Revenue Accounting Standard Progressing Toward
Implementation
Amendments and guidance address issues
Well over two years have passed since the
monumental revenue accounting standard was
jointly issued by the International Accounting
Standards Board (IASB) and Financial Accounting
Standards Board (FASB) in April 2014. Since
then, six amendments have been made to the FASB
pronouncement and two to the IASB pronouncement,
including deferral by both Boards of the
effective date for an additional year to 2018,
which provides the better part of four years
between issuance and implementation.
The core principle of the global standard is
for companies to recognize revenues in a way
that shows the transfer of goods and services to
customers that reflects the payment to which the
company expects to be entitled. To achieve that
core principle, an entity shall apply all of the
following five steps:
- Identify the contract with a
customer;
- Identify the separate performance
obligations in the contract;
- Determine the transaction price;
- Allocate the transaction price to
the separate performance obligations in the
contract; and
- Recognize revenue when (or as) the
entity satisfies a performance obligation.
The standard applies broadly across all
industries, with exceptions only for some
leases, insurance contracts, financial
instruments and guarantees (other than product
or service warranties), which are specifically
covered by other standards.
The amendments by both boards cover mainly
clarifications concerning the identification of
performance obligations, licensing, principal
versus agency considerations, and various narrow
scope improvements and practical expedients.
One major challenge, primarily for American
companies, is that the standard is “principles”
based, as opposed to the past “rules” based
standards that have been the norm for those
applying FASB standards. Consequently, judgment
plays a greater role under the newly converged
standard. As a means to bridge the gap, the
AICPA established a process to provide specific
guidance directed toward individual industries.
Task forces for sixteen different industries
have been at work identifying implementation
issues for consideration in a new Accounting
Guide on Revenue Recognition that is under
development.
As of August, 2016, 154 potential issues have
been identified. Industries with ten or more
issues include aerospace & defense, airlines,
engineering & construction contractors, gaming,
power and utility entities, software entities,
telecommunication entities, and timeshare
entities. The issues are submitted for due
diligence reviews by the AICPA’s Revenue
Recognition Working Group (RRWG) and Financial
Reporting Executive Committee (FinREC), before
being exposed for public comment. Where needed,
the FASB’s Transition Resource Group (TRG) is
consulted. Twenty-nine issues have reached the
exposure draft stage, and nine have been
finalized.
Additionally, the FASB on August 31, 2016
tentatively approved a number of items to
include in technical corrections updates
expected in the fourth quarter. One of those
updates will:
- Supersede the guidance on
preproduction costs of long-term supply
arrangements, except for capitalization of
certain molds, tools, and dies;
- Amend the impairment testing
guidance for contract costs;
- Amend the guidance for testing the
provision for losses on construction- and
production-type contracts;
- Exclude all contracts (not only
insurance contracts) that are within the
scope of the accounting standards on
insurance; and
- Align the cost-capitalization
guidance in the standard for financial
services-investment companies, resulting in
capitalization of direct incremental costs,
for advisors to both private and public
funds.
A separate update will exclude financial loan
guarantees, reinstate the guidance on the
accrual of advertising expenses, and make minor
changes regarding contract receivables and
liabilities.
Finally, the Not-For-Profit industry task
force referred the issue of grants and contracts
to the FASB for consideration. The FASB is
exploring ways to improve guidance for
distinguishing between conditions and
restrictions for contributions, using a “right
of return” approach.
The revenue accounting standard is just one
of two monumental accounting changes occurring
in 2018/2019. Next month, the Audit & Accounting
Alert will recap the new standard on leases that
is effective in 2019. The IFRS has stated that
early adoption of the lease standard is
permissible if the revenue accounting standard
has also been adopted. With these complicated
accounting and timing issues, companies may need
to consider a strategy, in order to optimize how
and when to implement the standards. One of our
Integra International firms has developed a
structured approach to proactively address the
multi-faceted aspects of effective lease
accounting implementation. If you can not wait
until the next Audit & Accounting Alert, contact
me for the firm name.
For further information, see
The End of Accounting and the Path Forward for
Investors and Managers and
Managers and AICPA Revenue Recognition Task
Force - Status of Implementation
Perceptions of Audit Quality Attributes
Directors, CFOs and auditors weigh in
Last month, the Audit & Accounting Alert
reported on the Federation of European
Accountants’ (FEE) paper detailing the state of
audit quality initiatives (AQI) internationally.
This month, a different approach is explored by
the Association of Chartered Accountants (ACCA).
In July, in conjunction with Macquarie
University, Sydney, ACCA presented results of a
survey report: Directors’, CFOs’ and
auditors’ perceptions of audit quality
attributes: a comparative study.
The ACCA survey looked at the implications of
the following ten designated audit quality
attributes from the perspective of the three
stakeholder groups: directors, CFOs and
auditors:
- Audit firm size
- Partner/manager attention to audit
- Communication between audit team
and client management
- Audit partner tenure
- Audit quality assurance review
- Provision of non-audit services
(NAS)
- Audit firm industry experience
- Partner knowledgeable about client
industry
- Senior manager or manager
knowledge of client industry
- Very knowledgeable audit team
Some of the attributes, like industry
knowledge and assurance reviews, correlate
directly with the FEE AQIs, while others, like
firm size, have a more indirect relationship.
Survey results revealed some areas of
similarity between the three stakeholder groups,
while other areas displayed differences. They
all felt that firm size was the most important
attribute, while partner/manager attention to
audit was next in importance. While
communication between audit team and client
management was considered more important than
other attributes, audit partner tenure and audit
quality assurance reviews (both internal and
external) were considered to be relatively low
in importance.
Of the areas of difference, directors and
CFOs ranked provision of non-audit services as
higher in importance than did auditors. Also,
while all three groups ranked the last four
(“knowledge”) attributes as having relatively
moderate influence compared to other attributes,
directors ranked manager industry knowledge as
the more important of those, while CFOS ranked
partner industry knowledge as the more
important, and auditors ranked a very
knowledgeable audit team as the more important.
The authors of the ACCA study state that the
ranking of audit firm size as the most important
attribute is consistent with prior research. Of
course, the fact that most of the survey
participants are from large audit firms or large
companies, may also have something to do with
the result. More surprising is the low ranking
given to audit partner tenure and audit quality
assurance reviews, since regulators have given
these areas a lot of attention. Of course,
auditors cannot be expected to care for
intrusive inspections, while CFOs and directors
may not see much direct benefit to them, either.
All could be expected to desire audit partner
tenure, for the benefit of the extended
knowledge and experience that comes with it.
The differences in perceptions of audit
quality expressed by the three stakeholder
groups in the survey is reminiscent of the
differences in emphasis placed on audit quality
indicators by regulatory authorities, as
described last month in the FEE paper. There is
still a long way to go to develop consensus as
to the best way to identify and attain a
consistently high level of quality in audit
performance and results.
Next month, we will look at a newly issued
report of Highlights and Progress stemming from
the first year results of the AICPA’s Enhancing
Audit Quality Initiative. The report expresses
encouragement, from what current accomplishments
indicate for the prospects of future advances.
For further information, see
Directors’, CFOs’ and auditors’ perceptions of
audit quality attributes: a comparative study.
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New Look Coming for Non-Profit Financial
Statements
FASB issues major new standard for US
organizations
When first described as an exposure
draft in the June, 2015 Audit & Accounting
Alert, the now newly released (August 18, 2016)
standard, Not-for-Profit Entities: Presentation
of Financial Statements of Not-for-Profit
Entities (ASU No. 2016-14), represented the
first major proposed change for reporting in the
non-profit arena in over 20 years.
FASB Statement 117, Financial
Statements of Not-for-Profit Organizations
(6/93), along with FASB Statement 116,
Accounting for Contributions Received and
Contributions Made (6/93), had brought
standardization to reporting practices at that
time. However, just as times are rapidly
changing in the realm of for-profit reporting,
users of not-for-profit financials are calling
for updates here as well.
The length of time from exposure in April,
2015 to issuance almost a year-and-a-half later,
is indicative of the comprehensive nature of the
deliberations undertaken. Along with 260 comment
letters to consider, well over a hundred
meetings, workshops and roundtables were
conducted with various industry groups,
preparers, auditors and other stakeholders.
The first major change to enhance clarity and
usefulness for users, such as donors and
creditors, impacts the statement of financial
condition. The current separation of restricted
net assets into temporary and permanent, along
with calling the rest unrestricted, apparently
has caused confusion. Consequently, those three
designations are replaced by two: net assets
with donor restrictions and net assets without
donor restrictions. The disclosure requirements
for describing types, amounts and liquidity of
donor restrictions are retained, as well as for
board designations, which differ from donor
restrictions in that they are self-imposed.
Also, capital gifts will be released from
restriction once placed in service, rather than
over time, unless specified differently by the
donor.
Endowment fund treatment has also
caused confusion. When the current fair value of
the fund falls below the original donor given
amount, the shortfall will now be reflected in
the net assets with donor restrictions, rather
than in unrestricted net assets, as is the case
in the present standard. Also, disclosures are
to describe current policies and actions taken.
Liquidity is an important issue with the
proposal. Qualitative and quantitative
disclosures are designed to help the user
ascertain the availability and timing of cash
and other assets to fulfil obligations, as they
occur generally and specifically for the coming
year. Also, the influence of donor restrictions,
internal board directed limitations, and the
organization’s liquidity management policies are
a focus to be emphasized.
The proposed changes in the statement of
activities result from a lack of specificity in
the current standard. The new rules will require
showing the change in net assets for the two new
above-mentioned classes. Also, operating
expenses will need to be shown, here or
elsewhere, both by nature and function.
Investment return is to be reported net of
related expenses, in order to improve
comparability between non-profits, regardless of
whether investments are managed internally,
externally, or through use of mutual funds or
similar vehicles.
One change from the original exposure draft
is that either the direct or indirect method
will be allowed for the statement of cash flows,
similar to the current standard. The proposal
initially was going to require only the direct
method, which typically takes more work compared
to the indirect method. The direct method
presents the specific cash flows, such as the
amount of cash collected from customers and paid
to suppliers, payroll paid to employees,
interest received and paid, and income taxes
paid. The indirect method generally shows just
the net changes in balance sheet accounts. If
the direct method is used, the new standard,
unlike the old one, no longer requires an
additional reconciliation using the indirect
method.
The other significant change from the
exposure draft involves the operating measure.
The FASB decided to conduct further research
before requiring the use of an operating measure
to report operating versus non-operating
activities.
The new standard is effective generally in
2018, with early application permitted. .
For further information, see
ASU No. 2016-14, Not-for-Profit Entities:
Presentation of Financial Statements of
Not-for-Profit Entities.
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