The adoption of ASC Topic 606 – Revenue from Contracts with Customers will most likely result in updates to the timing and process for recognizing revenue from contracts with customers, as well as how revenues are presented and disclosed in a company's financial statements. It could impact the balance sheet and income statement from assets and working capital to net income, including footnote disclosures.
Public business entities, except emerging growth companies, have started adopting the revenue recognition standard for fiscal years starting after December 15, 2017. All other entities will adopt for fiscal years starting after December 15, 2018.
During 2017, a few early adopters of the new standard, including Alphabet and Ford, received SEC comment letters with respect to their first Form 10-Q filed after adoption, that included correspondence regarding accounting for, and disclosures required under ASC Topic 606. Other early adopters with comments from the SEC related to ACS Topic 606 include General Dynamics, Commvault Systems, CBOE Holdings, Workday and First Solar.
The comments from the SEC covered a variety of topics including: impact of transition, disaggregation of revenues, gross versus net revenue reporting, point in time versus over time recognition, costs to obtain and fulfill contracts, variable consideration, unsatisfied performance obligations and changes in contract balances.
Significant Management Judgments
Several of the comments received by early adopters indicated a requirement for additional information to support or explain management's significant judgments, including with respect to point in time and/or over time recognition, variable consideration, performance obligations and principle versus agent or gross versus net accounting.
As required by the standard, entities should plan to disclose the significant judgments made that affect the determination of the amount and timing of revenue from contracts with customers, including the timing of satisfaction of performance obligations, determining the transaction price and the amounts allocated to performance obligations.
For performance obligations that an entity satisfies over time, an entity should disclose the methods used to recognize revenue (for example, a description of the output methods or input methods used and how those methods are applied) as well as an explanation of why the methods used provide a faithful depiction of the transfer of goods or services.
For performance obligations satisfied at a point in time, an entity should disclose the significant judgments made in evaluating when a customer obtains control of promised goods or services.
Lastly, regarding the transaction price, entities are required to disclose information about the methods, inputs and assumptions used to:
- Determine the transaction price, including estimating variable consideration;
- Allocate the transaction price in an arrangement with more than one distinct performance obligation, including estimating standalone selling prices of promised goods or services; and,
- Measure obligations for returns and refunds.
Disaggregation of Revenue
The new standard requires entities to disclose a disaggregation of revenue into categories that best depict how the nature, amount, timing, and uncertainty of revenues and cash flows are affected by economic factors. The extent to which an entity's revenue is disaggregated for the purposes of this disclosure depends on the facts and circumstances that pertain to the entity's contracts with customers, e.g. some entities may need to use more than one type of category, while other entities may meet the objective by using only one type of category to disaggregate revenue.
From the SEC comments to the early adopters reviewed, we noted a request for additional information to provide the reasons why the chosen disaggregation is considered most appropriate, as well as a request to ensure the disaggregation is consistent with other sections of the From 10-Q (or upcoming Form 10-K), such as management’s discussion and analysis (MD&A).
When determining the category (or categories) to disaggregate revenue, an entity should consider factors about the entity's revenue presentation for other purposes, including the following:
- Disclosures presented outside the financial statements (for example, in earnings releases, annual reports, MD&A or investor presentations);
- Information regularly reviewed by the chief operating decision maker for evaluating the financial performance of operating segments; and,
- Other information that is used by the entity or users of the entity’s financial statements to evaluate the entity’s financial performance or make resource allocation decisions.
Costs to Obtain or Fulfill a Contract
Comments from the SEC included the requirements to adequately describe details regarding capitalized costs, including the amount and a description of the costs capitalized, along with the amortization methodology and appropriate amortization period, as well as the amount of amortization.
As can be derived from the nature of the SEC comments discussed herein, management should take note that even if there was no accounting impact from the adoption of ASC Topic 606, the new standard has more extensive, including qualitative, disclosure requirements. Companies could therefore receive comments with respect to a revenue accounting policy that was not affected by the adoption of ASC Topic 606, but which the SEC considers inadequately explained to a user of the financial statements.
The magnitude of the impact related to the adoption of ASC Topic 606, including how the standard as it is written will be implemented in practice, is still in infantile stages; a lot of parties are watching from the sidelines to see how it develops.
As calendar year-end companies start filing their first Form 10-Q after adoption, compliance and disclosures are expected to improve as companies become more familiar with the standard. The interpretation of the standard by the SEC for implementation in practice will also move further towards fruition during the course of 2018.
However, it is clear the intention of the new standard is for financial statements to provide sufficient and effective information that users of the financial statements would find beneficial, including from an equity or debt investor perspective. While management should ensure the quantitative requirements of the new standard are met, it would also require careful presentation of adequate but concise disclosures that explain judgments and are more consistent with how the chief operating decision makers in management discuss and analyze revenue, in order to address the new qualitative requirements of the standard.
For More Information
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Published on April 24, 2018