Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) for public business entities, certain not-for-profit entities, and certain employee benefit plans. The amendments become effective for public entities for annual reporting periods beginning after December 15, 2017. In other words, we are now less than six months away from a new Revenue Recognition (“new rev rec”) standard, which may significantly impact the compliance profession, compliance programs, and compliance practitioners. Joe Howell, Executive Vice President (EVP) at Workiva Inc., spoke with me about key changes and how they might impact compliance. FASB recognized that its revenue recognition requirements around the U.S. generally accepted accounting principles (GAAP) differed from those in the International Financial Reporting Standards (IFRS) and that both sets of requirements needed improvement. This led to a project by FASB and the International Accounting Standards Board to jointly clarify the principles for recognizing revenue and to develop a common converged revenue standard for GAAP and IFRS. Hence the new rev rec standard. The implementation will be a massive undertaking. According to Howell, “The accounting standard is 700 pages long, and in the US accounting literature, it replaces over 200 other pieces of accounting guidance on revenue.” The official name is “Revenue from Contracts with Customers,” and Howell noted there are a “lot of surprises, and the things that are true for almost everybody is that they are going to be facing some level of change in the way they account and report revenue. They will most certainly have to change how they disclose their revenue-related things. Included in the revenue standards are over six pages worth of new disclosure requirements.” One of the key differences in this new rev rec standard is that it requires companies to disclose new information beyond data a company might have been required to release in the past. Howell thinks this will pressure auditors “to get comfortable with what the company provided them and which they incorporated into their decision-making process in forming an opinion. This is quite different for disclosure controls because the auditor’s typically not relying on those.” This will create risks for auditors adjusting to the new rev rec standard because as they learn more about it and apply it going forward into 2018, they may have to revisit it before reporting and revising some of it. This is important to the compliance profession and the compliance practitioner because internal controls over financial reporting involved in implementing this new standard are critical to the effective use of implementation and how you implement it. The Securities and Exchange Commission (SEC) has said explicitly in several public statements and through their early comment letters on disclosures made in advance of implementation that companies must inform the SEC about the accounting policies that they are changing and how this new standard will affect a company’s accounting processes, and finally how those effects are going to be managed. Howell believes “The SEC is making it clear that this is a real compliance issue.” Moreover, the SEC has indicated that these disclosures are central to the new rev rec standard. Howell said, “typically, if a company has some sort of failure in their disclosures for an accounting standard, they’re treated under section Sarbanes-Oxley (SOX) Section 302 of the SEC rules, and that has a level of significance or liability, which is much lower than the liability that a company might face under SOX Section 404, which has to do with the actual internal controls over financial reporting.” While disclosure of internal controls might not typically bring Section 404 scrutiny, they may now do so under the new rev rec standard. Howell articulated that when performing a financial audit, an auditor would usually not rely on a disclosure control in the past. However, under the new rev rec standard, if there is a change during the year in how an auditor views a disclosure control, it could require them “to go back and either figure out if the audit work that they did is tainted and they need to go back and do that work in the form of substantive testing, or they need to go back to see if there were mitigating controls that were in place that still allowed them to rely on the internal control processes to get comfortable with what the company provided them and which they incorporated into their decision-making process in forming an opinion. This is quite different for disclosure control because the auditor’s typically not relying on those.” Of course, this is overlaid with the requirements of effective internal controls under the Foreign Corrupt Practices Act (FCPA) and the lack of materiality standards. One only need to consider the Wells Fargo fraudulent accounts scandal to see how a lack of materiality does not prevent the types of risk from moving forward to become huge public relations disasters, hundreds of millions of dollars in fines and costs estimated at over $1bn for failures of internal controls. Yet there are other tie-ins into compliance that the compliance practitioner needs to understand and prepare for going forward. The prior rev rec standard was rules-based. As a lawyer, that was an approach I was quite comfortable with both from a learning standpoint and communicating with business folks. But now, the standard is much more judgment-based, and when a standard is more judgment based, there can be more room for manipulation. Howell explained the response by compliance is “making sure that you have changes in the business processes necessary to gather the information that has not previously been required to continue to monitor; how that information is factoring into the judgments that managers must make as they report their revenue under the new standard; and that those judgments themselves are properly documented.” This final point demonstrates the convergence and overlap between the compliance profession, compliance programs, and compliance practitioners going forward. Compliance internal controls are in place to both detect and prevent. They can also be used to gather the information that will be presented to auditors under the new rev rec standard. Many professionals are focused on the new rev rec from the auditing and implementation perspective. However, suppose you are a Chief Compliance Officer (CCO). In that case, you might want to go down the hall and have a cup of coffee with your Chief Financial Officer (CFO) and find out what internal controls might be changing or that they might be adding and consider how that will impact compliance in your organization.
Three Key Takeaways
- We are less than six months away from a new revenue recognition standard. Are you ready?
- This new revenue recognition standard is much more judgment-based; when a standard is more judgment-based, there can be more room for manipulation.
- Compliance internal controls can now gather the information presented to auditors under the new rev rec standard.
For more information on improving your internal controls management process, visit this month’s sponsor Workiva at workiva.com.
