Are you prepared to effectively deal with current and evolving SEC reporting issues, particularly SAB 74 disclosures and recently issued accounting standards in your first quarterly report on Form 10-Q this year? Attend our April 28th One Hour Video Briefing, First Quarter 2017 Form 10-Q Hot Topics as our expert faculty review the key issues to address in your Form 10-Q quarterly reporting.
By: George M. Wilson & Carol A. Stacey
Reed Wilson, our Form 10-K In-Depth Workshop leader, closely follows reporting by major companies. He found that Raytheon, in its fourth-quarter earnings release, announced it has adopted the new revenue recognition standard as of January 1, 2017, a full year before the required adoption date. Raytheon also elected the full retrospective adoption method. (Nice catch Reed!) You can find the earnings release here.
Here is an excerpt from the earnings release:
Effective January 1, 2017, the Company adopted the new revenue recognition standard utilizing the full retrospective transition method. Under this method, the standard was applied to each prior reporting period presented and the cumulative effect of applying the standard was recognized at the earliest period shown. The impact of adopting the new standard on the Company’s 2015 and 2016 net sales and operating income was not material. The 2016 net sales, effective tax rate and EPS from continuing operations in the financial outlook table below have been recast to reflect this change.
While it will obviously be a while until Raytheon reports a full quarter on the new method, this SAB 74 disclosure from its third-quarter Form 10-Q provides the story of the company’s adoption process. It provides an understanding of the steps in the process, and the depth of the process. Notice the comment about frequent reports over a two-year period! And all this work was in spite of the fact that the new standard did not have a material impact for Raytheon!
Note 2: Accounting Standards
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which will replace numerous requirements in U.S. GAAP, including industry-specific requirements, and provide 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 will permit companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.
In 2014, we established a cross-functional implementation team consisting of representatives from across all of our business segments. We utilized a bottoms-up approach to analyze the impact of the standard on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the requirements of the new standard to our revenue contracts. In addition, we identified, and are in the process of implementing, appropriate changes to our business processes, systems and controls to support recognition and disclosure under the new standard. The implementation team has reported the findings and progress of the project to management and the Audit Committee on a frequent basis over the last two years.
We have been closely monitoring FASB activity related to the new standard, as well as working with various non-authoritative groups to conclude on specific interpretative issues. In the first half of 2016, we made significant progress toward completing our evaluation of the potential changes from adopting the new standard on our future financial reporting and disclosures. Our progress was aided by the FASB issuing ASU 2016-10, Identifying Performance Obligations and Licensing, which amended the current guidance on performance obligations and provided additional clarity on this topic, and the significant progress of the non- authoritative groups in concluding on specific interpretative issues. We also made significant progress on our contract reviews and detailed policy drafting. Based on our evaluation, we expect to early adopt the requirements of the new standard in the first quarter of 2017 and anticipate using the full retrospective transition method.
The impact of adopting the new standard on our 2015 and 2016 total net sales and operating income is not expected to be material. We also do not expect a material impact to our consolidated balance sheet. The immaterial impact of adopting ASU 2014-09 primarily relates to the deferral of commissions on our commercial software arrangements, which previously were expensed as incurred but under the new standard will generally be capitalized and amortized over the period of contract performance, and policy changes related to the recognition of revenue and costs on our defense contracts to better align our policies with the new standard. The impact to our results is not material because the analysis of our contracts under the new revenue recognition standard supports the recognition of revenue over time under the cost-to-cost method for the majority of our contracts, which is consistent with our current revenue recognition model. Revenue on the majority of our contracts will continue to be recognized over time because of the continuous transfer of control to the customer. For U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit, and take control of any work in process. Similarly, for non-U.S. government contracts, the customer typically controls the work in process as evidenced either by contractual termination clauses or by our rights to payment for work performed to date to deliver products or services that do not have an alternative use to the company. Under the new standard, the cost-to-cost measure of progress continues to best depict the transfer of control of assets to the customer, which occurs as we incur costs. In addition, the number of our performance obligations under the new standard is not materially different from our contract segments under the existing standard. Lastly, the accounting for the estimate of variable amounts is not expected to be materially different compared to our current practice.
As always, your thoughts and comments are welcome!
By: George M. Wilson & Carol A. Stacey
SAB 74 (SAB Codification 11-M) disclosures surrounding the new revenue recognition, leasing and financial instrument impairment standards have been receiving a lot of attention lately, especially with the SEC Staff announcement about them at the September EITF meeting.
This is not the only reporting that a new accounting standard might involve. Since these new standards could have an impact on ICFR, this is a good time to remember the requirements to report material changes in ICFR. These requirements apply to both Item 9A in Form 10-K and Part I Item 4 in Form 10-Q. They begin with S-K Item 308(c):
(c) Changes in internal control over financial reporting. Disclose any change in the registrant’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of §240.13a-15 or 240.15d-15 of this chapter that occurred during the registrant’s last fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
With changes to ICFR for revenue recognition for information about contracts and estimates, like stand-alone selling price and when control transfers, and changes to ICFR for capitalization of all leases, these new standards could require material changes to ICFR. Is this the type of change included in the S-K 308(c) disclosure requirement?
This is an excerpt from the ICFR C&DI’s, number 7, about SOX reporting which you can find here:
After the registrant’s first management report on internal control over financial reporting, pursuant to Item 308 of Regulations S-K or S-B, the registrant is required to identify and disclose any material changes in the registrant’s internal control over financial reporting in each quarterly and annual report. This would encompass disclosing a change (including an improvement) to internal control over financial reporting that was not necessarily in response to an identified material weakness (i.e. the implementation of a new information system) if it materially affected the registrant’s internal control over financial reporting. Materiality, as with all materiality judgments in this area, would be determined upon the basis of the impact on internal control over financial reporting and the materiality standard articulated in TSC Industries, Inc. v. Northway, Inc. 426 U.S. 438 (1976) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). This would also include disclosing a change to internal control over financial reporting related to a business combination for which the acquired entity that has been or will be excluded from an annual management report on internal control over financial reporting as contemplated in Question 3 above. As an alternative to ongoing disclosure for such changes in internal control over financial reporting, a registrant may choose to disclose all such changes to internal control over financial reporting in the annual report in which its assessment that encompasses the acquired business is included.
The SEC Regulations Committee of the CAQ has also discussed a particularly intricate issue in this transition. What if you change your ICFR this year, but the change is for future reporting when you begin to report under the new standard next year? This issue is still in play, as this excerpt from the minutes discusses:
- Changes in ICFR in preparation for the adoption of a new accounting standard
Item 308(c) of Regulation S-K requires disclosure of changes in internal control over financial reporting (“ICFR”) during the most recent quarter that have materially affected or are reasonably likely to materially affect the registrant’s ICFR. The Committee and the staff discussed how this requirement applies to changes in ICFR that are made in preparation for the adoption of a new accounting standard when those changes are in periods that precede the date of adoption and do not impact the preparation of the financial statements until the new standard is adopted.
The staff indicated that they are evaluating whether additional guidance is necessary for applying the requirements of Item 308(c) in connection with the transition to the new revenue standard.
So, as you begin implementing systems and processes for these new standards, don’t forget this part of the reporting!
As always, your thoughts and comments are welcome!
By: George M. Wilson & Carol A. Stacey, SECI Institute
Much has been written and said about the resources and time that will be required to implement the new revenue recognition standard. All public companies must implement the new standard for fiscal periods beginning after December 15, 2017, roughly 15 months from now. For calendar year-end companies, the first report on Form 10-Q using the new model will be filed in about 18 months. Time is, well, short.
Even the SEC has expressed their concerns about this transition. If you have not seen their comments, check out their expansion of SAB 74 disclosures announced at the September EITF meeting in this post.
Now, we are not writing this post to nag people. Our goal is to help you assess your particular situation with a deeper understanding of the areas you will need to address and the time and resources you will need. Armed with appropriate information you can build a plan and obtain the requisite resources.
Amidst all the commentary there isn’t much detail about the specific challenges in transitioning to the new revenue recognition model. Obviously a single blog post can’t do that either! But what we can do is help you with some starting points that your situation analysis will have to address to determine the resources your company will need. So, here are highlights of three of the more involved areas.
- As you likely know the new standard is contract based. Step one in the five step revenue recognition model is to identify contracts with customers. This means you need processes and controls to assure all contracts with customers are identified and tracked. And, perhaps more complex, modifications to contracts will need to be tracked and recorded. How much work and time will be required to build the systems to capture and control this information flow?
- The new standard requires many judgments, including, what are your performance obligations, how you will estimate variable consideration and how you will estimate stand-alone selling price to allocate consideration. How much time will you need to build these processes and the controls surrounding these processes?
- Even if the timing of your revenue recognition will not change, you will need to make substantially more disclosures including what are your performance obligations, how and when they are satisfied, how you estimate variable consideration and how you estimate stand-alone selling price. Perhaps the most subjective of all the new disclosures is the requirement to disaggregate revenue based on how different revenue streams are affected by “economic factors”. How much time will you need to assess “economic factors” and make these kinds of judgments about disclosures?
This process will be different for every company. For a retailer the process will likely need less time than for a custom manufacturer. But all companies will need some time. The time to analyze the new standard, build the policies for how the new standard will apply to your business, do the proper documentation, build processes and establish controls is what this is all about. And while it may not change how or when some companies recognize revenue, it will affect how and when you make disclosures.
This discussion does not even begin to address a raft of other issues companies face such as the decision about which transition method to use or how you will assess when customers “obtain control” of a product or service to determine the time revenue is recognized under the new standard.
So, again, not to nag, we do urge you to begin your planning process and if you have not yet done so, begin to learn how the new standard works and assess how it will apply to your business.
If you would like to let us know where are you in the process, we will share aggregate status reports in future posts.
Here are some example status updates.
Aware of the new standard.
Studying the new standards to learn how it works.
Reviewing how the new standard will apply to your business.
Drafting the policy white paper for the new standard.
Modifying accounting systems and processes for the new standard.
Updating IT systems or acquiring IT systems for the new standard.
Implementing new IT systems.
Currently running parallel between the old and new standard.
As always, your thoughts and comments are welcome!
At the September 22, 2016 EITF meeting the SEC Staff made an important announcement about SAB Topic 11-M/SAB 74 disclosures about recently issued accounting standards.
We have done a number of posts about this disclosure, and you can review the basics here.
Because companies will be implementing three major new standards over the next few years the Staff:
Emphasized the importance of these disclosures because investors need to be aware of how much the new revenue recognition, leases and financial instrument impairment standards may or may not affect future results, and
Discussed what companies should do if they cannot yet quantify the impact of these changes.
In the Staff Announcement SEC Assistant Deputy Chief Accountant Jenifer Minke-Girard stated that if a company cannot yet estimate the impact of adopting these new standards then it should consider making incremental qualitative disclosures about the potential significance of adopting the new standards that would include:
The status of the company’s implementation process,
A description of any significant implementation matters that have not yet been addressed,
The effect of any accounting policies that the registrant expects to select upon adoption, and
How such policies may differ from current accounting policies.
While not saying that a specific time table was appropriate, Ms. Minke-Girard said it would be appropriate to include these disclosures in interim filings before the end of the calendar year and the timing of this announcement at the September EITF meeting was to provide time to make these disclosures in year-end filings.
As always, your thoughts and comments are appreciated!
In recent weeks we have been posting about areas to deal with in advance of year-end. So far we have addressed:
The spirit and rationale behind these posts is that it is always a good idea to proactively anticipate problems that may arise and act to keep issues from becoming problems.
As we continue this series our next post is about SAB 74 (Topic 11-M in the SAB Codification), the requirement for disclosures about recently issued accounting standards.
With the major changes coming from the new revenue recognition standard, the new lease standard, and for financial companies the new financial instrument impairment standard, these disclosures become increasingly important. Users need to be forewarned about the expected impact of these new standards. This is essentially a known trend disclosure in your MD&A.
Here is an excerpt from Topic 11-M. You can read the entire SAB here.
Interpretive Response: The staff believes that the registrant should evaluate each new accounting standard to determine the appropriate disclosure and recognizes that the level of information available to the registrant will differ with respect to various standards and from one registrant to another. The objectives of the disclosure should be to (1) notify the reader of the disclosure documents that a standard has been issued which the registrant will be required to adopt in the future and (2) assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. The staff understands that the registrant will only be able to disclose information that is known.
The following disclosures should generally be considered by the registrant:
A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.
A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.
A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.
Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.
As a company gets closer to the adoption date for a new standard these disclosures should evolve. And although “[t]he staff understands that the registrant will only be able to disclose information that is known”, the other side of this disclosure is that when you know something, you should disclose it!
One last heads up – when you file your 10-K for the year before adoption, in other words you will adopt the day after that year-end, the staff will likely expect robust disclosure, including quantification of the impact of adoption.
When a company has decided which method it will use to adopt, it should disclose that information!
As a company researches and builds an understanding of how much a new standard will affect the financial statements, this impact should be disclosed.
Frequently we are concerned that there is uncertainty in this process, and that is never comfortable to discuss in an SEC report. Here are two excerpts that are examples of this disclosure from a June 30, 2016 Form 10-K. They deal with this uncertainty (emphasis added):
In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.
The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We currently anticipate early adoption of the new standard effective July 1, 2017 in conjunction with our adoption of the new revenue standard. Our ability to early adopt is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.
We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for office, retail, and datacenter operating leases.
Revenue from Contracts with Customers
In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which 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 FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations.
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 (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.
The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We currently anticipate early adoption of the new standard effective July 1, 2017. Our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.
We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for software license revenue. We expect revenue related to hardware, cloud offerings, and professional services to remain substantially unchanged. Specifically, under the new standard we expect to recognize (Product A) revenue predominantly at the time of billing rather than ratably over the life of the related device. We also expect to recognize license revenue at the time of billing 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 be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing.
We currently believe that the net change in (Product A) revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard.
Lastly, as we always like to do, here are two example comments to reinforce the issues in this disclosure:
Please revise your disclosures to fully comply with Question 2 of SAB Topic 11:M for each standard listed. Specifically, if early adoption is permitted, you should state the date that you plan to adopt the standard. You should also discuss the impact that adoption of each standard is expected to have on your financial statements or, if applicable, make a statement to the effect that you are still assessing the impact that adoption of each standard will have on your financial statements and the impact is not known or reasonably estimable at this time.
Please revise to include a discussion of the potential effects that recently issued accounting standards will have on your financial statements when adopted in a future period. Refer to SAB Topic 11.M. For example, please revise to disclose the potential effect of ASU No. 2014-09, Revenue from Contracts with Customers.
The next topic from our 2016 Form 10-K Tune-up One-Hour Briefing is SAB 74 disclosures. You can listen to the briefing on-demand with CPE and CLE credit available at:
To begin, what does SAB 74, which is Topic 11-M in the SAB Codification, actually require? You can read the whole SAB at:
Here are a few highlights.
First, it is clear that this disclosure is not required for all new Accounting Standards Updates:
“The Commission addressed a similar issue and concluded that registrants should discuss the potential effects of adoption of recently issued accounting standards in registration statements and reports filed with the Commission. The staff believes that this disclosure guidance applies to all accounting standards which have been issued but not yet adopted by the registrant unless the impact on its financial position and results of operations is not expected to be material.”
This part of the SAB dovetails very nicely with an important part of the SEC’s Disclosure Effectiveness Initiative, which is to eliminate immaterial disclosures that potentially “clutter up” a report and potentially obscure material information.
Here are two examples to explore this issue.
CocaCola did not mention recently issued accounting standards in their 2014 Form 10-K MD&A. They apparently made the judgment that there was no material impact in the current year from new accounting standards. They did include SAB 74 disclosures in their financial statements in note 1. You can check it out at:
Intel treated this disclosure in exactly the same way, and you can find their 2014 10-K at:
So, the first theme for SAB 74 is focus on material information.
The second point to think about with this disclosure is what do we need to say about new standards that we believe will be material.
The SAB contains four disclosure requirements:
1. “A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.
2. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.
3. A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.
4. Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.”
As you consider these disclosures, the first thing that arises is that over time there will be a progression in the detail of the disclosure.
For example, most companies at this point in time will not know which method they will use to implement the new revenue recognition standard. But, as we go through next year, we will get closer to that decision. When the decision is made, the disclosure should be updated to inform investors about which method will be used. The same issue applies to quantifying the impact of a change.
The fourth disclosure, the potential impact on other significant matters, points out that when such a situation exists, this information may not be appropriate to disclose in the financial statements, but would be disclosed in MD&A.
This means that this disclosure should not always be exactly the same in the financial statements and MD&A.
As a brief PS, we have blogged about this topic before and suggested some wording for SAB 74 disclosures about the new revenue recognition standard. You can read that post at:
As always, your thoughts and comments are welcome!
Welcome to the last half of March! For all of us with 90 day deadlines for our Form 10-K, it is getting close to time to file!
As you prepare for the final reviews of your Form 10-K we thought we would share a list of “Hot-Button Topics” to make sure they are addressed appropriately in your filing.
We developed this list while presenting on-site workshops with CPA firms, and think it may be valuable for all of us who are preparers too.
Here are the topics:
1. SAB 74 Disclosures (see Topic 11M in the codification at: http://www.sec.gov/interps/account/sabcode.htm) – make sure your SAB 74 Recent Accounting Pronouncement disclosure for new standards includes all four points from the SAB and addresses all material new standards for your company, including revenue recognition.
2. Cybersecurity – Most likely almost every company should have a risk factor for cybersecurity, but perhaps more disclosure is appropriate for your company. Be sure to check out Corp Fin Disclosure Topic 2 (at http://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic2.htm).
3. Take time now to be sure that your webpage and such other public disclosures are consistent with 10-K, 10-Q etc. (E.g. segment discussions)
4. Segments are always a big deal. Check out the speech by OCA Deputy Chief Accountant Dan Murdock (at: http://www.sec.gov/News/Speech/Detail/Speech/1370543611034#.VQn1sGd0yUk). And, don’t’ forget the PACCAR enforcement action related in part related to segment disclosure (http://www.sec.gov/litigation/litreleases/2013/lr22711.htm).
5. Item 1 – S-K Item 101(a) – Big changes in “mode of conducting business”, even significant strategic changes, should be discussed.
6. Item 1 – S-K Item 101(c) – The description of the business must be by segment.
7. Review Item 1 discussion of distributions channels and methods etc. for consistency with Rev Rec Accounting.
8. Item 1A – For risk factors assure major risks from a manager’s perspective are included.
9. Item 2 – Relate to impairment risk and possible capex in future as applicable.
10. Item 3 – Not the same as the footnotes to f/S. More factual details, plaintiff suits etc.
11. MD&A – Quantification of changes is a major theme in SEC Comment Letters.
12. MD&A – Known trends – things that could make past not predictive of the future – No surprise stock drops!!
Hope all this helps, and if you have ideas for more topics, let us know!