Remarks at the Bloomberg BNA Conference on Revenue Recognition
Wesley R. Bricker, Deputy Chief Accountant
New York, NY
Sept. 17, 2015
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 of the author’s colleagues upon the staff of the Commission.
Thank you for the kind introduction and the invitation to speak at today’s conference. But, 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.
In my view, this conference appropriately highlights the profession’s continued call to apply more principle-based accounting models more generally, and specifically to contracts with customers. The transition from a reporting model that currently consists of industry specific and at times disparate models, to a single comprehensive model grounded in core concepts and clear principles and converged with International Financial Reporting Standards (“IFRS”) is a shift that has the potential to benefit investors with more decision useful information. I believe that the new model — when applied with appropriate professional judgment — will consistently report revenue, one of the single most important measures used by investors, regardless of a company’s industry or the capital markets accessed.
The mere hope to achieve the promise of a single standard will not be sufficient—instead, we must approach the new revenue standard with a clear understanding of its principles and apply those principles with reasonable professional judgments rooted in values of practicality and informational utility. We also must ensure controls are implemented that continue to uphold those reasonable professional judgments. I believe that proceeding in this manner will ensure that our navigation through the new standard will produce information that is relevant, faithfully represents the underlying economics of revenue arrangements with customers and, is comparable, not only among companies within and across industries but also across capital markets.
Today, I will talk more about the strategy to navigate our transition to the new revenue standard. This strategy not only considers the role of reasonable professional judgment but also the importance of simply getting the job done. We must move forward with our implementation efforts without delay by understanding the key principles of the standard and considering how the standard impacts revenue arrangements. Some may believe that nothing has changed for their company. That may be true, but I caution you to take this time to refresh your thinking about your arrangements with your customers. Take seriously how the change in existing revenue literature or additional guidance provided by the standard impacts your arrangements.
Before I continue, I’d like to update you about a key change in the Accounting Group of the Office of the Chief Accountant. I want to thank Jenifer Minke-Girard for taking on the new role of Assistant Deputy Chief Accountant. In her prior role as the Senior Associate Chief Accountant, she led our accounting consultations process with registrants, firms, trade groups, and other SEC Divisions and Offices, and prior to that, led our oversight of accounting standard setting. In her new role, she will assist me in executing the full scope of responsibilities of the Accounting Group including consultations, communications, and oversight. Both Jenifer and I will continue to be supported by a highly dedicated and capable team of accounting professionals within the Accounting Group.
Revenue Recognition and the Need for Professional Judgment
The FASB’s Conceptual Framework for accounting is appropriately premised on providing users with relevant financial information that faithfully represents the economics of a transaction and necessitates reasonable professional judgment. The new revenue model which is more solidly built on this framework illustrates this point. Consider the existing guidance for recognizing revenue related to real estate sales and software licenses which are rules based, principled in many respects on abuse prevention, and favor a delay in revenue recognition when the amount or timing of the related sales price is uncertain. This makes the accounting relatively straightforward and I dare say, in some situations, simple since far fewer judgments need to be made. Consider the following examples. A buyer purchases a multi-tenant property of which some of the leases will expire in the next 12 months and the seller guarantees that the cash flows of the property will cover the operating needs of the property for the next several years. Under our current framework, the transaction likely would not be accounted for as a sale at the inception of the arrangement. In contrast, the new guidance would likely not preclude sale accounting and derecognition of the asset because of the seller’s obligation to provide support to the extent that control of the property has passed to the buyer. If so, the seller will be required to separately measure, allocate, and recognize the portion of the transaction price related to the property and the guarantee.
Similarly, consider a multiple element software arrangement where vendor specific objective evidence of fair value for each undelivered element of the arrangement is currently required before any revenue can be recognized. This requirement necessitates a judgment of whether vendor specific evidence of fair value has been established but obviates the need to apply the judgments necessary to estimate the value of each element of the arrangement or consider over what period the revenue allocated to each of the elements should be recognized. In contrast, the new standard will require that each element in a multiple element arrangement be separated, reasonably measured, and recognized in a manner that reflects the transfer of control of the good or service to the customer.
Lastly, consider the lesser degree of judgment required when applying the existing guidance related to the allocation and recognition of variable consideration. In general, variable consideration is delayed until all uncertainty about the amount has been eliminated. This will change under the new standard which will require more judgment to “estimate the amount of consideration to which the entity will be entitled”  and for which “it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur when the uncertainty is resolved.” This will have a significant impact on arrangements that include discounts, rebates, incentives, penalties, performance bonuses, and any other variable payment terms in contracts with customers since those will need to be estimated at inception and recognized as control is transferred subject to the constraint.
As a profession are we up to the task of making well-reasoned, practical judgments necessary to provide users with the most relevant information about revenue arrangements? We must be up to the task since investors and other financial statement users need it. To do this, the financial reporting community which includes preparers, auditors, and other regulators must lead the implementation effort by making sure those judgments are grounded in the principles of the standard, and each step outlined in the standard is applied in a practical way that considers the utility of the resulting information to users. Aggressive interpretations taken to preserve an existing reporting outcome that is not consistent with the principles of the new revenue standard will not be well received.
Some may be asking themselves, how can I be sure my judgments are reasonable and withstand the scrutiny of others? This is an important question, and preparers and auditors may wish to consider various resources that discuss how to form and document professional judgments. One resource is the Center for Audit Quality’s Professional Judgment Resource. This resource details five key elements of an effective judgment process which include:
- Identify and define the issue
- Gather the facts and information and identify the relevant literature
- Perform the analysis and identify alternatives
- Make the decision
- Review and complete documentation and rationale for the conclusion
The new revenue recognition standard requires a number of significant judgments when applying the guidance. Among those are estimating the transaction price, allocating it to performance obligations, and determining when the obligation is satisfied. I urge you to consider each of these areas and any other judgments you may need to make as you implement the standard and the importance of documenting your key judgments and basis for them.
As a related matter, be mindful of the existing disclosure requirements in financial statements and in MD&A regarding accounting policies. Investors need transparent disclosure of critical accounting policies, judgments, and uncertainties affecting the application of those policies, and the likelihood that materially different amounts would be reported under different conditions or using different assumptions.
Learning the Principles of the Standard in a Collaborative Manner
As I’ve said, implementation of the new revenue standard — or any principles-based standard for that matter — requires not only professional judgment rooted in values of good reasoning, practicality, and informational utility but also the engagement of and collaboration among all stakeholders as we better understand the nuances, challenges, and at times, ambiguity of applying the principles of the standard to a variety of fact sets. The FASB and IASB staff and members of the FASB/IASB Joint Transition Resource Group (“TRG”) have been instrumental in providing a collaborative forum to solicit, analyze, and discuss implementation issues and to inform the Boards about those issues. This process has yielded useful enhancements to the standard which will improve the consistency of application, which is a hallmark of our financial reporting system. Moreover, it has been a critical forum for stakeholders to share views about and understand how to make appropriate judgments. I understand the pipeline of TRG issues has diminished considerably and while there are some issues to discuss during the upcoming meeting on November 9th currently none are expected to require further enhancements to the standard. Fewer issues seem like a good thing and could support an observation that implementation efforts are well underway. However, while the standard was appropriately delayed, preparers should not delay a thorough review of their revenue arrangements. Future TRG deliberations and the educational opportunities are limited unless preparers and their related industry groups identify and refer any remaining issues to the TRG.
The AICPA, FEI, and other groups are working to help educate constituents on the application of the principles in the new standard. I understand that the AICPA expects to publish a new audit and accounting guide on revenue recognition in 2016 that will include illustrative examples on the application of the new standard and we support this important project. To accomplish this task, the AICPA created sixteen industry task forces to evaluate how the principles of the standard should be applied to common arrangements within a particular industry. We appreciate the efforts of the AICPA and the volunteers who work on these task forces. Based on our discussions with some of the individuals involved in these groups, we have concerns that the issues that have been identified have not been elevated to the TRG as few issues have been referred to the TRG. The ultimate success of their efforts will be marked not only by their ability to produce robust educational guidance in a timely manner but also by their ability to identify the right interpretive questions. I encourage each of the groups and individual members to be mindful of my earlier remarks about appropriate reasonable professional judgment. I also caution the task forces to avoid the pressure to resolve issues with judgments that are not consistent with the principles of the new revenue standard regardless of whether those judgments represent a consensus view of a task force. Such resolutions, including those that seek to avoid raising issues to the TRG in order to preserve existing reporting or to avoid a possible outcome that may not be preferred are not appropriate.
I also urge all 192 plus members of the AICPA revenue recognition industry task forces to consider how best to prioritize any issues that may require standard setting efforts — especially ones related to the application of the scope of the standard. They should also consider the practices — perhaps best practices — being employed by some of the AICPA’s industry expert panels. In this regard, I understand that the Depository Institutions Expert Panel is assessing each major class of transactions to consider whether and, if so, what impact the new revenue standard will have on the accounting for those transactions. To the extent that all or some have not done so or have done so intermittently, I encourage the AICPA revenue recognition industry task forces to also work with their related expert panels. Collaboration and cooperation are important to this endeavor. The implementation processes operate best when all of the members bring their expertise and objective judgment to bear on issues under consideration, focus on faithful and practical applications of the standard, and produce information that serves the needs of investors. Ultimately, credible consensuses should be thoroughly vetted in order to arrive at a reasonable application of the new revenue standard.
To the extent that a registrant has a material interpretative question that may not be appropriate for the TRG either because it is not likely to be wide ranging or is specific to a particular set of facts, OCA is available for consultation. Registrants should follow our established consultation process posted on our website.
On a related note, my thoughts regarding the importance of staying abreast of implementation issues and related resolutions that are arising throughout the implementation process is equally relevant to companies applying U.S. GAAP and those applying IFRS.
As the TRG’s slate of issues gets resolved and the standard’s effective date approaches, it is critically important to identify and resolve timely any remaining scope related questions. As I mentioned in my introductory remarks, it is not prudent to assume that the standard does not affect you. The revenue standard applies with few exceptions to transactions with customers and rescinds and changes many of today’s practices. In this vein, it is incumbent on preparers to take a fresh look at their contracts and consider whether, why, and how the new guidance impacts them.
- For example, consider the variety of arrangements entered into by participants in the oil and gas industry — joint ownership, operating, sales, and gas balance agreements. These arrangements are currently accounted for in accordance with industry-specific guidance, including a non-authoritative 1986 paper from the Council of Petroleum Accountants Societies and an SEC Observer comment. Since we now have a comprehensive standard for revenue recognition in Topic 606 that will apply to all industries when effective, OCA intends to remove the SEC Observer comment coincident with the new standard’s effective date. After we remove the SEC Observer comment, I would expect industry participants to apply relevant authoritative accounting literature to the recognition, measurement, presentation, and disclosure of the various arrangements.
- Another example I’d like to highlight relates to a rise in gross versus net revenue presentation inquiries we have received arising from a shift towards partnerships between technology companies and data-rich companies in other industries, such as the financial services industry. This highlights the need for all participants to take a fresh look at the impact of emerging and evolving business models under the new standard.
As you can see it is important that the profession identify and resolve scope-related questions so that questions about the application of the new revenue standard or other Topics can be resolved. It is also important to resolve scope-related questions so that companies can provide appropriate disclosures regarding the impact that the new revenue standard will have on their financial statements when they become effective in a future period. We expect the level of these disclosures to increase between now and adoption and are looking forward to understanding more about the impacts during our review of the 2015 financial statements.
Internal Control over Financial Reporting
As I mentioned, transition to the new revenue standard requires a fresh look at accounting and also a fresh look at the related internal controls. Investors expect companies to have internal controls in place to reasonably assure the reliability of the financial information reported by management. Therefore, transition plans for the new revenue standard should include initiatives for identifying and implementing the necessary changes to internal control over financial reporting. In this regard, I believe it is likely that we will see more disclosures of material changes to ICFR pursuant to management’s quarterly disclosure obligations.
The new revenue standard may require changes to relevant business processes and the control activities within them. However, it might also require a refresh of the other components of internal control over financial reporting, especially professional competence. Expectations related to this and the other components of ICFR were made more explicit in the principles of the COSO 2013 Framework.
One aspect of the COSO 2013 Framework emphasizes the importance of being able to attract, develop and retain competent individuals in alignment with the financial reporting objectives. All companies must have appropriate resources to evaluate revenue arrangements and properly apply the principles of the new standard. While those resource needs might be satisfied, for example, through a designated accounting policy function or through a relationship with a qualified service provider, having resources with sufficient training and competence is fundamental to the effectiveness of a company’s overall control environment. With a general movement towards principles-based accounting frameworks, companies need to assess and continually reassess the impact to their existing accounting and financial reporting competencies and make adjustments as appropriate to their training, retention, and recruitment programs.
As I mentioned, the new revenue standard will require significantly more judgments. This highlights the importance of another element of a company’s control environment — setting the right “tone at the top” and expectations for responsible conduct throughout the organization. Appropriate tone at the top is the foundation for the consistent application of the sound judgments required by the new standard. Management should consider whether the existing controls support the formation and enforcement of sound judgments or whether changes are necessary.
Companies may also consider changes to their established business practices as they transition to the new standard. For example, companies may amend or tailor their contracts with customers. Application of the new standard, including preparation of the required disclosures, may also require gathering and analyzing new information and sharing such information with relevant parties. Management should consider whether its reporting systems are designed to accurately capture the effects of changes to customer contracts and other information required for compliance with the new standard and ensure the integrity of such information throughout the financial reporting process. Therefore, it will be important to take a fresh look at the information and communication component of ICFR and the related controls over a company’s information technology.
And last but not least, it is important to keep in mind that the effectiveness of any changes to internal controls are predicated on a comprehensive and timely assessment of risks that may arise as a result of applying the standard. Such risks may exist at various levels and in different areas of a company and their appropriate identification and assessment may require involvement of management and employees from both the accounting and financial reporting function and other functional areas of a company.
These are just some areas of ICFR that may be impacted by the transition to the new revenue standard. However, they highlight the importance of taking a holistic view of the potential effects that the new standard may have on internal controls.
For those who are well underway in the execution of their implementation strategy, I applaud your efforts. While the one-year deferral may have given some breathing room, I urge those that have just begun or are behind in their efforts to consider the best practices of those who are well underway. Continue to approach the transition with a thoughtful strategy and an eye toward the end goal. The standard is generally effective in 2018 — a date that will arrive more quickly than you may believe. The new standard is comprehensive and, as I’ve mentioned, a refresh of accounting, disclosure, and controls may be required and may result in a change to the related systems and processes.
While I’ve spoken a lot about the things the profession should be thinking about and doing, you may be asking yourselves what has the Accounting Group within the Office of the Chief Accountant done and plans to do during this transition period? We continue to follow our transition strategy which includes three prongs:
- One. We are actively monitoring the profession’s implementation efforts underway including the TRG, the AICPA’s Financial Reporting Executive Committee, and the Financial Executives International Revenue Recognition Working Group among others to identity the nature and volume of implementation questions and views that are emerging with respect to implementation. Additionally, we have been meeting with various members of the accounting profession including representatives from accounting firms, registrants, and industry groups to obtain an understanding of the various implementation questions arising and how to address implementation issues. By actively monitoring implementation efforts, we will be able to identify areas where divergence in application may be occurring.
- Two. We are curating the results of our active monitoring and creating “institutional memory” through documentation regarding our views on the judgments needed.
- Three. We are in the process of designing training to support the education of the Commission’s staff responsible for reviewing and enforcing registrants’ financial reporting for revenue arrangements. Our training will be comprehensive to include the principles of the standard, the basis for the standard setters’ conclusions in establishing those principles, and views taken by the TRG and related industry working groups during the implementation period.
The profession can meet the challenge before us if we navigate the course in a transparent, collaborative, and coordinated way. Much work has been done to implement the standard and our journey continues. We all will navigate the path forward and make adjustments to our course where necessary. I look forward to working with you as we move forward.
 See Financial Accounting Standards Board Accounting Standards Update No. 2014-09 Revenue from Contracts with Customers (Topic 606) (May 2014), available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176164076069&acceptedDisclaimer=true.
 Financial Accounting Standards Board.
 Statement of Financial Accounting Concepts No. 8, Chapter 3 Qualitative Characteristics of Useful Financial Information (September 2010), available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176157498129&acceptedDisclaimer=true.
 Accounting Standards Codification (“ASC”) Subtopic 360-20 Real Estate Sales and ASC Subtopic 985-605 Software — Revenue Recognition.
 ASC 985-605-25-9.
 ASC 606-10-32-2.
 ASC 606-10-32-11.
 See the Center for Audit Quality’s, “Professional Judgment Resource” available at http://www.thecaq.org/docs/reports-and-publications/professional-judgment-resource.pdf?sfvrsn=4.
 International Accounting Standards Board.
 The Financial Accounting Standards Board and the International Accounting Standards Board.
 American Institute of Certified Public Accountants.
 Financial Executives International.
 Office of the Chief Accountant.
 See https://www.sec.gov/info/accountants/ocasubguidance.htm.
 Generally Accepted Accounting Principles.
 ASC 932-10-S99-5.
 See SEC Staff Accounting Bulletin (SAB) No. 74 (Topic 11:M), Disclosure of the Impact that Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant When Adopted in a Future Period.
 The Committee of Sponsoring Organizations of the Treadway Commission issued the 2013 Internal Control — Integrated Framework on May 14, 2013. See the press release at http://coso.org/documents/COSO%20Framework%20Release%20PR%20May%2014%202013%20Final%20PDF.pdf.