruments impairment and lease standards all involve many new and sometimes complex accounting judgments and estimates.

 

Issues ranging from how to estimate current expected credit losses to what is stand-alone selling price confront us with new, difficult, and subjective judgment calls.

 

Even the Chief Accountant has discussed this issue in a recent speech, which we discussed in our blog. In his remarks, the Chief Accountant focused on ICFR, specifically mentioning:

 

“Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and

 

Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.”

 

To help us all deal with these challenges the Anti-Fraud Collaboration, a group made up of the Center For Audit Quality, FEI, NACD and IIA, has issued a report titled “Addressing Challenges for Highly Subjective and Complex Accounting Areas”.

 

This report is built on a foundation of detailed analysis of several SEC and PCAOB enforcement cases, a webcast and two workshops. The report has a robust discussion of several of the issues underlying these enforcement cases. One important conclusion drawn from this work is that a lack of controls surrounding subjective and complex accounting judgments is frequently a root cause underlying reporting problems. Based on this conclusion, the report includes a discussion of ways to help establish appropriate controls for such estimates and judgments. In fact, one of the enumerated objectives of the report is to:

 

“Facilitate a robust discussion about accounting policy, centering on highly subjective and complex accounting areas, and the design and operating effectiveness of ICFR”

In the report, there are several insights into ICFR issues surrounding complex judgments. For example:

 

Difficult Accounting Issues

 

Three accounting issues were problematic for companies under investigation: revenue recognition, loan impairment, and valuation. Both highly subjective and complex, these three areas were under stress during the financial crisis and therefore more prone to manipulation or error. The analysis of the AAERs also highlighted issues with the accounting policies pertaining to these areas. In the enforcement actions studied, the SEC cited that the companies either did not have an adequate accounting policy or procedure for the issue being investigated; the company was non-compliant with their existing policy or procedure; or that management acted to override the company’s accounting policy.

 

 

The report goes on to state:

 

For all members of the financial reporting supply chain, the importance of tone at the top cannot be overstated. In most cases of alleged financial fraud, the SEC names the CEO and/or the CFO in the complaint. Commission staff noted that the driver of earnings management—the catalyst for most fraud cases—is often top management, such that the focus on the CEO and CFO is not surprising. In cases the PCAOB has brought against individual auditors, it is usually the lead audit engagement partner or other senior members of an audit engagement team who are disciplined.

 

 

Hopefully, as you think about the design of ICFR over the new estimates and judgments required to implement the revenue recognition, lease and financial instrument impairment standards, you will find some helpful ideas in this report.

 

As always, your thoughts and comments are welcome!

 

 

Overcome the Challenges Resulting from the FASB’s New Lease Accounting Standard!

The FASB’s new lease accounting standard presents complex accounting, internal control, systems and implementation challenges. Attend SECI’s live interactive workshop, Implementing the FASB’s New Leases Accounting Standard Workshop being held May 17th in Dallas with additional dates and locations this fall. Attendees will learn the conceptual underpinnings, overall structure and details of this new standard as it applies to both lessees and lessors. Implementation considerations, system issues and related topics will be discussed in detail and concepts will be reinforced by use of examples and case studies.

http://www.pli.edu/Content/Seminar/Implementing_the_FASB_s_New_Lease_Accounting/_/N-4kZ1z10dmc?fromsearch=false&ID=309311&t=WLH7_DPAD

The New Going Concern Disclosures – An Example

By: George M. Wilson & Carol A. Stacey

Sears, a storied retailer with a rich history, provides a perhaps not unexpected example of the new going concern disclosures in their recently filed 10-K. In their financial statements on page 66 of the 10-K you will find these disclosures:

Our historical operating results indicate substantial doubt exists related to the Company’s ability to continue as a going concern. We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned. In addition, the PPPFA contains certain limitations on our ability to sell assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the planned actions take into account the applicable restrictions under the PPPFA.

If we continue to experience operating losses, and we are not able to generate additional liquidity through the mechanisms described above or through some combination of other actions, while not expected, we may not be able to access additional funds under our amended Domestic Credit Agreement and we might need to secure additional sources of funds, which may or may not be available to us. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to the indenture) falls below the principal amount of the notes plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for the notes on the last day of any two consecutive quarters, it could trigger an obligation to repurchase notes in an amount equal to such deficiency.

This, as the bolded sentence above illustrates, is an example of the situation where there is substantial doubt about the ability of Sears to continue as a going concern, but the substantial doubt is mitigated by the company’s plans. The new reporting requirement for going concern disclosures has a two path approach. The first is:

If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is alleviated as a result of consideration of management’s plans, an entity shall disclose in the notes to financial statements information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the notes):

  • Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
  • Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  • Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

The second disclosure path is:

If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, the entity shall include a statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Additionally, the entity shall disclose information that enables users of the financial statements to understand all of the following:

  • Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
  • Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  • Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

Sears provides us an interesting example and the delicate dance of the wording in their disclosure sheds light on how challenging this new requirement can be for companies.

And, to close the loop, here is the opinion paragraph from the auditor of Sear’s financial statements:

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sears Holdings Corporation and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2017, in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

As always, your thoughts and comments are welcome!