By: George M. Wilson & Carol A. Stacey
New accounting standards always draw attention from the SEC. Way back in the 1990s, SFAS 133 (now of course ASC 815) was issued to create dramatically different new guidance for derivative and hedge accounting. Louis Dreyfus Natural Gas early adopted the new standard. After certain issues were raised in an SEC review, Louis Dreyfus Natural Gas was forced to restate its initial application of the new derivative accounting model. Their 10-K/A actually included this language:
EXPLANATORY NOTE REGARDING THE REVIEW OF THE COMPANY’S PUBLIC FILINGS BY THE SECURITIES AND EXCHANGE COMMISSION:
IN SEPTEMBER 1999, THE STAFF OF THE SECURITIES AND EXCHANGE COMMISSION
INFORMED THE COMPANY THAT THE DOCUMENTATION FOR ITS DERIVATIVE CONTRACTS AND HEDGING ACTIVITIES WAS INSUFFICIENT AT THE OCTOBER 1, 1998 DATE OF ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133, “ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” (“SFAS 133”) TO QUALIFY FOR THE SPECIAL HEDGE ACCOUNTING PROVISIONS OF THE STANDARD. THE COMPANY BELIEVED THAT IT COMPLIED WITH THE SPIRIT AND INTENT OF THE PROVISIONS OF THE STANDARD WITH RESPECT TO DOCUMENTATION; HOWEVER, THE STAFF OF THE SECURITIES AND EXCHANGE COMMISSION CONCLUDED THAT THE COMPANY HAD NOT SPECIFICALLY COMPLIED WITH THE PROVISIONS OF THE STANDARD …..
As we discussed in this post last May, several companies have early adopted the new revenue recognition standard. It is not surprising that the SEC has already reviewed at least some of these companies. The first two comment letters we have found were to First Solar and Workday. Both appear to be financial reviews, with comments on the financial statements and MD&A in First Solar’s case. The revenue recognition comments, which were resolved by First Solar in their first response letter, and by Workday after one follow-up comment, shed some interesting light into the approach the staff is using in assessing whether companies are appropriately implementing the new revenue recognition model.
Note 2. Summary of Significant Accounting Policies, page 7
- Tell us your significant payment terms and how the timing of satisfaction of performance obligations relates to the timing of payment and the effect on the contract asset and liability balances. Disclose the information required by ASC 606-10-50-9 and 50-12(b) in future filings.
Revenue Recognition – Solar Power Systems Sales and/or Engineering, Procurement and Construction Services, page 8
- We note your disclosure that your solar power system sales include performance guarantees that represent a form of variable consideration and are recognized as adjustments to revenue. Please help us better understand your accounting for these potential bonus payments and/or liquidated damages. In this regard, based on your disclosure, it is unclear to us whether these amounts are included as part of your estimate of your transaction price at the outset of the arrangement and then reassessed at the end of each reporting period. Refer to ASC 606-10-32-5 through 32-10 and ASC 606-10-32-14.
- Please help us better understand how you reflect consideration in the form of a non-controlling interest as part of your transaction price. In this regard, clarify for us which amounts are included in your estimate of fair value at contract inception and why any profit associated with the non-controlling interest is deferred. Refer to ASC 606-10- 32-21 through 32-24.
- Revise future filings to disclose why for performance obligations that you satisfy over time the method used provides a faithful depiction of the transfer of goods or services. Refer to ASC 606-10-50-18.
Form 10-Q for the quarter ended April 30, 2017 Note 2. Accounting Standards and Significant Accounting Policies Revenue Recognition, page 10
- We note that prior to the adoption of ASC 606, you capitalized direct sales commissions when they could be associated specifically with non-cancelable subscription contracts, and now, you capitalize all incremental sales commissions. Please describe the additional commission fees that you are now capitalizing, and tell us how you determined that these are incremental costs of obtaining a contract. Refer to ASC 340-40-25-2.
- We note you amortize your commission costs over a period of benefit that you have determined to be five years while your subscription contracts are generally three years or longer. Please help us understand how you determined that five years was the appropriate period of benefit. In this regard, tell us how you considered renewals. Please clarify whether additional sales commissions are paid upon contract renewal and, if so, whether such amounts are commensurate with the initial commissions. Please also reconcile your considerations to your disclosure on page 46 that your ability to predict renewals is limited. Refer to ASC 340-40-35-1.
That these comments focus on two issues, (1) providing robust disclosures and (2) building an understanding of how the company made judgments in the application of this new principles-based standard is not surprising.
With the implementation of the new revenue recognition standard soon upon most of us, the information from the review process of early adopters has already provided some helpful insights.
As always, your thoughts and comments are welcome.