What’s the biggest takeaway from the experiences of public companies that have adopted the new revenue recognition and lease accounting standards? For both accounting rules, the process has been more time-consuming and complicated than many of them ever anticipated.
Finance teams that haven’t tackled this accounting rule should give themselves enough runway to go through the adoption process:
Understand that it won’t be easy (because it’s not!): It’s not just about journal entries—there are significant efforts to inventory all your leases, analyze how the new guidance will be applied, elect practical expedients, and establish policies to determine management judgment and assumptions, and develop new disclosures.
You also shouldn’t underestimate the scope involved. Most companies either think they don’t have embedded leases in service contracts or they expect that looking for embedded leases will be fairly straightforward and assume it’s going to be a quick and easy process. We’ve found it takes longer than expected to scope these out because it requires a good understanding of the services that are being provided and the assets that are utilized. The operations side needs to be involved. Think about what your procedures will be for identifying embedded leases, not just during adoption, but also on an ongoing basis. Every time you have a new lease, how are you going to identify that there’s a contract that might include a lease?
Getting the information you need: Give enough time to track down the information you need to do the calculations for each lease. This includes tracking down the actual lease agreements themselves. Also educate the organization—anyone responsible for managing a contract could provide you with valuable information on identifying if there’s a specific identified asset or if the company has a right of control over the asset. Also dig through your AP activity—vendor contracts and purchase orders—and identify any services that might involve an asset. There needs to be an ongoing process for identifying potential new contracts and purchase orders that might involve an asset and might need to be assessed under this new way of accounting for leases.
Focusing on the right matters: Understand what is material to your balance sheet and focus your attention on potential lease arrangements that are material to your company. We recommend setting a capitalization threshold and coming up with a policy for which leases will be capitalized. This is a guideline to go by and is not technically GAAP—be careful that you don’t go so far that in the aggregate you create a material misstatement. It’s a much more practical approach than just automatically doing the accounting for every transaction.
Some Challenges of Adopting ASC 606, Revenue from Contracts with Customers
Adjusting to making variable consideration estimates: This part of the standard significantly changes practice for many companies because you didn’t used to make these estimates. You used to wait until your fees were fixed and determinable—it made your life a lot easier. So, now you’re not going to wait to recognize revenue, and you need to estimate these amounts. Think through the methodology for making these estimates and how you can ensure that it will be practical going forward.
Identifying performance obligations: Performance obligation identification can be especially challenging to determine whether the promises are distinct within the context of a contract. If it’s capable of being distinct, it seems to be a lot more straightforward, but figuring out things like the interdependence of promises on other goods and services has been challenging.
Dealing with disclosures: Some public companies experienced quantitative impact upon adoption of ASC 606, but all companies have had to implement new disclosures, and that has been fairly significant for people to build processes around. And it’s a key area that the Securities and Exchange Commission has focused on in comment letters. For example, they have asked for additional disclosures related to significant judgments made in identifying performance obligations.
Be Prepared for These Technical Accounting Changes
Private companies still struggling with ASC 606 adoption don’t have the resources or bandwidth to work on multiple standards adoptions in parallel or even back-to-back. The Financial Accounting Standards Board’s tentative decision to propose delaying the effective date for leases for private companies would be a welcome relief for those companies.
While the lease accounting standard is dominating the queries our Technical Accounting Group is getting these days, we can tell you that our best advice is to be prepared. Know what the challenges are, and lean on the lessons learned and best practices of the companies that have surmounted these complex rules before you.
Diana Gilbert, a senior consultant in RoseRyan’s Technical Accounting Group, has deep corporate and operational finance experience focusing on technical accounting, revenue recognition, process improvement and financial systems, SEC reporting and SOX compliance. Prior to RoseRyan, she held controller roles at a number of Silicon Valley technology companies and was a senior manager at KPMG.
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