Remarks before the Bloomberg BNA Conference on Revenue Recognition
Sylvia E. Alicea, Professional Accounting Fellow, Office of the Chief Accountant
May 8, 2017
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or Commissioners, or of the author’s colleagues on the staff of the Commission.
Thank you for the kind introduction and the invitation to speak at today’s conference. Before I continue, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission Staff.
This morning, I would like to provide an update on the Office of the Chief Accountant’s (OCA) revenue implementation strategy and share some observations related to recent consultations about application of the new revenue standard. I’d also like to provide reminders on transition disclosures and managements’ and audit committees’ ICFR-related responsibilities when implementing new GAAP standards, including the new revenue, leases and credit impairment standards.
A new comprehensive revenue model and OCA’s role in implementation
We are less than one year from public companies’ required adoption of the FASB and IASB’s new, comprehensive framework for reporting revenue to investors. For those who have implemented the new revenue standard as well as those who are well underway in the execution of their implementation strategy, I applaud your efforts. For those companies who are still working, the transition date is rapidly approaching.
The current revenue recognition guidance codified in the FASB’s Accounting Standards Codification (ASC) Topic 605, Revenue Recognition, builds from guidance issued over several decades by different standard-setting bodies.
Let’s take a step back for a moment to 1970 when the Accounting Principles Board issued Statement No. 4 (APB No. 4), Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises. In its brevity, the guidance provided that “revenue is generally recognized when both of the following conditions are met: (i) the earning process is complete or virtually complete, and (ii) an exchange has taken place.”
After formation of the FASB, the Board established similar concepts in 1985 in the Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (CON 5). CON 5 identified two criteria necessary for revenue recognition: (i) the revenue must be realized or realizable, and (ii) earned. Those recognition and measurement concepts were later codified by the FASB in ASC Subtopic 605-10, Revenue Recognition-Overall and added to and further interpreted over time, resulting in industry- and transaction-specific guidance, which often resulted in different accounting for economically similar transactions. The Commission and its staff also provided interpretations related to the existing revenue guidance.
When the FASB and IASB developed a converged revenue standard to improve financial reporting, the SEC staff supported the enhancement in financial reporting and disclosures for revenue arrangements. The new model aims to more closely reflect the economics of an entity’s contracts with customers as well as management’s expectations for consideration they expect to be entitled to in exchange for transferring the promised goods and services to its customers. The new model is also comprehensive. It has different concepts and enhanced disclosure requirements. It will require reasonable judgment to apply – and those new concepts, disclosures and judgments may require changes in systems and related controls.
At the 2015 BNA conference on revenue recognition, Wes Bricker outlined OCA’s plans for the transition period – including:
- active monitoring of implementation groups, such as the Revenue Transition Resource Group (TRG) and AICPA Industry Task Forces;
- curating the results of our active monitoring and consultations to create institutional knowledge; and
- collaborating with other offices and divisions to support the education of the Commission staff who are responsible for reviewing and enforcing registrants’ financial reporting.
Our nine-person Revenue team in OCA continues to execute this strategy. Additionally, with the progression of implementation efforts to company-specific finalization of accounting positions, OCA continues to consult with registrants as registrants advance their implementation efforts.
Recent consultation themes
Over the last 18 months, OCA has consulted on a number of registrant-specific fact patterns. In 2016, we communicated our views related to the existence of a contract, application of the contract combination guidance, application of the guidance on sales- and usage-based royalties and application of the ‘impracticability’ exception when a Form S-3 registration statement is filed after the registrant has filed its first Form 10-Q reflecting adoption of the new revenue standard. More recently, we communicated SEC staff observations on the application of the principal and agent considerations for identifying the role of the reporting entity when another party is involved in a contract with a customer.
Because registrants across different industries have consulted with OCA regarding the identification of performance obligations – and because this is an important step of the five-step model, potentially affecting the amount, timing and, in some cases, the presentation of revenue recognition – I would like to share some observations from those recent consultations. In addition, since the guidance is converged in this area, these observations may be helpful to domestic and foreign registrants.
Identifying the contract
The new revenue standard provides a definition of a contract, which encompasses enforceable rights and obligations. A critical aspect of identifying a contract with a customer includes identifying and evaluating all relevant contractual terms because those terms may affect a registrant’s accounting conclusions. For example, the existence of termination clauses or repurchase rights, including put options, may have a significant effect on the enforceable rights and obligations of both a registrant and its customer.
For example, when one or both parties have a right to terminate a contract, a registrant would need to evaluate the nature of the termination provision, including whether the termination provision is substantive. This requires the application of reasonable judgment and could affect the duration of the contract. As another example, contractual terms requiring a registrant to repurchase an asset contingent upon a future event would also be an important feature to evaluate. The judgment about whether the put option is substantive could result in the transaction being accounted for as either a lease or a sale (in the scope of ASC Topic 606).
Therefore, registrants should carefully assess the specific facts and circumstances of each transaction – including all relevant contractual terms – and exercise reasonable judgment when identifying and evaluating each contract with its customers.
Identifying performance obligations
Certain registrants from different industries recently consulted with OCA regarding their application of the guidance for identifying performance obligations. For example, some consultations were from companies who enter into license agreements and provide updates to the licensed technology that existed at inception of the license agreement as well as new technologies. While the industries and facts varied, I think there are some important recurring takeaways related to identifying the unit of account.
First, the concept of a “deliverable” under existing revenue guidance should not be presumed to be the same as the concept of a “performance obligation” under the new revenue standard. The identification of a registrant’s performance obligation(s) will require a “fresh look” that begins with an evaluation of the contractual terms in its contracts with customers. Registrants may ultimately determine – as a result of their “fresh look” – that there is no change in the unit of account. In the fact patterns OCA has evaluated, most of the registrants’ conclusions regarding performance obligations happened to be consistent with their conclusions regarding deliverables under existing revenue guidance. However, this doesn’t obviate the need for a “fresh look.”
Second, while the staff did not object to the registrants’ proposed accounting for the promised goods and services as a single performance obligation, the staff’s views were based on the registrants’ careful analysis of the promised goods and services and whether those goods and services were both “capable of being distinct” and “distinct within the context of the contract.” A company must support its identification of performance obligations according to the core principles in the standard – including whether or not the promised goods and services are inputs to a combined output. There are examples in the new revenue standard that are intended to illustrate application of the principles in the standard. However, the examples do not eliminate (or obviate) the reasonable judgment required to apply those core principles.
Last, as we’ve previously emphasized, it’s critical that preparers understand the underlying transaction, including their specific facts and circumstances and contractual terms, and then faithfully apply the principles of the new revenue standard. This may require reasonable judgment, and in some cases, those judgments may necessitate changes to internal control over financial reporting. In the consultation requests OCA received, registrants demonstrated that they had done the work to identify and evaluate the implications of differences in contractual terms and the substance of their business arrangements in supporting their accounting policies.
There are a couple of additional observations that I’d like to share based on recent fact patterns OCA has evaluated before moving on to a reminder about transition disclosures.
OCA was recently consulted on whether the measure of progress should be adjusted for the cost of third-party services provided as part of a single performance obligation. The new revenue standard requires an adjustment to the measure of progress when – for example – those costs do not depict the entity’s performance in transferring control of goods or services to the customer. The new revenue standard also includes an illustrative example of how to apply that guidance.
The Basis for Conclusions in the new revenue standard, while non-authoritative, provides information about the reasonable judgment required when applying this guidance in noting that …“the adjustment to the cost-to-cost measure of progress for uninstalled materials is generally intended to apply to a subset of goods in a construction-type contract and only if the entity is essentially providing a simple procurement service to the customer.” Therefore, the SEC staff would be skeptical of the broad application of this guidance to other types of arrangements.
Importance of disclosures
The disclosures required by the new standard are designed to allow an investor to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The pertinent facts and related reasonable judgments related to a registrant’s contracts with customers, including the significant judgments made in applying the principles of the new revenue standard, should be disclosed to better inform investors’ decisions.
Continued emphasis on transition disclosures
Over the last several months, the SEC staff has encouraged companies to provide transition disclosures to investors about the anticipated effects of adoption of the new revenue, leases and credit impairment standards.
The SEC staff has long advised in Staff Accounting Bulletin No. 74 (SAB 74; Topic 11.M) that companies should provide transition disclosures of the impact that a recently-issued accounting standard will have on its financial statements when that standard is adopted in a future period.
However, when a company does not know, or cannot reasonably estimate the expected financial statement impact, that fact should be disclosed. But, in these situations, the SEC staff expects a qualitative description of the effect of the new accounting policies, and a comparison to the company’s current accounting to aid investors’ understanding of the anticipated impact. It should also disclose the status of its implementation process and significant implementation matters yet to be addressed.
Further, these disclosures should be subject to effective internal control over financial reporting. As management completes portions of its implementation plan for a new GAAP standard and develops an assessment of the anticipated impact of the standard, effective internal controls should be in place to timely identify disclosure content and to provide for appropriately informative disclosure to investors based on the information known at that time. In designing such controls and considering their necessary level of precision, management should consider, among others, the nature of the transition disclosures in light of the status of the company’s implementation efforts and the objective of these disclosures.
From a preliminary look at recent Forms 10-K and 10-Q filings, we continue to be encouraged by the number of companies that have enhanced their transition disclosures. However, I observe that some companies indicate that the impact of the new revenue standard is not expected to be material. The changes in the new revenue standard will impact nearly all companies. Even if the extent of change on the balance sheet or income statement is not deemed to be material, the related disclosures may be material.
The scope of the new standard addresses not only amounts and timing of revenue but also new, comprehensive disclosures about contracts with customers, including the significant reasonable judgments the registrant has made when applying the guidance. Accordingly, the basis of any statement that the impact of the new standard is immaterial should reflect consideration of the full scope of the new standard, which covers recognition, measurement, presentation, and disclosure.
Some have suggested that when SAB 74 refers to the “financial statements” it is concerned only with effects on the primary financial statements and not how disclosures in the notes to the financial statements may also be affected. I believe that such a view misses the definition of “financial statements,” which includes the accompanying notes.
Updating and maintaining internal controls will be particularly important as companies work through the implementation of significant new GAAP standards. Companies' implementation activities will require careful planning and execution, including careful evaluation of the specific facts and circumstances, to determine the appropriate application of new GAAP standards. Management's ability to fulfill its financial reporting responsibilities significantly depends on a comprehensive and timely assessment of risks. Such risks may exist at various levels and in different areas of a company and those risks may include whether the employees involved in the transition to new GAAP standards have the appropriate competencies to make the reasonable judgments required to faithfully apply the principles in the standards. Management may find published third-party transition resources helpful in making these judgments. However, it’s important for management to remember their responsibility to keep books, records, and accounts that accurately reflect their transactions and to maintain internal accounting controls designed to provide reasonable assurance that their transactions are recorded in conformity with GAAP.
The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control – Integrated Framework (2013), which most companies base their evaluation of the effectiveness of ICFR on, includes guidance for management on what constitutes effective risk assessment. This guidance illustrates the importance of the integration of control activities with the risk assessment. I believe that this linkage is important for all companies — regardless of the framework used or the company's size – in achieving the objective of reliable financial reporting.
The transition to a new GAAP standard necessitates the need for management to carefully consider whether the transition (or consistent application of the standard once implemented) results in new risks or changes to previously identified risks, including fraud risks.
It is important to remember that different factors and influences can impact the risk of fraud. At its core, fraud is the result of decisions or actions by individuals. As such, management should carefully consider how the transition to new GAAP standards will affect opportunities, incentives, pressures, attitudes, and rationalizations in a manner that could drive changes to previously identified fraud risks. These considerations also play an important role in the design and effectiveness of internal controls that mitigate those risks.
For example, during transition to the new revenue standard, companies should consider whether the potential for management bias in reasonable judgments required to apply the new guidance may lead to the identification of new fraud risks. Potential examples related to areas of judgment susceptible to management bias include the identification of performance obligations, the estimation of standalone selling price for distinct goods and services, as well as the estimation of variable consideration when determining the transaction price. It is important for management to consider whether new or changes in internal controls are warranted to reduce the risk associated with management bias. For example, management may want to establish a framework that defines how management will execute the judgments required in the new GAAP standards. This may allow for a more consistent application of the principles in the new GAAP standards that helps reduce the risk of management bias.
In addition to the COSO framework, there are other sources of guidance available to management to assist with fraud risk assessment. These sources suggest that a company should have an appropriate oversight function, including an audit committee, in place to reduce risks associated with fraud. Companies should consider engaging the audit committee early and often in its risk assessment process. The audit committee’s oversight of management’s risk assessment, as well as its oversight of the internal controls that mitigate the identified risks, not only helps management fulfill its financial reporting responsibilities, but also serves as a potential deterrent to fraudulent activity.
Getting the accounting and disclosures right – to include providing timely disclosure about the anticipated effect of transition – is just one important aspect of successful implementation of new GAAP standards. Equally important to successful implementation are enhanced processes and effective internal controls to mitigate the risk of material misstatement, including misstatements due to fraud.
Thank you for your kind attention. I’d be happy to answer a few questions.
 This includes the Accounting Principles Board (APB), AICPA Accounting Standards Executive Committee and the Financial Accounting Standards Board.
 See APB 4 paragraph 150.
 See Concepts Statement 5, paragraphs 83 (a) and (b).
 In 1986, the Commission set forth specific criteria in Accounting and Auditing Enforcement Release (AAER) 108 that a bill-and-hold arrangement must meet in order to satisfy the revenue recognition requirements of APB 4, and the conceptual criteria in Exchange Act Release No. 17878. And, more recently, in 1999, the SEC staff specified criteria that should be met before registrants could record revenue by drawing upon existing rules, including Concepts Statement 5 through the issuance of SAB 101. The SAB did not create or change any existing revenue recognition rules. Rather, the SAB explained how the staff interprets the application of those rules, by analogy, to other transactions that existing rules did not specifically address.
 See Wesley R. Bricker, Deputy Chief Accountant, Remarks at the Bloomberg BNA Conference on Revenue Recognition (Sept.17, 2015), available at, https://www.sec.gov/news/speech/wesley-bricker-remarks-bloomberg-bna-conf-revenue-recognition.html
 See Sylvia E. Alicea, Professional Accounting Fellow – Office of the Chief Accountant, Remarks before the 2016 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 5, 2016), available at,
 See Wesley R. Bricker, Deputy Chief Accountant, Remarks before the 35th Annual SEC and Financial Reporting Institute Conference (June 9, 2016), available at, https://www.sec.gov/news/speech/bricker-remarks-35th-financial-reporting-institute-conference.html
 See Wesley R. Bricker, Deputy Chief Accountant, Remarks before the 2016 Baruch College Financial Reporting Conference (May 5, 2016), available at, https://www.sec.gov/news/speech/speech-bricker-05-05-16.html
 See Wesley R. Bricker, Chief Accountant, Remarks before the Annual Life Sciences Accounting & Reporting Congress: “Advancing Effective Internal Control and Credible Financial Reporting” (Mar. 21, 2017), available at, https://www.sec.gov/news/speech/bricker-remarks-annual-life-sciences-accounting-and-reporting-congress-032117
 See ASC 606-10-25-2.
 See FASB/IASB Joint Transition Resource Group for Revenue Recognition, October 2014 Meeting – Summary of Issues Discussed and Next Steps, available at, http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176164720312
See also FASB/IASB Joint Transition Resource Group for Revenue Recognition, November 2015 Meeting – Summary of Issues Discussed and Next Steps, available at, http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176168069952
 See ASC 606-10-25-19.
 See ASC 606-10-55-21.
 See Example 19, Uninstalled Materials, in ASC 606-10-55-187 through 606-10-55-192.
 See BC172 of ASU No. 2014-09, Revenue from Contracts with Customers, available at, http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176164076149&acceptedDisclaimer=true
 See Minutes of the Emerging Issues Task Force (EITF) Meeting on September 22, 2016, SEC Staff Announcement, available at, http://www.fasb.org/cs/ContentServer?pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176168580761
 Staff Accounting Bulletin (SAB) Topic 11.M, Disclosure of the impact that recently issued accounting standards will have on the financial statements of a registrant when such standards are adopted in a future period, available at, https://www.sec.gov/interps/account/sabcodet11.htm#M
 See Minutes of the Emerging Issues Task Force (EITF) Meeting on September 22, 2016, SEC Staff Announcement, available at, http://www.fasb.org/cs/ContentServer?pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176168580761
See also Sylvia E. Alicea, Professional Accounting Fellow – Office of the Chief Accountant, Remarks before the 2016 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 5, 2016), available at, https://www.sec.gov/news/speech/alicea-2016-aicpa.html
 See Rule 1-01(b) of Regulation S-X.
 See the Fraud Risk Management Guide (2016), available at, https://www.coso.org/documents/COSO-Fraud-Risk-Management-Guide-Executive-Summary.pdf
See also, Management Override of Internal control: The Achilles’ Heel of Fraud Prevention, at http://www.aicpa.org/ForThePublic/AuditCommitteeEffectiveness/DownloadableDocuments/achilles_heel.pdf