Revenue Recognition Webinar Series: Industry Considerations and Cross-Functional Implications

Chris WrightChris Wright, Managing Director
Leader of Protiviti’s Finance Remediation and Reporting Compliance practice

 

 

By now, regular readers of this blog should be well-aware that new Financial Accounting Standards Board (FASB) revenue recognition rules will apply to reporting periods beginning after December 15, 2018 — and will be allowed a year earlier for those who are ready. Now is the time for companies to be considering the potential effects of this change and running diagnostic exercises to determine how much work will be required to adapt their policies, procedures and controls to the new rules in time to be ready for their chosen or mandated due date.

Protiviti launched the Revenue Recognition webinar series in November of last year, working through the six elements of infrastructure, delineating the probable impacts of the transition process in each. The final installment — Industry Considerations and Cross-Functional Implications —  was held on July 23.

Chris Wright, Managing Director and leader of our Finance Remediation and Reporting Compliance practice, wraps up our post-blog Q&A series by answering some of the top questions posed during the live session.

Q: How will the new revenue recognition standards affect internal controls and how will that affect Sarbanes-Oxley (SOX) audits?

A: Internal and SOX audits, which test controls, will be impacted in a downstream manner through changes in accounting policy, which is likely to be affected by the new rules, and more so in some industries than others. Industries that rely on long-term and percentage-of-completion contracts — construction and aerospace, for example, and anyone who is manufacturing for the defense industry — are particularly likely to see substantial changes. If the company has to recognize revenue sooner, or based on different indicators, that will have to be baked into a new accounting policy. If that policy changes, then what people do at their desktops — in the accounting organization, the operations and logistics areas, in treasury and tax, and in HR, where they compute the commissions, etc. — may also change. And of course, whenever you change processes, you have to assess whether the controls you had in place before address any additional risks that come from that change. This is where the flow-through effect of the new rules could move all the way into the domains of internal and SOX audits.

Q: Does this new standard do away with percentage-of-completion accounting for long-term contracts?

A: As an academic matter, yes. As a practical matter, however, its effects may not go away completely. All generally accepted accounting principles regarding revenue recognition are replaced by the new standard. The rules on percentage-of-completion accounting have been around for 35 years. Companies have gotten used to them. What’s really going to be a challenge is to separate and account for multiple margins and deliverables – the delivery of one plane, one tank, or one building — within a single contract. One contract might have separate streams with different margins from quarter to quarter, or year to year.

Down the road, it’s not inconceivable that companies may not only change accounting policies as a result of the new standard, but also change their pricing and their approach to accounting. That’s why we recommend a cross-functional view of the new rules. If the initial diagnostic has determined a need for substantial change, it is important to assemble a team with a full view of all upstream and downstream impacts. Without assessing the gap between the new rules and the current rules, there is a potential to overestimate the simplicity or complexity of the changes — we need to get past guessing. The diagnostic assessment needs to start at the treetops and get to a granular level, and happen sooner rather than later.

Q: What are the biggest issues facing manufacturers whose standard “free-on-board” (FOB) terms are FOB shipping point, but do have some FOB destination customers?

A: As a practical matter, the new rules shouldn’t affect a company’s policy regarding the point at which ownership of goods transfers to the recipient. What needs to be clear is the terms, and that there are no further performance obligations — policies, procedures and controls. From a cross-functional perspective, it is important to test this process all the way through, and the sales force needs to be educated to make sure that what they are telling customers matches the terms in the company’s contract — terms which are the basis for the company’s new accounting policy.

Q: What should internal audit do to prepare for the changes?

A: Chief audit executives (CAE) are in a unique position as liaisons between the audit committee and management. The audit committee will likely want to weigh in on things like prospective versus retroactive reporting and early adoption. CAEs need to make sure that these items are on the audit committee agenda and that they are being addressed. On the management side, internal audit needs to at least attend diagnostic and subsequent project management meetings, and ideally should be represented as a fully participating voice in the project management organization. Although internal auditors should not be writing accounting policy, they play a big role in making sure revenue recognition issues, particularly the cross-functional implications — both upstream and downstream — are considered and addressed. We’re seeing that plans for testing the consistent application of the new rules may require a different skill set than some companies have committed to, and that they need to move from junior internal auditors with checklists to more senior personnel with more developed critical thinking capabilities. Otherwise, how can the CAE expect the internal audit function to be effective in challenging senior accounting officers as they apply a very different accounting approach to such a critical area as revenue recognition?

The new revenue recognition standard is an important and complex issue that could have process, policy and control implications throughout your organization. To help you and your organization navigate this change, we have established the microsite protiviti.com/revenuerecognition, with links to all five of our recorded webinars, and additional thought leadership on this topic.

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