Finance and accounting executives hustling to bring their companies into line with the Financial Accounting Standards Board’s new revenue recognition standard by its December 31 deadline are grappling with unprecedented judgment calls, according to a top American Institute of Certified Public Accountants officer.
“There are number of areas in the standards themselves that call for judgment, and those are the areas that continue to be the challenging [ones],” says Jim Dolinar, chairman of the AICPA’s financial reporting executive committee. Public entities must adopt the revenue recognition standards for reporting periods starting after December 15 (which equates to a January 1, 2018 launch date for companies with a December 31 year-end).
One of the thorniest new issues involves having to identify revenue when it includes so-called “variable considerations.” Such components include refunds, performance bonuses, discounts, and rebates, according to RevenueRecognition.com.
Corporate accountants will now have to figure out how to report variable considerations as they exist from “day one of a contract,” notes Dolinar, a managing partner of the assurance professional practice at Crowe Horwath. “Variable consideration is something companies didn’t have to deal with previously” except under a small number of very specific circumstances.
“Now you’ve got [a] principles-based standard” to work through,” he adds. That means that FASB doesn’t lay out precise rules for companies on how to comply with many of its provisions. For instance, how to report the costs associated in selling a software product that includes options for the customer to buy additional copies is an issue that may now require added judgment.
“You have to walk through the model” in the new standard to decide whether to report that the customer has a right to to get an additional copy or must pay a market rate for it, Dolinar adds. “It’s not as cut and dried as it used to be.”
Another challenge for preparers is that they now have to judge whether to recognize “a significant financing component” in their sales contracts and, if so, how much to recognize, according to Dolinar. In such cases, the customer pays a considerable sum before the provider fulfills the contract. (On the other hand, the provider may provide a financing element by enabling the customer to delay payments.)
Determining significant financing elements in a contract was “something that people really didn’t have to focus on before,” he says. Now, however, corporate accountants will, for example, have to consider whether customers pay upfront for smartphones or over the life of the contract — even if there’s no difference in the price.
“In the past, companies would say, ‘Well, there’s no financing to that’ ” if the price remained the same, according to Dolinar. Now, however, “the standard is clear that you can’t just jump to that assumption. You have to go through and do an assessment to determine whether it truly is a significant financing element.”
One “very nuanced” example of an issue requiring judgment is how to determine which party in a transaction is a “principal” and which is an “agent,” the AICPA financial reporting chair observes.
Under the new rules, a company “is a principal if it controls the specified good or service before that good or service is transferred to a customer.” The function of an agent, on the other hand, “is to arrange for the good or service to be provided to the customer by the other party.”
Stated that way, complying with the provision seems simple enough. But the issue gets more complex, for example, when accountants for two different airlines carrying a customer on different legs of the same trip must tease out whether their companies are principles or agents and how to apportion the revenue, according to Dolinar.
“The standard is clear that you might be a principal for part of the transaction, but you may be an agent for another part of the transaction. And that’s not something that companies had to really think about in the past,” he adds.